Table ofContents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION********Washington,D.C.  20549**

 

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**FORM 20-F**

 
| **o** | **Registration Statement Pursuant to Section 12(b) or  12(g) of The Securities Exchange Act of 1934** |
|-------|----------------------------------------------------------------------------------------------------------------------|

 

**OR**

 
| **x** | **Annual Report Pursuant to Section 13 or 15(d) of  The Securities Exchange Act of 1934 for the fiscal year ended December 31,  2009** |
|-------|-------------------------------------------------------------------------------------------------------------------------------------------------------|

 

**OR**

 
| **o** | **Transition Report Pursuant to Section 13 or  15(d) of The Securities Exchange Act of 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**OR**

 
| **o** | **Shell Company Report Pursuant to Section 13  or 15(d) of The Securities Exchange Act of 1934** |
|-------|------------------------------------------------------------------------------------------------------------|

** **

**Commissionfile number 0-30752**

 

**ÆTERNAZENTARIS INC.**

(Exact Name of Registrant as Specified in its Charter)

 

**Not Applicable**(Translation ofRegistrant’s Name into English)

 

**Canada** (Jurisdiction of Incorporation)

 

**1405 du Parc-Technologique Blvd.Quebec City, Quebec Canada, G1P 4P5**

(Addressof Principal Executive Offices)

 

**Dennis Turpin**

**Telephone: 418-652-8525**

**E-mail: dturpin@aezsinc.com**

**1405 du Parc-TechnologiqueBlvd.Quebec City, Quebec Canada, G1P 4P5**

(Name,Telephone, E-mail and Address of Company Contact Person)

 

Securities registered or to be registered pursuant toSection 12(b) of the Act:

 

| ** **     | ** ** | **Title of Each Class** | ** ** | ** ** | ** ** |   | **Name of Each Exchange on Which  Registered** |   |
|----------------|------------|-------------------------|------------|------------|------------|--------|------------------------------------------------|--------|
| Common  Shares |       | NASDAQ  Global Market   |
|           |       | Toronto  Stock Exchange |

 

Securities registered or to be registered pursuant toSection 12(g) of the Act:  **NONE**

 

Securities for which there is a reporting obligationpursuant to Section 15(d) of the ACT: **NONE**

 

Indicate the number of outstanding shares of each ofthe issuer’s classes of capital or common stock as of the close of the periodcovered by the annual report:  63,089,954common shares as of December 31, 2009.

 

Indicate by check mark whether the registrant is awell-known seasoned issuer, as defined in Rule 405 of the SecuritiesAct.  Yes  o      No  x

 

If this report is an annual or transition report,indicate by check mark if the registrant is not required to file reportspursuant to Section 13 or 15(d) of the Securities Exchange Act of1934.  Yes  o      No  x

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes  x      No  o

 

Indicate by check mark whether the registranthas submitted electronically and posted on its corporate Web site, if any,every Interactive Data File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files).  Yes  o     No  x

 

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

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

 

Indicate by check mark which basis of accounting theregistrant has used to prepare the financial statements included in thisfiling:

 
| U.S.  GAAP       o |   | International  Financial Reporting Standards as issued by the International Accounting  Standards Board       o |   | Other       x |
|-------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------|

 

If “other” has been checked in response to theprevious question, indicate by check mark which financial statement item theregistrant has elected to follow.  Item17  o    Item 18 x

 

If this is an annual report, indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes  o      No  x

 

 

 

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Table of Contents

 

**Basis of Presentation**

 

General

 

Except where the contextotherwise requires, all references in this annual report on Form 20-F (“Form 20-F”)to the “Company”, “Æterna Zentaris Inc.”, “we”, “us”, “our” or similar words orphrases are to Æterna Zentaris Inc. and its subsidiaries, taken together. In this annual report, references to “$” and “US$” are to United States dollarsand references to “CAN$” are to Canadian dollars.  Unless otherwiseindicated, the statistical and financial data contained in this annual reportare presented as at December 31, 2009.

 

**Forward-Looking Statements**

 

This annual report contains forward-looking statements made pursuant to the safe harbor provisions of the U.S. Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties, which could cause the Company’s actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, among others, the availability of funds and resources to pursue R&D projects, the successful and timely completion of clinical studies, the ability of the Company to take advantage of business opportunities in the pharmaceutical industry, uncertainties related to the regulatory process and general changes in economic conditions. Investors should consult the Company’s quarterly and annual filings with the Canadian and U.S. securities commissions for additional information on risks and uncertainties relating to the forward-looking statements. Investors are cautioned not to rely on these forward-looking statements. The Company does not undertake to update these forward-looking statements and we disclaim any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-looking statements contained herein to reflect future results, events or developments except if we are requested to do so by a governmental authority or applicable law.

 

Table ofContents

 

**TABLE OF CONTENTS**

 

**GENERAL INFORMATION**

 
| ** **      | ** ** | ** **                                             | **Page**                                                 |
|-----------------|------------|--------------------------------------------------------|----------------------------------------------------------|
| ** **      |       | ** **                                             | ** **                                               |
| **PART I** |       | ** **                                             | **1**                                                    |
| ** **      |       | ** **                                             | ** **                                               |
|            | Item 1.    | Identity of Directors,  Senior Management and Advisers | 1                                                        |
|            |       | A.                                                     | Directors and senior management                          | 1 |
|            |       | B.                                                     | Advisors                                                 | 1 |
|            |       | C.                                                     | Auditors                                                 | 1 |
|            | Item 2.    | Offer Statistics and  Expected Timetable               | 1                                                        |
|            |       | A.                                                     | Offer  statistics                                        | 1 |
|            |       | B.                                                     | Method  and expected timetable                           | 1 |
|            | Item  3.   | Key  Information                                       | 1                                                        |
|            |       | A.                                                     | Selected  financial data                                 | 1 |
|            |       | B.                                                     | Capitalization and  indebtedness                         | 4 |
|            |       | C.                                                     | Reasons for the offer and  use of proceeds               | 4 |
|            |       | D.                                                     | Risk factors                                             | 4 |
|            | Item 4.    | Information on  the Company                            | 17                                                       |
|            |       | A.                                                     | History and  development of the Company                  | 17 |
|            |       | B.                                                     | Business overview                                        | 18 |
|            |       | C.                                                     | Organizational  structure                                | 50 |
|            |       | D.                                                     | Property, plants  and equipment                          | 50 |
|            | Item 4A.   | Unresolved  Staff Comments                             | 50                                                       |
|            | Item 5.    | Operating  and Financial Review and Prospects          | 51                                                       |
|            | Item 6.    | Directors,  Senior Management and Employees            | 78                                                       |
|            |       | A.                                                     | Directors and  senior management                         | 78 |
|            |       | B.                                                     | Compensation                                             | 81 |
|            |       | C.                                                     | Board practices                                          | 93 |
|            |       | D.                                                     | Employees                                                | 94 |
|            |       | E.                                                     | Share ownership                                          | 95 |
|            | Item 7.    | Major  Shareholders and Related Party Transactions     | 95                                                       |
|            |       | A.                                                     | Major shareholders                                       | 95 |
|            |       | B.                                                     | Related party  transactions                              | 96 |
|            |       | C.                                                     | Interests of  experts and counsel                        | 96 |
|            | Item 8.    | Financial  Information                                 | 96                                                       |
|            |       | A.                                                     | Consolidated  statements and other financial information | 96 |
|            |       | B.                                                     | Significant changes                                      | 96 |
|            | Item 9.    | The Offering and  Listing                              | 97                                                       |
|            |       | A.                                                     | Offer and listing  details                               | 97 |
|            |       | B.                                                     | Plan of distribution                                     | 97 |
|            |       | C.                                                     | Markets                                                  | 97 |
|            |       | D.                                                     | Selling shareholders                                     | 97 |
|            |       | E.                                                     | Dilution                                                 | 98 |
|            |       | F.                                                     | Expenses of the issuer                                   | 98 |
|            | Item 10.   | Additional  Information                                | 98                                                       |
|            |       | A.                                                     | Share capital                                            | 98 |
|            |       | B.                                                     | Memorandum  and articles of association                  | 98 |
|            |       | C.                                                     | Material contracts                                       | 107 |
|            |       | D.                                                     | Exchange controls                                        | 108 |
|            |       | E.                                                     | Taxation                                                 | 109 |
|            |       | F.                                                     | Dividends and  paying agents                             | 114 |
|            |       | G.                                                     | Statement by experts                                     | 114 |
|            |       | H.                                                     | Documents on display                                     | 114 |

 

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Table of Contents

 
|              |       | I.                                                                           | Subsidiary information                                | 114    |
|-------------------|------------|------------------------------------------------------------------------------|-------------------------------------------------------|--------|
|              | Item 11.   | Quantitative  and Qualitative Disclosures About Market Risk                  | 114                                                   |
|              | Item 12.   | Description  of Securities Other than Equity Securities                      | 116                                                   |
|              |       | A.                                                                           | Debt securities                                       | 116    |
|              |       | B.                                                                           | Warrants and rights                                   | 116    |
|              |       | C.                                                                           | Other securities                                      | 116    |
|              |       | D.                                                                           | American depositary  shares                           | 116    |
|              |       |                                                                         |                                                  |   |
| **PART II**  | ** ** |                                                                         | **116**                                               |
| ** **        | ** ** |                                                                         | ** **                                            |
|              | Item 13.   | Defaults,  Dividend Arrearages and Delinquencies                             | 116                                                   |
|              | Item 14.   | Material  Modification to the Rights of Security Holders and Use of Proceeds | 116                                                   |
|              | Item 15.   | Controls and  Procedures                                                     | 116                                                   |
|              | Item 16.   | [Reserved]                                                                   | 117                                                   |
|              | Item 16A.  | Audit  Committee Financial Expert                                            | 117                                                   |
|              | Item 16B.  | Code of Ethics                                                               | 117                                                   |
|              | Item 16C.  | Principal  Accountant Fees and Services                                      | 117                                                   |
|              |       | A.                                                                           | Audit  Fees                                           | 117    |
|              |       | B.                                                                           | Audit-related Fees                                    | 117    |
|              |       | C.                                                                           | Tax  Fees                                             | 118    |
|              |       | D.                                                                           | All Other Fees                                        | 118    |
|              |       | E.                                                                           | Audit  Committee Pre-Approval Policies and Procedures | 118    |
|              | Item 16D.  | Exemptions  from the Listing Standards for Audit Committees                  | 118                                                   |
|              | Item 16E.  | Purchases of  Equity Securities by the Issuer and Affiliated Purchasers      | 118                                                   |
|              | Item 16F.  | Changes in  Registrant’s Certifying Accountant                          | 118                                                   |
|              | Item 16G.  | Corporate  Governance                                                        | 118                                                   |
|              |       |                                                                         |                                                  |
| **PART III** |       | **119**                                                                      |
| ** **        | ** ** |                                                                         | ** **                                            |
|              | Item 17.   | Financial Statements                                                         | 119                                                   |
|              | Item 18.   | Financial  Statements                                                        | 119                                                   |
|              | Item 19.   | Exhibits                                                                     | 171                                                   |

 

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**Table of Contents**

** **

**PART I**

** **

## **Item 1.    Identityof Directors, Senior Management and Advisers**

## ** **

### ***A.            Directors and senior management***

### *** ***

Not applicable.

 

### ***B.            Advisors***

### *** ***

Not applicable.

 

### ***C.            Auditors***

### *** ***

Not applicable.

 

## **Item 2.    OfferStatistics and Expected Timetable**

## ** **

### ***A.            Offer statistics***

### *** ***

Not applicable.

 

### ***B.            Method and expected timetable***

### *** ***

Not applicable.

 

## **Item 3.    KeyInformation**

## ** **

### ***A.            Selected financial data***

### *** ***

The selected financialdata should be read in conjunction with our audited consolidated financialstatements and the related notes included elsewhere in this annual report, and “Item5. Operating and Financial Review and Prospects” of this annual report.

 

1

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Table ofContents

 

**ConsolidatedStatements of Operations Data**

*(inthousands of US dollars, except share and per share data)*

***Canadian GAAP***

 
| ** **                                                   | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                   | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                   | ** ** | **$**                             | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** |
| ** **                                                   | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenues**                                                 |       | 63,237                            |       | 38,478 |   | 42,068 |   | 38,799 |   | 44,813 |   |
| **Operating expenses**                                       |       |                              |       |   |   |   |   |   |   |   |   |
| Cost of sales, excluding depreciation and  amortization      |       | 16,501                            |       | 19,278 |   | 12,930 |   | 11,270 |   | 8,250 |   |
| Research and development costs                               |       | 44,217                            |       | 57,448 |   | 39,248 |   | 27,422 |   | 25,544 |   |
| Research and development tax credits and grants              |       | (403                              | )          | (343 | ) | (2,060 | ) | (1,564 | ) | (317 | ) |
| Selling, general and administrative expenses                 |       | 16,040                            |       | 17,325 |   | 20,403 |   | 16,478 |   | 14,403 |   |
| Depreciation and amortization                                |       |                              |       |   |   |   |   |   |   |   |   |
| Property, plant and equipment                                |       | 3,285                             |       | 1,515 |   | 1,562 |   | 2,816 |   | 1,665 |   |
| Intangible assets                                            |       | 7,555                             |       | 5,639 |   | 4,004 |   | 6,148 |   | 4,279 |   |
| Impairment of long-lived assets held for sale                |       | —                            |       | — |   | 735 |   | — |   | — |   |
|                                                         |       | 87,195                            |       | 100,862 |   | 76,822 |   | 62,570 |   | 53,824 |   |
|                                                         |       |                              |       |   |   |   |   |   |   |   |   |
| **Loss from operations**                                     |       | (23,958                           | )          | (62,384 | ) | (34,754 | ) | (23,771 | ) | (9,011 | ) |
| ** **                                                   |       |                              |       |   |   |   |   |   |   |   |   |
| **Other income (expenses)**                                  | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Interest income**                                          |       | 349                               |       | 868 |   | 1,904 |   | 1,441 |   | 1,235 |   |
| Interest expense                                             |       |                              |       |   |   |   |   |   |   |   |   |
| Long-term debt and convertible term loans                    |       | —                            |       | — |   | (85 | ) | (1,270 | ) | (6,979 | ) |
| Other                                                        |       | (5                                | )          | (118 | ) | — |   | (163 | ) | (31 | ) |
| Foreign exchange (loss) gain                                 |       | (1,110                            | )          | 3,071 |   | (1,035 | ) | 319 |   | (87 | ) |
| Loss on disposal of long-lived assets held for sale          |       | —                            |       | (35 | ) | — |   | — |   | — |   |
| Loss on disposal of equipment                                |       | —                            |       | (44 | ) | (28 | ) | — |   | — |   |
| Gain on disposal of long-term investment                     |       | —                            |       | — |   | — |   | 409 |   | — |   |
|                                                         |       | (766                              | )          | 3,742 |   | 756 |   | 736 |   | (5,862 | ) |
| ** **                                                   | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Share in the results of an affiliated company**            |       | —                            |       | — |   | — |   | 1,575 |   | — |   |
| ** **                                                   |       |                              |       |   |   |   |   |   |   |   |   |
| **Loss before income taxes from continuing operations**      |       | (24,724                           | )          | (58,642 | ) | (33,998 | ) | (21,460 | ) | (14,873 | ) |
| ** **                                                   |       |                              |       |   |   |   |   |   |   |   |   |
| **Income tax (expense) recovery**                            |       | —                            |       | (1,175 | ) | 1,961 |   | 29,037 |   | (609 | ) |
| ** **                                                   |       |                              |       |   |   |   |   |   |   |   |   |
| **Net (loss) earnings from continuing operations**           |       | (24,724                           | )          | (59,817 | ) | (32,037 | ) | 7,577 |   | (15,482 | ) |
| ** **                                                   | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net (loss) earnings from discontinued operations**         |       | —                            |       | — |   | (259 | ) | 25,813 |   | 26,053 |   |
| **Net (loss) earnings for the year**                         |       | (24,724                           | )          | (59,817 | ) | (32,296 | ) | 33,390 |   | 10,571 |   |
| ** **                                                   |       |                              |       |   |   |   |   |   |   |   |   |
| **Net (loss) earnings per share from continuing operations** |       |                              |       |   |   |   |   |   |   |   |   |
| Basic                                                        |       | (0.43                             | )          | (1.12 | ) | (0.61 | ) | 0.14 |   | (0.34 | ) |
| Diluted                                                      |       | (0.43                             | )          | (1.12 | ) | (0.61 | ) | 0.14 |   | (0.34 | ) |
| ** **                                                   |       |                              |       |   |   |   |   |   |   |   |   |
| **Net earnings per share from discontinued operations**      |       |                              |       |   |   |   |   |   |   |   |   |
| Basic                                                        |       | —                            |       | — |   | — |   | 0.50 |   | 0.57 |   |
| Diluted                                                      |       | —                            |       | — |   | — |   | 0.48 |   | 0.57 |   |
| ** **                                                   | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net (loss) earnings per share**                            | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                        |       | (0.43                             | )          | (1.12 | ) | (0.61 | ) | 0.64 |   | 0.23 |   |
| Diluted                                                      |       | (0.43                             | )          | (1.12 | ) | (0.61 | ) | 0.62 |   | 0.23 |   |
|                                                         |       |                              |       |   |   |   |   |   |   |   |   |
| **Weighted average number of shares**                        | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                        |       | 56,864,484                        |       | 53,187,470 |   | 53,182,803 |   | 52,099,290 |   | 46,139,814 |   |
| Diluted                                                      |       | 56,864,484                        |       | 53,187,470 |   | 53,182,803 |   | 52,549,260 |   | 46,139,814 |   |

 

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Table of Contents

 

*US GAAP*

** **
| ** **                                                     | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                     | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                     | ** ** | **$**                             | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** |
| ** **                                                     | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net (loss) earnings for the year**                           |       | (16,794                           | )          | (56,070 | ) | (37,428 | ) | 34,262 |   | 15,970 |   |
| **Of which:**                                                  |       |                              |       |   |   |   |   |   |   |   |   |
| **Net (loss) earnings from continuing operations**             |       | (16,794                           | )          | (56,070 | ) | (36,415 | ) | 8,449 |   | (10,083 | ) |
| **Net (loss) earnings from discontinued operations**           |       | —                            |       | — |   | (1,013 | ) | 25,813 |   | 26,053 |   |
| ** **                                                     | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net (loss) earnings per share from continuing operations**   |       |                              |       |   |   |   |   |   |   |   |   |
| Basic                                                          |       | (0.30                             | )          | (1.05 | ) | (0.68 | ) | 0.16 |   | (0.22 | ) |
| Diluted                                                        |       | (0.30                             | )          | (1.05 | ) | (0.68 | ) | 0.16 |   | (0.22 | ) |
|                                                           |       |                              |       |   |   |   |   |   |   |   |   |
| **Net (loss) earnings per share from discontinued operations** |       |                              |       |   |   |   |   |   |   |   |   |
| Basic                                                          |       | —                            |       | — |   | (0.02 | ) | 0.50 |   | 0.56 |   |
| Diluted                                                        |       | —                            |       | — |   | (0.02 | ) | 0.49 |   | 0.56 |   |
| ** **                                                     | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net (loss) earnings per share**                              | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                          |       | (0.30                             | )          | (1.05 | ) | (0.70 | ) | 0.66 |   | 0.34 |   |
| Diluted                                                        |       | (0.30                             | )          | (1.05 | ) | (0.70 | ) | 0.65 |   | 0.34 |   |
|                                                           |       |                              |       |   |   |   |   |   |   |   |   |
| **Weighted average number of shares**                          | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                          |       | 56,864,484                        |       | 53,187,470 |   | 53,182,803 |   | 52,099,290 |   | 46,139,814 |   |
| Diluted                                                        |       | 56,864,484                        |       | 53,187,470 |   | 53,182,803 |   | 52,549,260 |   | 46,139,814 |   |

 

**ConsolidatedBalance Sheet Data**

*(in thousands of US dollars)*

 

*Canadian GAAP*

 
| ** **                 | ** ** | **As at December 31,** | ** ** |
|----------------------------|------------|-----------------------------|------------|
| ** **                 | ** ** | **2009**                    | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                 | ** ** | **$**                       | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** |
| ** **                 | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash equivalents  |       | 38,100                      |       | 49,226 |   | 10,272 |   | 8,939 |   | 12,234 |   |
| Short-term investments     |       | —                      |       | 493 |   | 31,115 |   | 51,550 |   | 22,370 |   |
| Working capital            |       | 29,745                      |       | 39,554 |   | 37,325 |   | 85,413 |   | 99,502 |   |
| Restricted cash            |       | 878                         |       | — |   | — |   | — |   | — |   |
| Total assets               |       | 86,262                      |       | 108,342 |   | 123,363 |   | 223,491 |   | 419,785 |   |
| Long-term debt and payable |       | 143                         |       | 172 |   | — |   | 687 |   | 29,866 |   |
| Share capital              |       | 41,203                      |       | 30,566 |   | 30,566 |   | 168,466 |   | 130,344 |   |
| Shareholders’ equity  |       | 9,226                       |       | 21,475 |   | 88,591 |   | 178,879 |   | 109,531 |   |

 

*US GAAP*

 
| ** **                 | ** ** | **As at December 31,** | ** ** |
|----------------------------|------------|-----------------------------|------------|
| ** **                 | ** ** | **2009**                    | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                 | ** ** | **$**                       | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** |
| ** **                 | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash equivalents  |       | 38,100                      |       | 49,226 |   | 10,272 |   | 8,939 |   | 12,234 |   |
| Short-term investments     |       | —                      |       | 493 |   | 31,115 |   | 51,550 |   | 22,370 |   |
| Working capital            |       | 29,745                      |       | 39,554 |   | 37,325 |   | 85,413 |   | 99,502 |   |
| Restricted cash            |       | 878                         |       | — |   | — |   | — |   | — |   |
| Total assets               |       | 84,116                      |       | 100,001 |   | 109,182 |   | 209,143 |   | 404,587 |   |
| Long-term debt and payable |       | 143                         |       | 172 |   | — |   | 687 |   | 30,858 |   |
| Share capital              |       | 33,226                      |       | 22,589 |   | 22,589 |   | 160,489 |   | 129,750 |   |
| Shareholders’ equity  |       | 5,729                       |       | 13,134 |   | 74,410 |   | 169,704 |   | 99,797 |   |

 

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### ***B.            Capitalization and indebtedness***

### *** ***

Not applicable.

 

### ***C.            Reasons for the offer and use ofproceeds***

### *** ***

Not applicable.

 

### ***D.            Risk factors***

### *** ***

**Risks Related to Us and Our Business**

 

***Investments in biopharmaceutical companiesare generally considered to be speculative.***

 

Theprospects for companies operating in the biopharmaceutical industry maygenerally be considered to be uncertain, given the very nature of the industryand, accordingly, investments in biopharmaceutical companies should beconsidered to be speculative.

 

***We have a history of operating losses andwe may never achieve or maintain operating profitability.***

 

Ourproduct candidates remain at the development stage and we have incurredsubstantial expenses in our efforts to develop products. Consequently, we haveincurred recurrent operating losses and, as disclosed in our auditedconsolidated financial statements for the years ended December 31, 2009,2008 and 2007, we had an accumulated deficit of $127.5 million as of December 31,2009. Our operating losses have adversely impacted, and will continue toadversely impact, our working capital, total assets and shareholders’ equity.We do not expect to reach operating profitability in the immediate future, andour expenses are likely to increase as we continue to expand our research anddevelopment (“R&D”) and clinical study programs and our sales and marketingactivities and seek regulatory approval for our product candidates. Even if wesucceed in developing new commercial products, we expect to incur additionaloperating losses for at least the next several years. If we do not ultimatelygenerate sufficient revenue from commercialized products and achieve ormaintain operating profitability, an investment in our securities could resultin a significant or total loss.

 

***Our clinical trials may not yield resultswhich will enable us to obtain regulatory approval for our products, and asetback in any of our clinical trials would likely cause a drop in the price ofour securities.***

 

Wewill only receive regulatory approval for a product candidate if we candemonstrate in carefully designed and conducted clinical trials that theproduct candidate is both safe and effective. We do not know whether our pendingor any future clinical trials will demonstrate sufficient safety and efficacyto obtain the requisite regulatory approvals or will result in marketableproducts. Unfavorable data from those studies could result in the withdrawal ofmarketing approval for approved products or an extension of the review periodfor developmental products. Clinical trials are inherently lengthy, complex,expensive and uncertain processes and have a high risk of failure. It typicallytakes many years to complete testing, and failure can occur at any stage oftesting. Results attained in preclinical testing and early clinical studies, ortrials, may not be indicative of results that are obtained in later studies.

 

Noneof our product candidates has to date received regulatory approval for itsintended commercial sale. We cannot market a pharmaceutical product in anyjurisdiction until it has completed rigorous preclinical testing and clinicaltrials and passed such jurisdiction’s extensive regulatory approval process. Ingeneral, significant research and development and clinical studies are requiredto demonstrate the safety and efficacy of our product candidates before we cansubmit regulatory applications. Pre-clinical testing and clinical developmentare long, expensive and uncertain processes. Preparing, submitting andadvancing applications for regulatory approval is complex, expensive andtime-consuming and entails significant uncertainty. Data obtained frompre-clinical and clinical tests can be interpreted in different ways, whichcould delay, limit or prevent regulatory approval. It may take us many years tocomplete the testing of our product candidates and failure can occur at anystage of this process. In addition, we have limited experience in conductingand managing the clinical trials necessary to obtain regulatory approval in theUnited States, in Canada and abroad and, accordingly, may encounter unforeseenproblems and delays in the approval process. Though we may engage a clinicalresearch organization with experience in conducting regulatory trials, errorsin the conduct, monitoring and/or auditing could invalidate the results from aregulatory perspective. Even if a product candidate is approved by the U.S.Food and Drug Administration (“FDA”), the Canadian Therapeutic ProductsDirectorate or any other regulatory authority, we may not obtain approval foran indication whose market is large enough to recoup our investment in thatproduct candidate. In addition, there can be no assurance that we will everobtain all or any required regulatory approvals for any of our productcandidates.

 

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Weare currently developing our product candidates based on R&D activities,preclinical testing and clinical trials conducted to date, and we may not besuccessful in developing or introducing to the market these or any other newproducts or technology. If we fail to develop and deploy new productssuccessfully and on a timely basis, we may become non-competitive and unable torecoup the R&D and other expenses we incur to develop and test newproducts.

 

Interimresults of preclinical or clinical studies do not necessarily predict theirfinal results, and acceptable results in early studies might not be obtained inlater studies. Safety signals detected during clinical studies and pre-clinicalanimal studies may require us to do additional studies, which could delay thedevelopment of the drug or lead to a decision to discontinue development of thedrug. Product candidates in the later stages of clinical development may failto show the desired safety and efficacy traits despite positive results ininitial clinical testing. Results from earlier studies may not be indicative ofresults from future clinical trials and the risk remains that a pivotal programmay generate efficacy data that will be insufficient for the approval of thedrug, or may raise safety concerns that may prevent approval of the drug.Interpretation of the prior pre-clinical and clinical safety and efficacy dataof our product candidates may be flawed and there can be no assurance thatsafety and/or efficacy concerns from the prior data were overlooked ormisinterpreted, which in subsequent, larger studies appear and prevent approvalof such product candidates.

 

Furthermore,we may suffer significant setbacks in advanced clinical trials, even afterpromising results in earlier studies. Based on results at any stage of clinicaltrials, we may decide to repeat or redesign a trial or discontinue developmentof one or more of our product candidates. Further, actual results may vary oncethe final and quality-controlled verification of data and analyses has beencompleted. If we fail to adequately demonstrate the safety and efficacy of ourproducts under development, we will not be able to obtain the requiredregulatory approvals to commercialize our product candidates.

 

Clinicaltrials are subject to continuing oversight by governmental regulatoryauthorities and institutional review boards and:

 

·                  must meet the requirementsof these authorities;

·                  must meet requirements forinformed consent; and

·                  must meet requirements forgood clinical practices.

 

Wemay not be able to comply with these requirements in respect of one or more ofour product candidates.

 

Inaddition, we rely on third parties, including Contract Research Organizations (“CROs”)and outside consultants, to assist us in managing and monitoring clinicaltrials. Our reliance on these third parties may result in delays in completing,or in failing to complete, these trials if one or more third parties fails toperform with the speed and level of competence we expect.

 

Afailure in the development of any one of our programs or product candidatescould have a negative impact on the development of the others. Setbacks in anyphase of the clinical development of our product candidates would have anadverse financial impact (including with respect to any agreements andpartnerships that may exist between us and other entities), could jeopardizeregulatory approval and would likely cause a drop in the price of oursecurities.

 

***If we are unable to successfully completeour clinical trial programs, or if such clinical trials take longer to completethan we project, our ability to execute our current business strategy will beadversely affected.***

 

Whetheror not and how quickly we complete clinical trials is dependent in part uponthe rate at which we are able to engage clinical trial sites and, thereafter,the rate of enrollment of patients, and the rate we collect, clean, lock andanalyze the clinical trial database. Patient enrollment is a function of manyfactors, including the design of the protocol, the size of the patientpopulation, the proximity of patients to and availability of clinical sites,the eligibility criteria for the study, the perceived risks and benefits of thedrug under study and of the control drug, if any, the efforts to facilitatetimely enrollment in clinical trials, the patient referral practices ofphysicians, the existence of competitive clinical trials, and whether existingor new drugs are approved for the indication we are studying. Certain clinicaltrials are designed to continue until a pre-determined number of events haveoccurred to the patients enrolled. Trials such as this are subject to delaysstemming from patient withdrawal and from lower than expected event rates andmay also incur increased costs if enrollment is increased in order to achievethe desired number of events. If we experience delays in identifying andcontracting with sites and/or in patient enrollment in our clinical trialprograms, we may incur additional costs and delays in our development programs,and may not be able to complete our clinical trials on a cost-effective ortimely basis. In addition, conducting multi-national studies adds another levelof complexity and risk as we are subject to events affecting countries outsideCanada. Moreover, negative or inconclusive results from the clinical trials weconduct or adverse medical events could cause us to have to repeat or terminatethe clinical trials. Accordingly, we may not be able to complete the clinicaltrials within an acceptable time frame, if at all. If we or any third party havedifficulty enrolling a sufficient number of patients to conduct our clinicaltrials as planned, we may need to delay or terminate ongoing clinical trials.

 

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Additionally,we have never filed a new drug application (“NDA”), or similar application forapproval in the United States or in any country for our current productcandidates, which may result in a delay in, or the rejection of, our filing ofan NDA or similar application. During the drug development process, regulatoryagencies will typically ask questions of drug sponsors. While we endeavor toanswer all such questions in a timely fashion, or in the NDA filing, somequestions may not be answered by the time we file our NDA. Unless the FDAwaives the requirement to answer any such unanswered questions, submission ofan NDA may be delayed or rejected.

 

***Even if we obtain regulatory approvals forour product candidates, we will be subject to stringent ongoing governmentregulation.***

 

Evenif regulatory authorities approve any of our product candidates, themanufacture, marketing and sale of such products will be subject to strict andongoing regulation. Compliance with such regulation will be expensive andconsume substantial financial and management resources. For example, anapproval for a product may be conditioned on our agreement to conduct costlypost-marketing follow-up studies to monitor the safety or efficacy of theproducts. In addition, as a clinical experience with a drug expands afterapproval because the drug is used by a greater number and more diverse group ofpatients than during clinical trials, side effects or other problems may beobserved after approval that were not observed or anticipated duringpre-approval clinical trials. In such a case, a regulatory authority couldrestrict the indications for which the product may be sold or revoke theproduct’s regulatory approval.

 

Weand our contract manufacturers will be required to comply with applicablecurrent Good Manufacturing Practice (“cGMP”) regulations for the manufacture ofour products. These regulations include requirements relating to qualityassurance, as well as the corresponding maintenance of rigorous records anddocumentation. Manufacturing facilities must be approved before we can use themin the commercial manufacturing of our products and are subject to subsequentperiodic inspection by regulatory authorities. In addition, material changes inthe methods of manufacturing or changes in the suppliers of raw materials aresubject to further regulatory review and approval.

 

Ifwe, or any future marketing collaborators or contract manufacturers, fail tocomply with applicable regulatory requirements, we may be subject to sanctionsincluding fines, product recalls or seizures and related publicityrequirements, injunctions, total or partial suspension of production, civilpenalties, suspension or withdrawals of previously granted regulatory approvals,warning or untitled letters, refusal to approve pending applications formarketing approval of new products or of supplements to approved applications,import or export bans or restrictions, and criminal prosecution and penalties.Any of these penalties could delay or prevent the promotion, marketing or saleof our products.

 

***If our products do not gain marketacceptance, we may be unable to generate significant revenues.***

 

Evenif our products are approved for commercialization, they may not be successfulin the marketplace. Market acceptance of any of our products will depend on anumber of factors including, but not limited to:

 

·                  demonstration of clinicalefficacy and safety;

·                  the prevalence and severityof any adverse side effects;

·                  limitations or warningscontained in the product’s approved labeling;

·                  availability of alternativetreatments for the indications we target;

·                  the advantages anddisadvantages of our products relative to current or alternative treatments;

·                  the availability of acceptablepricing and adequate third-party reimbursement; and

·                  the effectiveness ofmarketing and distribution methods for the products.

 

Ifour products do not gain market acceptance among physicians, patients,healthcare payers and others in the medical community, which may not accept orutilize our products, our ability to generate significant revenues from ourproducts would be limited and our financial conditions will be materiallyadversely affected. In addition, if we fail to further penetrate our core marketsand existing geographic markets or successfully expand our business into newmarkets, the growth in sales of our products, along with our operating results,could be negatively impacted.

 

Ourability to further penetrate our core markets and existing geographic marketsin which we compete or to successfully expand our business into additionalcountries in Europe, Asia or elsewhere is subject to numerous factors, many ofwhich are beyond our control. Our products, if successfully developed, maycompete with a number of drugs and therapies currently manufactured andmarketed by major pharmaceutical and other biotechnology companies. Ourproducts may also compete with new products currently under development byothers or with products which may be less expensive than our products. Wecannot assure you that our efforts to increase market penetration in our coremarkets and existing geographic markets will

 

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besuccessful. Our failure to do so could have an adverse effect on our operatingresults and would likely cause a drop in the price of our securities.

 

***We may require significant additionalfinancing, and we may not have access to sufficient capital.***

 

Wemay require additional capital to pursue planned clinical trials, regulatoryapprovals, as well as further R&D and marketing efforts for our productcandidates and potential products. Except as expressly described in thisdocument and the documents incorporated by reference herein, we do notanticipate generating significant revenues from operations in the near futureand we currently have no committed sources of capital.

 

Wemay attempt to raise additional funds through public or private financings,collaborations with other pharmaceutical companies or financing from othersources. Additional funding may not be available on terms which are acceptableto us. If adequate funding is not available to us on reasonable terms, we mayneed to delay, reduce or eliminate one or more of our product developmentprograms or obtain funds on terms less favorable than we would otherwiseaccept. To the extent that additional capital is raised through the sale ofequity securities or securities convertible into or exchangeable for equitysecurities, the issuance of those securities could result in dilution to ourshareholders. Moreover, the incurrence of debt financing could result in asubstantial portion of our future operating cash flow, if any, being dedicatedto the payment of principal and interest on such indebtedness and could imposerestrictions on our operations. This could render us more vulnerable tocompetitive pressures and economic downturns.

 

Weanticipate that our existing working capital, including the proceeds from anysale of securities and anticipated revenues, will be sufficient to fund ourdevelopment programs, clinical trials and other operating expenses for the nearfuture. However, our future capital requirements are substantial and mayincrease beyond our current expectations depending on many factors including:

 

·                  the duration and results ofour clinical trials for our various product candidates going forward;

·                  unexpected delays ordevelopments in seeking regulatory approvals;

·                  the time and cost inpreparing, filing, prosecuting, maintaining and enforcing patent claims;

·                  other unexpecteddevelopments encountered in implementing our business development and commercializationstrategies;

·                  the outcome of litigation,if any; and

·                  further arrangements, ifany, with collaborators.

 

Inaddition, the ongoing recessionary global market and economic conditions aswell as certain continuing difficulties in the credit and capital markets maymake it even more difficult for us to raise additional financing in the future.

 

***A substantialportion of our future revenues may be dependent upon our agreement with******KeryxBiopharmaceuticals, Inc. (“Keryx”)******.***

 

We currently expect that a substantial portion of ourfuture revenues may be dependent upon our strategic partnership with Keryx.Under this strategic partnership, Keryx has significant development andcommercialization responsibilities with respect to the development and sale ofPerifosine. If Keryx were to terminate its agreement with us, fail to meet itsobligations or otherwise decrease its level of efforts, allocation of resourcesor other commitments under this agreement, our future revenues and/or prospectscould be negatively impacted and the development and commercialization ofPerifosine would be interrupted. In addition, if Keryx does not achieve some orany of the development, regulatory and commercial milestones or if it does notachieve certain net sales thresholds as set forth in the agreement, we will notfully realize the expected economic benefits of the agreement. Further, theachievement of certain of the milestones under this strategic partnershipagreement will depend on factors that are outside of our control and most arenot expected to be achieved for several years, if at all. Any failure tosuccessfully maintain our strategic partnership agreement could materially andadversely affect our ability to generate revenues.

 

***If we are unsuccessful in increasing ourrevenues and/or raising additional funding, we may possibly cease to continueoperating as we currently do.***

 

Althoughour audited consolidated financial statements for the years ended December 31,2009, 2008 and 2007 have been prepared on a going concern basis, whichcontemplates the realization of assets and liquidation of liabilities duringthe normal course of operations, our ability to continue as a going concern isdependent on the successful execution of our business plan, which will requirean increase in revenue and/or additional funding to be provided by potentialinvestors as well as non-traditional sources of financing. Although we statedin our audited consolidated financial statements for the years

 

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endedDecember 31, 2009, 2008 and 2007 that management believed that the Companyhad, as at December 31, 2009, sufficient financial resources to fund plannedexpenditures and other working capital needs for at least the 12-month periodfollowing such date, there can be no assurance that management will be able toreiterate such belief in our future financial statements.

 

Wehave had sustained losses, accumulated deficits and negative cash flows fromoperations since our inception. We expect that this will continue throughout2010.

 

Additionalfunding may be in the form of debt or equity or a hybrid instrument dependingon the needs of the investor. Given the prevailing global economic and creditmarket conditions, we may not be able to raise additional cash resourcesthrough these traditional sources of financing. Although we are also pursuingnon-traditional sources of financing, the global credit market crisis has alsoadversely affected the ability of potential parties to pursue suchtransactions. We do not believe that the ability to access capital markets orthese adverse conditions are likely to improve significantly in the nearfuture. Accordingly, as a result of the foregoing, we continue to reviewtraditional sources of financing, such as private and public debt or equityfinancing alternatives, as well as other alternatives to enhance shareholdervalue, including, but not limited to, non-traditional sources of financing,such as alliances with strategic partners, the sale of assets or licensing ofour technology or intellectual property, a combination of operating and relatedinitiatives or a substantial reorganization of our business. If we do not raiseadditional capital, we do not expect our operations to generate sufficient cashflow to fund our obligations as they come due.

 

Therecan be no assurances that we will achieve profitability or positive cash flowsor be able to obtain additional funding or that, if obtained, they will besufficient, or whether any other initiatives will be successful, such that wemay continue as a going concern. There are material uncertainties related tocertain adverse conditions and events that could cast significant doubt on ourability to remain a going concern.

 

***We may not achieve our projecteddevelopment goals in the time-frames we announce and expect.***

 

Weset goals and make public statements regarding the timing of the accomplishmentof objectives material to our success, such as the commencement, enrollment andcompletion of clinical trials, anticipated regulatory submission and approvaldates and time of product launch. The actual timing of these events can varydramatically due to factors such as delays or failures in our clinical trials,the uncertainties inherent in the regulatory approval process and delays inachieving manufacturing or marketing arrangements sufficient to commercializeour products. There can be no assurance that our clinical trials will becompleted, that we will make regulatory submissions or receive regulatoryapprovals as planned or that we will be able to adhere to our current schedulefor the launch of any of our products. If we fail to achieve one or more ofthese milestones as planned, the price of our securities would likely decline.

 

***If we fail to obtain acceptable prices oradequate reimbursement for our products, our ability to generate revenues willbe diminished.***

 

Theability for us and/or our partners to successfully commercialize our productswill depend significantly on our ability to obtain acceptable prices and theavailability of reimbursement to the patient from third-party payers, such asgovernmental and private insurance plans. These third-party payers frequentlyrequire companies to provide predetermined discounts from list prices, and theyare increasingly challenging the prices charged for pharmaceuticals and othermedical products. Our products may not be considered cost-effective, andreimbursement to the patient may not be available or sufficient to allow us orour partners to sell our products on a competitive basis. It may not bepossible to negotiate favorable reimbursement rates for our products.

 

Inaddition, the continuing efforts of third-party payers to contain or reduce thecosts of healthcare through various means may limit our commercial opportunityand reduce any associated revenue and profits. We expect proposals to implementsimilar government control to continue. In addition, increasing emphasis on managedcare will continue to put pressure on the pricing of pharmaceutical andbiopharmaceutical products. Cost control initiatives could decrease the pricethat we or any current or potential collaborators could receive for any of ourproducts and could adversely affect our profitability. In addition, in theUnited States, in Canada and in many other countries, pricing and/orprofitability of some or all prescription pharmaceuticals andbiopharmaceuticals are subject to government control.

 

Ifwe fail to obtain acceptable prices or an adequate level of reimbursement forour products, the sales of our products would be adversely affected or theremay be no commercially viable market for our products.

 

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***Competition in our targeted markets isintense, and development by other companies could render our products ortechnologies non-competitive.***

 

Thebiomedical field is highly competitive. New products developed by othercompanies in the industry could render our products or technologiesnon-competitive. Competitors are developing and testing products andtechnologies that would compete with the products that we are developing. Someof these products may be more effective or have an entirely different approachor means of accomplishing the desired effect than our products. We expectcompetition from biopharmaceutical and pharmaceutical companies and academicresearch institutions to increase over time. Many of our competitors andpotential competitors have substantially greater product developmentcapabilities and financial, scientific, marketing and human resources than wedo. Our competitors may succeed in developing products earlier and in obtainingregulatory approvals and patent protection for such products more rapidly thanwe can or at a lower price.

 

***We may not obtain adequate protection forour products through our intellectual property.***

 

Werely heavily on our proprietary information in developing and manufacturing ourproduct candidates. Our success depends, in large part, on our ability toprotect our competitive position through patents, trade secrets, trademarks andother intellectual property rights. The patent positions of pharmaceutical andbiopharmaceutical firms, including Æterna Zentaris, are uncertain and involvecomplex questions of law and fact for which important legal issues remainunresolved. Applications for patents and trademarks in Canada, the UnitedStates and in other foreign territories have been filed and are being activelypursued by us. Pending patent applications may not result in the issuance ofpatents and we may not be able to obtain additional issued patents relating toour technology or products. Even if issued, patents to us or our licensors maybe challenged, narrowed, invalidated, held to be unenforceable or circumvented,which could limit our ability to stop competitors from marketing similarproducts or limit the length of term of patent protection we may have for ourproducts. Changes in either patent laws or in interpretations of patent laws inthe United States and other countries may diminish the value of ourintellectual property or narrow the scope of our patent protection. The patentsissued or to be issued to us may not provide us with any competitive advantageor protect us against competitors with similar technology. In addition, it ispossible that third parties with products that are very similar to ours willcircumvent our patents by means of alternate designs or processes. We may haveto rely on method of use and new formulation protection for our compounds indevelopment, and any resulting products, which may not confer the sameprotection as claims to compounds per se.

 

Inaddition, our patents may be challenged by third parties in patent litigation,which is becoming widespread in the biopharmaceutical industry. There may beprior art of which we are not aware that may affect the validity orenforceability of a patent claim. There also may be prior art of which we areaware, but which we do not believe affects the validity or enforceability of aclaim, which may, nonetheless, ultimately be found to affect the validity orenforceability of a claim. No assurance can be given that our patents would, ifchallenged, be held by a court to be valid or enforceable or that a competitor’stechnology or product would be found by a court to infringe our patents. Ourgranted patents could also be challenged and revoked in opposition or nullityproceedings in certain countries outside the United States. In addition, we maybe required to disclaim part of the term of certain patents.

 

Patentapplications relating to or affecting our business have been filed by a numberof pharmaceutical and biopharmaceutical companies and academic institutions. Anumber of the technologies in these applications or patents may conflict withour technologies, patents or patent applications, and any such conflict couldreduce the scope of patent protection which we could otherwise obtain. Becausepatent applications in the United States and many other jurisdictions aretypically not published until eighteen months after their first effectivefiling date, or in some cases not at all, and because publications of discoveriesin the scientific literature often lag behind actual discoveries, neither wenor our licensors can be certain that we or they were the first to make theinventions claimed in our or their issued patents or pending patentapplications, or that we or they were the first to file for protection of theinventions set forth in these patent applications. If a third party has alsofiled a patent application in the United States covering our product candidatesor a similar invention, we may have to participate in an adversarialproceeding, known as an interference, declared by the United States Patent andTrademark Office to determine priority of invention in the United States. Thecosts of these proceedings could be substantial and it is possible that ourefforts could be unsuccessful, resulting in a loss of our U.S. patent position.

 

Inaddition to patents, we rely on trade secrets and proprietary know-how toprotect our intellectual property. If we are unable to protect theconfidentiality of our proprietary information and know-how, the value of ourtechnology and products could be adversely affected. We seek to protect ourunpatented proprietary information in part by requiring our employees,consultants, outside scientific collaborators and sponsored researchers andother advisors to enter into confidentiality agreements. These agreementsprovide that all confidential information developed or made known to theindividual during the course of the individual’s relationship with us is to bekept confidential and not disclosed to third parties except in specificcircumstances. In the case of our employees, the agreements provide that all ofthe technology which is conceived by

 

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theindividual during the course of employment is our exclusive property. Theseagreements may not provide meaningful protection or adequate remedies in theevent of unauthorized use or disclosure of our proprietary information. Inaddition, it is possible that third parties could independently developproprietary information and techniques substantially similar to ours orotherwise gain access to our trade secrets. If we are unable to protect theconfidentiality of our proprietary information and know-how, competitors may beable to use this information to develop products that compete with our productsand technologies, which could adversely impact our business.

 

Wecurrently have the right to use certain technology under license agreementswith third parties. Our failure to comply with the requirements of materiallicense agreements could result in the termination of such agreements, whichcould cause us to terminate the related development program and cause acomplete loss of our investment in that program.

 

Asa result of the foregoing factors, we may not be able to rely on ourintellectual property to protect our products in the marketplace.

 

***We may infringe the intellectual propertyrights of others.***

 

Ourcommercial success depends significantly on our ability to operate withoutinfringing the patents and other intellectual property rights of third parties.There could be issued patents of which we are not aware that our products ormethods may be found to infringe, or patents of which we are aware and believewe do not infringe but which we may ultimately be found to infringe. Moreover,patent applications and their underlying discoveries are in some casesmaintained in secrecy until patents are issued. Because patents can take manyyears to issue, there may be currently pending applications of which we areunaware that may later result in issued patents that our products or methodsare found to infringe. Moreover, there may be published pending applicationsthat do not currently include a claim covering our products or methods butwhich nonetheless provide support for a later drafted claim that, if issued,our products or methods could be found to infringe.

 

Ifwe infringe or are alleged to infringe intellectual property rights of thirdparties, it will adversely affect our business. Our research, development andcommercialization activities, as well as any product candidates or productsresulting from these activities, may infringe or be accused of infringing oneor more claims of an issued patent or may fall within the scope of one or moreclaims in a published patent application that may subsequently issue and towhich we do not hold a license or other rights. Third parties may own or controlthese patents or patent applications in the United States and abroad. Thesethird parties could bring claims against us or our collaborators that wouldcause us to incur substantial expenses and, if successful against us, couldcause us to pay substantial damages. Further, if a patent infringement suitwere brought against us or our collaborators, we or they could be forced tostop or delay research, development, manufacturing or sales of the product orproduct candidate that is the subject of the suit.

 

Thebiopharmaceutical industry has produced a proliferation of patents, and it isnot always clear to industry participants, including us, which patents covervarious types of products. The coverage of patents is subject to interpretationby the courts, and the interpretation is not always uniform. In the event ofinfringement or violation of another party’s patent or other intellectualproperty rights, we may not be able to enter into licensing arrangements ormake other arrangements at a reasonable cost. Any inability to secure licensesor alternative technology could result in delays in the introduction of ourproducts or lead to prohibition of the manufacture or sale of products by us orour partners and collaborators.

 

***Patent litigation is costly and timeconsuming and may subject us to liabilities.***

 

Ourinvolvement in any patent litigation, interference, opposition or otheradministrative proceedings will likely cause us to incur substantial expenses,and the efforts of our technical and management personnel will be significantlydiverted. In addition, an adverse determination in litigation could subject usto significant liabilities.

 

***We may not obtain trademark registrations.***

 

Wehave filed applications for trademark registrations in connection with ourproduct candidates in various jurisdictions, including the United States. Weintend to file further applications for other possible trademarks for ourproduct candidates. No assurance can be given that any of our trademarkapplications will be registered in the United States or elsewhere, or that theuse of any registered or unregistered trademarks will confer a competitiveadvantage in the marketplace. Furthermore, even if we are successful in ourtrademark registrations, the FDA and regulatory authorities in other countrieshave their own process for drug nomenclature and their own views concerningappropriate proprietary names. The FDA and other regulatory authorities alsohave the power, even after granting market approval, to request a company toreconsider the name for a product because of evidence of confusion in themarketplace. No assurance can be given that the FDA or any other regulatoryauthority will approve of any of our trademarks or will not requestreconsideration of one of our trademarks at some time in

 

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thefuture. The loss, abandonment, or cancellation of any of our trademarks ortrademark applications could negatively affect the success of the productcandidates to which they relate.

 

***Our revenues and expenses may fluctuatesignificantly, and any failure to meet financial expectations may disappointsecurities analysts or investors and result in a decline in the price of oursecurities.***

 

Wehave a history of operating losses. Our revenues and expenses have fluctuatedin the past and are likely to do so in the future. These fluctuations couldcause our share price to decline. Some of the factors that could cause ourrevenues and expenses to fluctuate include but are not limited to:

 

·                  the inability to completeproduct development in a timely manner that results in a failure or delay inreceiving the required regulatory approvals to commercialize our productcandidates;

·                  the timing of regulatorysubmissions and approvals;

·                  the timing and willingnessof any current or future collaborators to invest the resources necessary tocommercialize our product candidates;

·                  the revenue available fromroyalties derived from our strategic partners;

·                  licensing fees revenues;

·                  tax credits and grants(R&D);

·                  the outcome of litigation,if any;

·                  changes in foreign currencyfluctuations;

·                  the timing of achievementand the receipt of milestone payments from current or future collaborators; and

·                  failure to enter into newor the expiration or termination of current agreements with collaborators.

 

Dueto fluctuations in our revenues and expenses, we believe that period-to-periodcomparisons of our results of operations are not necessarily indicative of ourfuture performance. It is possible that in some future quarter or quarters, ourrevenues and expenses will be above or below the expectations of securitiesanalysts or investors. In this case, the price of our securities couldfluctuate significantly or decline.

 

***We will not be able to successfullycommercialize our product candidates if we are unable to make adequatearrangements with third parties for such purposes.***

 

Wecurrently have a lean sales and marketing staff. In order to commercialize ourproduct candidates successfully, we need to make arrangements with thirdparties to perform some or all of these services in certain territories.

 

Wecontract with third parties for the sales and marketing of our products. Ourrevenues will depend upon the efforts of these third parties, whose efforts maynot be successful. If we fail to establish successful marketing and salescapabilities or to make arrangements with third parties for such purposes, ourbusiness, financial condition and results of operations will be materiallyadversely affected.

 

Ifwe had to resort to developing a sales force internally, the cost ofestablishing and maintaining a sales force would be substantial and may exceedits cost effectiveness. In addition, in marketing our products, we would likelycompete with many companies that currently have extensive and well-fundedmarketing and sales operations. Despite our marketing and sales efforts, we maybe unable to compete successfully against these companies.

 

Weare currently dependent on strategic partners and may enter into futurecollaborations for the research, development and commercialization of ourproduct candidates. Our arrangements with these strategic partners may notprovide us with the benefits we expect and may expose us to a number of risks.

 

Weare dependent on, and rely upon, strategic partners to perform variousfunctions related to our business, including, but not limited to, the research,development and commercialization of some of our product candidates. Ourreliance on these relationships poses a number of risks.

 

Wemay not realize the contemplated benefits of such agreements nor can we becertain that any of these parties will fulfill their obligations in a mannerwhich maximizes our revenue. These arrangements may also require us to transfercertain material rights or issue our equity, voting or other securities tocorporate partners, licensees and others. Any license or sublicense of ourcommercial rights may reduce our product revenue.

 

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Theseagreements also create certain risks. The occurrence of any of the following orother events may delay product development or impair commercialization of ourproducts:

 

·                  not all of our strategicpartners are contractually prohibited from developing or commercializing,either alone or with others, products and services that are similar to orcompetitive with our product candidates, and, with respect to our strategicpartnership agreements that do contain such contractual prohibitions orrestrictions, prohibitions or restrictions do not always apply to our partners’affiliates and they may elect to pursue the development of any additionalproduct candidates and pursue technologies or products either on their own orin collaboration with other parties, including our competitors, whosetechnologies or products may be competitive with ours;

·                  our strategic partners mayunder-fund or fail to commit sufficient resources to marketing, distribution orother development of our products;

·                  we may not be able to renewsuch agreements;

·                  our strategic partners maynot properly maintain or defend certain intellectual property rights that maybe important to the commercialization of our products;

·                  our strategic partners mayencounter conflicts of interest, changes in business strategy or other issueswhich could adversely affect their willingness or ability to fulfill theirobligations to us (for example, pharmaceutical companies historically havere-evaluated their priorities following mergers and consolidations, which havebeen common in recent years in this industry);

·                  delays in, or failures toachieve, scale-up to commercial quantities, or changes to current raw materialsuppliers or product manufacturers (whether the change is attributable to us orthe supplier or manufacturer) could delay clinical studies, regulatorysubmissions and commercialization of our product candidates; and

·                  disputes may arise betweenus and our strategic partners that could result in the delay or termination ofthe development or commercialization of our product candidates, resulting inlitigation or arbitration that could be time-consuming and expensive, orcausing our strategic partners to act in their own self-interest and not in ourinterest or those of our shareholders or other stakeholders.

 

Inaddition, our strategic partners can terminate our agreements with them for anumber of reasons based on the terms of the individual agreements that we haveentered into with them. If one or more of these agreements were to beterminated, we would be required to devote additional resources to developingand commercializing our product candidates, seek a new partner or abandon thisproduct candidate which would likely cause a drop in the price of oursecurities.

 

Wehave entered into important strategic partnership agreements relating tocertain of our product candidates for various indications. Detailed informationon our research and collaboration agreements is available in our variousreports and disclosure documents filed with the Canadian securities regulatoryauthorities and filed with or furnished to the U.S. Securities and ExchangeCommission (the “SEC”), including the documents incorporated into this annualreport on Form 20-F. See, for example, Notes 4 and 26 to our auditedconsolidated balance sheets as at December 31, 2009 and 2008 and ouraudited consolidated statements of operations, changes in shareholders’ equity,comprehensive income (loss) and cash flows for each of the years in thethree-year period ended December 31, 2009, which are included elsewhere inthis annual report on Form 20-F.

 

Wehave also entered into a variety of collaborative licensing agreements withvarious universities and institutes under which we are obligated to supportsome of the research expenses incurred by the university laboratories and payroyalties on future sales of the products. In turn, we have retained exclusiverights for the worldwide exploitation of results generated during thecollaborations.

 

Inparticular, we have entered into an agreement with the TulaneEducational Fund (“Tulane”), which provides for the payment by us ofsingle-digit royalties on future worldwide net sales of cetrorelix andincluding Cetrotide®. Tulane isalso entitled to receive a low double-digit participation payment on anylump-sum, periodic or other cash payments received by us from sub-licensees(see Note 26 to our audited consolidated financial statements for the yearsended December 31, 2009, 2008 and 2007 included in this annual report on Form 20-F).

 

***We rely on third parties to conduct,supervise and monitor our clinical trials, and those third parties may notperform satisfactorily.***

 

Werely on third parties such as CROs, medical institutions and clinicalinvestigators to enroll qualified patients and conduct, supervise and monitorour clinical trials. Our reliance on these third parties for clinicaldevelopment activities reduces our control over these activities. Our relianceon these third parties, however, does not relieve us of our regulatoryresponsibilities, including ensuring that our clinical trials are conducted inaccordance with Good Clinical Practice (“GCP”) guidelines and theinvestigational plan and protocols contained in an Investigational New Drugapplication, or comparable

 

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foreignregulatory submission. Furthermore, these third parties may also haverelationships with other entities, some of which may be our competitors. Inaddition, they may not complete activities on schedule, or may not conduct ourpreclinical studies or clinical trials in accordance with regulatoryrequirements or our trial design. If these third parties do not successfullycarry out their contractual duties or meet expected deadlines, our efforts toobtain regulatory approvals for, and commercialize, our product candidates maybe delayed or prevented.

 

***In carrying out our operations, we aredependent on a stable and consistent supply of ingredients and raw materials.***

 

Therecan be no assurance that we, our contract manufacturers or our partners, willbe able, in the future, to continue to purchase products from our currentsuppliers or any other supplier on terms similar to current terms or at all. Aninterruption in the availability of certain raw materials or ingredients, orsignificant increases in the prices paid by us for them, could have a materialadverse effect on our business, financial condition, liquidity and operatingresults.

 

***The failure to perform satisfactorily bythird parties upon which we rely to manufacture and supply products may lead tosupply shortfalls.***

 

Werely on third parties to manufacture and supply marketed products. We also havecertain supply obligations *vis-à-vis*ourlicensing partners who are responsible for the marketing of the products. To besuccessful, our products have to be manufactured in commercial quantities incompliance with quality controls and regulatory requirements. Even though it isour objective to minimize such risk by introducing alternative suppliers toensure a constant supply at all times, we cannot guarantee that we will notexperience supply shortfalls and, in such event, we may not be able to performour obligations under contracts with our partners.

 

***We are subject to intense competition forour skilled personnel, and the loss of key personnel or the inability toattract additional personnel could impair our ability to conduct ouroperations.***

 

Weare highly dependent on our management and our clinical, regulatory andscientific staff, the loss of whose services might adversely impact our abilityto achieve our objectives. Recruiting and retaining qualified management andclinical, scientific and regulatory personnel is critical to our success.Competition for skilled personnel is intense, and our ability to attract andretain qualified personnel may be affected by such competition.

 

***Our strategic partners’ manufacturingcapabilities may not be adequate to effectively commercialize our productcandidates.***

 

Ourmanufacturing experience to date with respect to our product candidatesconsists of producing drug substance for clinical studies. To be successful,these product candidates have to be manufactured in commercial quantities incompliance with regulatory requirements and at acceptable costs. Our strategicpartners’ current manufacturing facilities have the capacity to produceprojected product requirements for the foreseeable future, but we will need toincrease capacity if sales continue to grow. Our strategic partners may not beable to expand capacity or to produce additional product requirements on favorableterms. Moreover, delays associated with securing additional manufacturingcapacity may reduce our revenues and adversely affect our business andfinancial position. There can be no assurance that we will be able to meetincreased demand over time.

 

***We are subject to the risk of productliability claims, for which we may not have or be able to obtain adequateinsurance coverage.***

 

Thesale and use of our products, in particular our biopharmaceutical products,involve the risk of product liability claims and associated adverse publicity.Our risks relate to human participants in our clinical trials, who may sufferunintended consequences, as well as products on the market whereby claims mightbe made directly by patients, healthcare providers or pharmaceutical companiesor others selling, buying or using our products. We manage our liability risksby means of insurance. We maintain liability insurance covering our liabilityfor our preclinical and clinical studies and for our pharmaceutical productsalready marketed. However, we may not have or be able to obtain or maintainsufficient and affordable insurance coverage, including coverage forpotentially very significant legal expenses, and without sufficient coverageany claim brought against us could have a materially adverse effect on ourbusiness, financial condition or results of operations.

 

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***Our business involves the use of hazardousmaterials which requires us to comply with environmental and occupationalsafety laws regulating the use of such materials. If we violate these laws, wecould be subject to significant fines, liabilities or other adverse consequences.***

 

Ourdiscovery and development processes involve the controlled use of hazardous andradioactive materials. We are subject to federal, provincial and local laws andregulations governing the use, manufacture, storage, handling and disposal ofsuch materials and certain waste products. The risk of accidental contaminationor injury from these materials cannot be completely eliminated. In the event ofan accident or a failure to comply with environmental or occupational safetylaws, we could be held liable for any damages that result, and any suchliability could exceed our resources. We may not be adequately insured againstthis type of liability. We may be required to incur significant costs to complywith environmental laws and regulations in the future, and our operations,business or assets may be materially adversely affected by current or futureenvironmental laws or regulations.

 

***Legislative actions, new accounting pronouncements andhigher insurance costs are likely to impact our future financial position orresults of operations.***

 

Changes in financialaccounting standards or implementation of accounting standards may causeadverse, unexpected revenue or expense fluctuations and affect our financialposition or results of operations. New pronouncements and varyinginterpretations of pronouncements have occurred with greater frequency and areexpected to occur in the future, and we may make or be required to make changesin our accounting policies in the future. Compliance with changing regulationsof corporate governance and public disclosure, notably with respect to internalcontrols over financial reporting, may result in additional expenses. Changinglaws, regulations and standards relating to corporate governance and publicdisclosure are creating uncertainty for companies such as ours, and insurancecosts are increasing as a result of this uncertainty.

 

***We are subject toadditional reporting requirements under applicable Canadian securities laws andthe Sarbanes-Oxley Act in the United States. We can provide no assurancethat we will at all times in the future be able to report that our internalcontrols over financial reporting are effective.***

 

As a public company, we are required to comply with Section 404of the Sarbanes-Oxley Act (“Section 404”) and NationalInstrument 52-109 — *Certificationof Disclosure in Issuers’ Annual and Interim Filings*, and we have toobtain an annual attestation from our independent auditors regarding ourinternal control over financial reporting. In any given year, we cannot becertain as to the timing of completion of our internal control evaluation,testing and remediation actions or of their impact on our operations. Uponcompletion of this process, we may identify control deficiencies of varyingdegrees of severity under applicable SEC and Public Company AccountingOversight Board rules and regulations. As a public company, we are required to report, among otherthings, control deficiencies that constitute material weaknesses or changes ininternal controls that, or that are reasonably likely to, materially affectinternal controls over financial reporting. A “material weakness” is adeficiency, or a combination of deficiencies, in internal control overfinancial reporting, such that there is a reasonable possibility that amaterial misstatement of the company’s annual financial statements will not be preventedor detected on a timely basis. If we fail to comply with the requirements of Section 404,Canadian requirements or report a material weakness, we might be subject toregulatory sanction and investors may lose confidence in our financialstatements, which may be inaccurate if we fail to remedy such materialweakness.

 

***It is possible that we may be a passive foreign investmentcompany, which could result in adverse tax consequences to U.S. investors.***

 

Adverse U.S. federalincome tax rules apply to “U.S. Holders” (as defined in “Item 10.E. —Taxation — Certain U.S. Federal Income Tax Considerations”) that directly orindirectly hold common shares or warrants of a passive foreign investmentcompany (“PFIC”). We will be classified as a PFIC for U.S. federal income taxpurposes for a taxable year if (i) at least 75 percent of our grossincome is “passive income” or (ii) at least 50 percent of the averagevalue of our assets, including goodwill (based on annual quarterly average), isattributable to assets which produce passive income or are held for theproduction of passive income.

 

Webelieve that we were not a PFIC for the 2009 taxable year. However, since thefair market value of our assets may be determined in large part by the marketprice of our Common Shares, which is likely to fluctuate, and the compositionof our income and assets will be affected by how, and how quickly, we spend anycash that is raised in any financing transaction, no assurance can be providedthat we will not be classified as a PFIC for the 2010 taxable year and for anyfuture taxable year.

 

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PFIC characterizationcould result in adverse U.S. federal income tax consequences to U.S. Holders.In particular, absent certain elections, a U.S. Holder would be subject to U.S.federal income tax at ordinary income tax rates, plus a possible interestcharge, in respect of a gain derived from a disposition of our common shares,as well as certain distributions by us. If we are treated as a PFIC for anytaxable year, a U.S. Holder may be able to make an election to “mark to market”Common Shares each taxable year and recognize ordinary income pursuant to suchelection based upon increases in the value of the Common Shares. However, amark-to-market election is not available to be made in respect of a warrant.

 

Under recently enacted U.S. tax legislation and subject to future guidance, if we are a PFIC, U.S. Holders will be required to file, for returnsdue after March 18, 2010, an annual information return with the IRSrelating to their ownership of our Common Shares. Although expected, noguidance has yet been issued about such return, including on the informationrequired to be reported on such return, the form of the return, or the due datefor the return.

 

For a more detaileddiscussion of the potential tax impact of us being a PFIC, see “Item 10.E. —Taxation — Certain U.S. Federal Income Tax Considerations.”

 

***We will report under International Financial ReportingStandards for our interim and annual consolidated financial statements for thefinancial year ending December 31, 2011.***

 

The Accounting StandardsBoard of the Canadian Institute of Chartered Accountants has announced thatCanadian publicly accountable enterprises are required to adopt InternationalFinancial Reporting Standards (“IFRS”), as issued by the InternationalAccounting Standards Board, effective January 1, 2011. We will be requiredto report under IFRS for our interim and annual consolidated financialstatements for the financial year ending December 31, 2011.

 

Although IFRS uses aconceptual framework similar to Canadian GAAP, we will need to addressdifferences in accounting policies. We are currently considering the impactthat IFRS will have on our financial statements. See “Item 5. —  Operatingand Financial Review and Prospects”.

 

***We may incur losses associated with foreign currencyfluctuations.***

 

Our operations are inmany instances conducted in currencies other than the euro, our functionalcurrency. Fluctuations in the value of currencies could cause us to incurcurrency exchange losses. We do not currently employ a hedging strategy againstexchange rate risk. We cannot assert with any assurance that we will not sufferlosses as a result of unfavorable fluctuations in the exchange rates betweenthe United States dollar, the euro, the Canadian dollar and other currencies.

 

***We may not be able to successfully integrate acquiredbusinesses.***

 

Future acquisitions maynot be successfully integrated. The failure to successfully integrate thepersonnel and operations of businesses which we may acquire in the future withours could have a material adverse effect on our operations and results.

 

**RisksRelated to the Securities**

 

***Our share price is volatile, which may result from factorsoutside of our control. If our common shares are delisted from the TSX orNASDAQ, investors may have difficulty in disposing of our common shares held bythem.***

 

Our common shares arecurrently listed and traded only on the Toronto Stock Exchange (the “TSX”) andNational Association of Securities Dealers Automated Quotations (“NASDAQ”). Ourvaluation and share price since the beginning of trading after our initiallistings, first in Canada and then in the United States, have had no meaningfulrelationship to current or historical financial results, asset values, bookvalue or many other criteria based on conventional measures of the value ofshares.

 

During the year ended December 31,2009, the closing price of our common shares ranged from CAN$0.57 to CAN$3.11per share on the TSX, and from $0.46 to $2.83 on the NASDAQ. Our share pricemay be affected by developments directly affecting our business and bydevelopments out of our control or unrelated to us. The biopharmaceuticalsector in particular, and the stock market generally, are vulnerable to abruptchanges in investor sentiment. Prices of shares and trading volume of companiesin the biopharmaceutical industry can swing dramatically in ways unrelated to,or that bear a disproportionate relationship to, operating performance. Ourshare price and trading volume may fluctuate based on a number of factorsincluding, but not limited to:

 

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·                  clinical and regulatory developmentsregarding our product candidates;

·                  delays in our anticipated development orcommercialization timelines;

·                  developments regarding current or futurethird-party collaborators;

·                  other announcements by us regarding technological,product development or other matters;

·                  arrivals or departures of key personnel;

·                  governmental or regulatory actionaffecting our product candidates and our competitors’ products in the UnitedStates, Canada and other countries;

·                  developments or disputes concerningpatent or proprietary rights;

·                  actual or anticipated fluctuations in ourrevenues or expenses;

·                  general market conditions andfluctuations for the emerging growth and biopharmaceutical market sectors; and

·                  economic conditions in the United States,Canada or abroad.

 

Our listing on both theTSX and NASDAQ may increase price volatility due to various factors including:different ability to buy or sell our common shares; different market conditionsin different capital markets; and different trading volumes. In addition, lowtrading volume may increase the price volatility of our common shares. A thintrading market could cause the price of our common shares to fluctuatesignificantly more than the stock market as a whole.

 

In the past, followingperiods of large price declines in the public market price of a company’ssecurities, securities class action litigation has often been initiated againstthat company. Litigation of this type could result in substantial costs anddiversion of management’s attention and resources, which would adversely affectour business. Any adverse determination in litigation could also subject us tosignificant liabilities.

 

We must meet continuinglisting requirements to maintain the listing of our common shares on the TSXand NASDAQ. For continued listing, NASDAQ requires, among other things, thatlisted securities maintain a minimum closing bid price of not less than $1.00per share. On January 22, 2010, we announced that we had received a letterfrom the NASDAQ Listing Qualifications Department indicating that the minimumclosing bid price of the common shares had fallen below $1.00 for 30consecutive trading days, and therefore, Æterna Zentaris was not in compliancewith NASDAQ Listing Rule 5450(a)(1) (the “Rule”). In accordance withNASDAQ Listing Rule 5810(C)(3)(a), we have been provided a grace period of180 calendar days, or until July 20, 2010, to regain compliance with thisrequirement. We can regain compliance with the Rule if the bid price ofour common shares closes at $1.00 or higher for a minimum of ten consecutivebusiness days during the grace period, although NASDAQ may, in its discretion,require us to maintain a minimum closing bid price of at least $1.00 per sharefor a period in excess of ten consecutive business days before determining thatwe have demonstrated the ability to maintain long-term compliance.

 

If we are unsuccessful inmeeting the minimum bid requirement by July 20, 2010, NASDAQ will providenotice to us that our common shares will be subject to delisting from theNASDAQ Global Market. If the Company receives a delisting notification, we may appeal tothe Listing Qualifications Panel or apply to transfer the listing of our commonhares to the NASDAQ Capital Market if we satisfy at such time all of theinitial listing standards on the NASDAQ Capital Market, other than compliancewith the minimum closing bid price requirement. If the application to theNASDAQ Capital Market is approved, then we will have an additional 180-day graceperiod in order to regain compliance with the minimum bid price requirementwhile listed on the NASDAQ Capital Market. There can be no assurance that wewill meet the requirements for continued listing on the NASDAQ Global Market orwhether our application to the NASDAQ Capital Market will be approved or thatany appeal would be granted by the Listing Qualifications Panel.

 

***Our largest shareholders have influence over our businessand corporate matters, including those requiring shareholder approval. Thiscould delay or prevent a change in control. Sales of common shares by suchshareholders could have an impact on the market price of our Securities.***

 

Our two largestshareholders, which held 13.97% and 12.94% of our outstanding common shares asof the date of this annual report on Form 20-F, have certain rights tonominate members of our Board of Directors as well as influence over ourbusiness and corporate matters, including those requiring shareholder approval.This could delay or prevent a change in control. Sales of common shares by suchshareholders could have an impact on the price of our securities.

 

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***We do not intend to pay dividends in thenear future.***

 

Todate, we have not declared or paid any dividends on our common shares. Wecurrently intend to retain our future earnings, if any, to finance furtherresearch and the expansion of our business. As a result, the return on aninvestment in our securities will, for the foreseeable future, depend upon anyfuture appreciation in value. There is no guarantee that our securities willappreciate in value or even maintain the price at which shareholders havepurchased their securities.

 

## **Item 4.    Informationon the Company**

## ** **

### ***A.            History and development of theCompany***

### *** ***

ÆternaZentaris Inc. is a late-stage drug development company specialized in oncologyand endocrine therapy.

 

Wewere incorporated on September 12, 1990 under the Canada BusinessCorporations Act (the “CBCA”) and continue to be governed by the CBCA. Ourregistered office is located at 1405 du Parc-Technologique Blvd., Quebec City,Quebec, Canada G1P 4P5, our telephone number is (418) 652-8525 andour website is www.aezsinc.com. None of the documents or information found onour website shall be deemed to be included in or incorporated into this annualreport.

 

On December 30, 2002,we acquired Zentaris AG, a biopharmaceutical company based in Frankfurt,Germany. Zentaris was a spin-off of Degussa AG and Asta Medica GmbH, a formerpharmaceutical company. With this acquisition, the Company changed its riskprofile and inherited an extensive and robust product pipeline withcapabilities from drug discovery to commercialization with a particular focuson endocrine therapy and oncology. As part of the acquisition, we alsoinherited a very experienced pharmaceutical team along with a network ofstrategic pharmaceutical partners. The total consideration paid for theacquisition of Zentaris was $51.9 million, net of cash and cash equivalentsacquired of $2.3 million, of which an amount of $26.7 million was paid in cashand the remaining amount of $25.2 million as a balance of purchase price.

 

InMay 2004, we changed our name to Æterna Zentaris Inc. and on May 11,2007, Zentaris GmbH was renamed Æterna Zentaris GmbH. Æterna Zentaris GmbH isour principal operating subsidiary.

 

OnApril 6, 2005, our former subsidiary Atrium Biotechnologies Inc. (nowAtrium Innovations Inc.) (“Atrium”), completed its initial public offering inCanada and began trading on the TSX under the ticker symbol “ATB.”

 

Throughout2006, as part of a thorough, strategic planning process, our management andBoard of Directors (the “Board”) made the decision to spin off Atrium in twophases. On September 19, 2006, we initiated the first phase, a secondaryoffering in which we sold 3,485,000 Subordinate Voting Shares of Atrium at aprice of CAN$15.80 per share. This secondary offering closed on October 18,2006, generating net proceeds of nearly $45 million to Æterna Zentaris.With this transaction closed, our remaining interest in Atrium was 11,052,996Subordinate Voting Shares representing 36.1% of its issued and outstandingshares. Therefore, we no longer had a controlling interest in Atrium as of October 18,2006.

 

Thesecond phase was to distribute our remaining interest in Atrium to ourshareholders concurrently with a reduction of the stated capital of our commonshares.

 

OnDecember 15, 2006, our shareholders approved a reduction of the statedcapital of our common shares in an amount equal to the fair market value of ourremaining interest in Atrium by way of a special distribution in kind to allour shareholders. This special distribution was completed on January 2,2007. For each common share held as of the record date of December 29,2006, our shareholders received 0.2078824 Subordinate Voting Shares of Atrium.In May 2007, we opened an office in the United States, located at20 Independence Boulevard, Warren, New Jersey 07059-2731.

 

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Wecurrently have three wholly-owned direct and indirect subsidiaries,Æterna Zentaris GmbH (“AEZS Germany”), based in Frankfurt, Germany,Æterna Zentaris, Inc., based in Warren, New Jersey in the UnitedStates, and Zentaris IVF GmbH, a direct wholly-owned subsidiary of AEZS Germanybased in Frankfurt, Germany.

 

|                                         |                           |                                |
|----------------------------------------------|--------------------------------|-------------------------------------|
|                                         | **Æterna  Zentaris Inc.** | ** **                          |
|                                         | **(Canada)**                   | ** **                          |
| ** **                                   | ** **                     | ** **                          |
| ** **                                   | ** **                     | ** **                          | ** ** |
|                                         |                           |                                |   |   |   |
|                                         |                           |                                |   |   |   |
|                                         | 100%                           |                                |   | 100% |   |
|                                         |                           |                                |
| **Æterna  Zentaris GmbH**               | ** **                     | **Æterna  Zentaris, Inc** |
| **(Germany)**                                | ** **                     | **(Delaware)**                      |
|                                         |                           |                                |
|                                         |                           |                                |   |
|                                         | 100%                           |                                |   |
|  

Zentaris IVF GmbH

(Germany)

  |                           |                                |

 

Fromthe formation of Atrium as our subsidiary in 1999 until the distribution of ourremaining interest in Atrium on January 2, 2007, Atrium did not declare orpay any dividends to its shareholders. Since the disposition of our entireinterest in Atrium, we have not had access to the liquidity or cash flowsgenerated by Atrium. Our current drug development strategy focuses mainly onour late-stage compounds perifosine (Phase 3 in multiple myeloma) and our Phase2 program in multiple cancers, AEZS-108 (Phase 2 in ovarian and endometrialcancer) and AEZS-130 (SolorelTM) (Phase 3 as diagnostictest for adult growth hormone deficiency), as well as on targeted earlier-stagecompounds, as depicted in the chart reproduced under the heading, “OurProduct Pipeline”.

 

Ourcommon shares are listed for trading on the TSX under the trading symbol “AEZ”and on the NASDAQ under the trading symbol “AEZS.”

 

The Company’s agent for SEC matters in the UnitedStates is its wholly-owned subsidiary, Æterna Zentaris, Inc., located at20 Independence Boulevard, Warren, New Jersey 07059-2731.

 

There have been no publictakeover offers by third parties with respect to the Company or by the Companyin respect of other companies’ shares during the last or current fiscal year.

 

### ***B.            Business overview***

### *** ***

Weare a late-stage drugdevelopment company specialized in oncology and endocrine therapy. Our pipelineencompasses compounds at all stages of development, from drug discovery throughmarketed products. The highest priorities in oncology are our Phase 3program with perifosine in multiple myeloma and our Phase 2 program inmultiple cancers, including metastatic colon cancer, as well as ourPhase 2 program with AEZS-108 in advanced endometrial and advanced ovariancancer combined with potential developments in other cancer indications. Inendocrinology, our lead program is the reactivation of a Phase 3 trial withAEZS-130 (SolorelTM) as a growth hormone (“GH”) stimulation test forthe diagnosis of GH deficiency in adults (“AGHD”).

 

RecentDevelopments

 

For a complete description of our recentcorporate and pipeline developments, refer to Item 5, “Operating and FinancialReview and Prospects—Highlights”.

 

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**Our Business Strategy**

 

Ourprimary business strategy is to advance, with the collaboration of ourstrategic partners, our product development pipeline with a focus on our flagshipproduct candidates in oncology and endocrinology. In addition, we also continueto advance certain other clinical and pre-clinical programs as described below.Our vision is to become a fully-integrated specialty biopharmaceutical company.

 

***Oncology***

 

Ourhighest oncology priorities are our perifosine Phase 3 program in multiplemyeloma and Phase 2 program in multiple cancers including metastatic coloncancer, as well as our Phase 2 program with AEZS-108 in advanced endometrialand advanced ovarian cancer combined with potential development in other cancerindications.

 

*Perifosine*

 

Perifosineis an orally active PI3K/Akt pathway inhibitor in a Phase 3 registration trialin multiple myeloma conducted by our North American partner Keryx for theterritories of North America and Mexico under a Special Protocol Assessmentreached with the Food and Drug Administration (“FDA”), which has also grantedperifosine Orphan Drug and Fast Track designations. Perifosine is also incurrent multiple Phase 2 clinical studies, including metastatic colon cancer,renal cell carcinoma and various other cancers.

 

Furthermore,our partner Keryx announced on February 3, 2010 that it has reachedanother special protocol assessment in refractory metastatic colon cancer withthe FDA and is planning the initiation of a registration Phase 3 trial in thisindication.

 

*AEZS-108*

 

AEZS-108represents a new targeting concept in oncology leading to personalized medicineusing a cytotoxic peptide conjugate which is a hybrid molecule composed of asynthetic peptide carrier and doxorubicin. The design of AEZS-108 allows forthe specific binding and selective uptake of the cytotoxic conjugate byLHRH-receptor-positive tumors. Phase 2 trials in advanced endometrial cancerand advanced ovarian cancer have met their predefined primary efficacyendpoints.

 

***Endocrinology***

 

Inendocrinology, aside from Cetrotide®, we intend tofurther advance the development of our lead program by the reactivation andfurther advancement of a Phase 3 trial with AEZS-130 (SolorelTM ) as a GH stimulation testfor the diagnosis of AGHD.

 

*AEZS-130*

 

AEZS-130,a growth hormone secretagogue (GHS), is a novel synthetic small molecule actingas a ghrelin mimetic that is orally active and stimulates the secretion of GH.A pivotal Phase 3 trial was initiated in the United States to investigate itssafety and efficacy as a GH stimulation test for the diagnosis of AGHD forwhich Orphan Drug status has been granted by the FDA. In addition to thediagnostic indication, we believe that AEZS-130, based on the results of Phase1 studies, has potential applications for the treatment of cachexia, acondition frequently associated with severe chronic diseases such as cancer,chronic obstructive pulmonary disease and AIDS.

 

***Clinical and Preclinical Programs***

 

Additionally,we are advancing in Phase 1, AEZS-112, an oral anticancer agent which involvesthree mechanisms of action, tubulin and topoisomeras II and angiogenesicinhibition, as well as several preclinical programs with targeted potential developmentcandidates. Among the targets for which we expect to propose clinicaldevelopment candidates in the coming years are: AEZS-120 (prostate cancervaccine), AEZS-127 (erucylphosphocholine derivatives), AEZS-129 (Erk and PI3Kinhibitor), AEZS-115 (non-peptide LHRH antagonists) and AEZS-123 (ghrelinreceptor antagonist).

 

Wealso continue to perform targeted drug discovery activities from which we areable to derive pre-clinical candidates. This drug discovery includes highthroughput screening systems and a library of more than 120,000 compounds.

 

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We are currently in a stagein which some of our products and product candidates are being furtherdeveloped or marketed jointly with strategic partners. We expect we willcontinue to seek strategic partnerships in the future as we move to realize ourvision of becoming a fully-integrated specialty biopharmaceutical company.

 

**Our product pipeline**

 

**Pipeline table**

 

**Status of our drug pipelineas at March 22, 2010**

 
| **Discovery**            | ** ** | **Preclinical**                                                                                                                                                                                                                                                                                   | ** ** | **Phase 1**                                                                                    | ** ** | **Phase 2**                                                                                                                         | ** ** | **Phase 3**                                                                                                                               | ** ** | **Commercial**                                                                                                |
|--------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|
| 120,000 compound library |       | AEZS-120

Prostate cancer vaccine

(oncology)

 

AEZS-129 

Erk & PI3K Inhibitors (oncology)

 

AEZS-127

ErPC (oncology)

 

AEZS-123

Ghrelin receptor antagonist (endocrinology)

 

AEZS-115

Non-peptide LHRH antagonists

(endometriosis & urology) |       | AEZS-112 (oncology)

 

AEZS-130

Therapeutic in tumor induced cachexia 

(endocrinology) |       | Perifosine

· Metastatic colon cancer

· Kidney cancer

· AEZS-108

· Ovarian cancer

· Endometrial cancer |       | Perifosine

· Multiple myeloma

 

AEZS-130 (SolorelTM)

· Diagnostic  in adult growth hormone  deficiency (endocrinology) |       | Cetrotide®

(*in vitro*  fertilization)                                                                  |
| **Partners**             |       |                                                                                                                                                                                                                                                                                              |       |                                                                                           |       |                                                                                                                                |       |                                                                                                                                      |       |                                                                                                          |
| ** **               |       |                                                                                                                                                                                                                                                                                              |       |                                                                                           |       | Perifosine: **Keryx**North America

 

**Handok**Korea (oncology)                                                              |       | Perifosine: **Keryx**North America

 

**Handok**Korea (oncology)                                                                    |       | Cetrotide®:**Merck Serono**

(World ex-Japan)

** **

**Nippon Kayaku  /  Shionogi**Japan |

 

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**ONCOLOGY**

 

**SIGNAL TRANSDUCTION INHIBITORS**

 

**Perifosine**

 

Perifosine is analkylphosphocholine compound with structural similarity to phospholipids, whichare the main constituents of cellular membranes, and it is an active ingredientwith anti-tumor capacities. In tumor cells, perifosine has demonstratedinteractions with vital signal transduction mechanisms and induction ofprogrammed cell death (apoptosis).

 

 

Perifosineexerts a marked cytotoxic effect in animal and human tumor cell lines. The mostsensitive cancer cell lines were larynx carcinoma, breast, small cell lung,prostate and colon. Based on the *in vitro*trials, the mode of action of perifosine appears to be fundamentally differentfrom that of currently available cytotoxics. Pharmacodynamic data havedemonstrated that perifosine possesses anti-tumor activity, including tumormodels that are resistant to currently available agents for cancer therapy.This activity is based on a direct and relatively specific action on tumors.

 

Inpreclinical and clinical Phase 1 trials (solid tumors), this orallyadministered agent has been found to have good tolerability. Five Phase 1trials have been conducted on perifosine, including one trial of perifosine incombination with radiotherapy.

 

Basedon findings in various tumor models, the U.S. National Cancer Institute, alongwith our North American partner, Keryx, investigated additional dosage regimensof perifosine in oncology patients. A number of screening Phase 2 studiesexamined perifosine as a single agent or in combination in several tumor types.Encouraging results lead to further development in specific indications.

 

Perifosine,the first-in-class AKT inhibitor in multiple Phase 2 studies, is beingdeveloped as an orally active anti-cancer agent.

 

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***Perifosine— Anti-cancer agent***

 

Perifosine — Multiple myoloma (“MM”)

 

InJune and December 2007, Keryx announced preliminary positive Phase 1and Phase 2 data on perifosine in patients with relapsed/refractory MM. Datademonstrated clinical activity of perifosine in combination with bortezomib anddexamethasone, and with lenalidomide plus dexamethasone.

 

InDecember 2008, Keryx presented final results of the Phase 1 clinical trialin which patients with relapsed or refractory MM were administered acombination of perifosine + lenalidomide and dexamethasone. Four cohorts of > 6 patients each were enrolled and perifosine dose was 50 or 100mg (daily), lenalidomide dose was 15 or 25 mg for days 1 to 21 anddexamethasone dose was 20 mg (for days 1-4; 9-12; and 17-20 for 4 cycles,followed by 20 mg for days 1-4) in 28-day cycles. To limitdexamethasone-related toxicities, the protocol was amended to use weeklydexamethasone (40 mg), applying to cohorts 3, 4, and the Maximal Tolerated Dose(MTD) cohort.  Dose Limiting Toxicity (DLT) was defined as grade (G) 3non-hematologic toxicity, G4 neutropenia for 5 days and/or neutropenic fever,or platelets <25,000/mm3 on >1 occasiondespite transfusion. Response was assessed by modified EBMT criteria. To beenrolled, patients had to have received at least one but no more than fourprior therapies. Patients refractory to lenalidomide/dexamethasone wereexcluded.  32 patients (17 men and 15 women, median age 61 years old,range 37-80) were enrolled; 6 patients in cohort 1 (Perifosine 50 mg,lenalidomide 15 mg, Dexamethasone 20 mg); 6 patients in cohort 2 (Perifosine 50mg, lenalidomide 25 mg, Dexamethasone 20 mg); 8 patients in cohort 3(Perifosine 100 mg, lenalidomide 15 mg, Dexamethasone 40mg/week); 6 patients incohort 4 (Perifosine 100 mg, lenalidomide 25 mg, Dexamethasone 40 mg/week) and6 patients at MTD (Cohort 4). Median prior lines of treatment was 2 (range1-4).  Prior therapy included dexamethasone (94%), thalidomide (83%),bortezomib (47%), and stem cell transplant (47%).  37% of patients hadprogressed on prior Thalidomide/Dexamethasone.  Two patients did notcomplete one full cycle (non-compliance and adverse event not related to studydrugs — both in cohort 3) and were not included in the safety and efficacyanalysis.  Of the 30 patients evaluable for safety, the most common (>10%) grade 1 / 2 events included nausea (13%); diarrhea (17%); weight loss(17%); upper respiratory infection (23%); fatigue (30%); thrombocytopenia(20%); neutropenia (20%); hypophosphatemia (23%); increased creatinine (23%);anemia (36%); hypercalcemia (47%).  Grade 3 / 4 adverse events >5% included neutropenia (20%); hypophosphatemia (17%); thrombocytopenia (13%);anemia (10%), fatigue (7%).  There was one reported DLT in cohort 3(nausea).  Lenalidomide was reduced in 8 patients, Perifosine reduced in 8patients and Dexamethasone reduced in 6 patients.  All 30 patients in theanalysis were evaluable for response, with best response as follows:

 
| **Response:  N = 30**                       | ** ** | **N (%)** | ** ** | **Duration  (wks)**        | ** ** | **ORR ( >PR)** |
|--------------------------------------------------|------------|-----------|------------|----------------------------|------------|-------------------|
| Near Complete  Response (nCR)                    |       | 2 (7%)    |       | 79+, 15+                   |       |              |
| Very Good Partial Response (VGPR)                |       | 3 (10%)   |       | 62+, 34, 17                |       | 15 (50%)          |
| Partial Response (PR)                            |       | 10 (33%)  |       | 26+ (range 11 –  54+) |       |              |
| Minimal Response (MR)                            |       | 6 (20%)   |       | 17+ (range 9 -  30+)       |       |              |
| Stable Disease (SD)                              |       | 7 (23%)   |       | 14+ (range 8 –  19)   |       |              |
| Progression (PD)                                 |       | 2 (7%)    |       | 8, 4                       |       |              |
| stable disease:  < 25% reduction in M-protein |

 

Patientshave tolerated the treatment regimen of Perifosine + Lenalidomide +Dexamethasone well with manageable toxicity, and with encouraging clinical activitydemonstrated by an overall response rate (“ORR”) (> PR) of 50%.

 

Updated results of thisstudy were presented in February 2009 at the 12th International Multiple Myeloma Meeting by ourpartner Keryx. Results indicated that Perifosine in combination with Lenalidomide (Revlimid) + dexamethasonecontinues to be well tolerated, with a median progression-free survival inresponding patients of 10.9 months. Median overall survival still has not beenreached now at 17 months. Nine patients remain on active treatment.

 

Also in December 2008during the meeting of the American Society of Hematology, Keryx presentedresults of a Phase 1/2 multicenter trial of perifosine + bortezomib in patientswith relapsed or relapsed/refractory MM who were previously relapsed from orrefractory to bortezomib ± dexamethasone. The Phase I stage of the studyenrolled a total of 18 patients in 4 cohorts of 3 patients each with dosing ofPerifosine 50 mg or 100 mg (daily) and bortezomib 1.0 or 1.3 mg/m2 (on day1, 4, 8, 11) in 21-day cycles. The selected dose for Phase 2 was perifosine 50mg once daily + bortezomib 1.3 mg/m2 (on day 1, 4, 8, 11)in 21-day cycles, with a planned enrollment of 64 patients. Dexamethasone 20 mg(on day of and after each bortezomib dose) could be added in patients withprogressive disease (PD). For the Phase 1 portion, Dose limiting toxicity (DLT)was defined as any grade (G) 3 non-hematologic toxicity, G4 neutropeniafor 5 day and/or neutropenic fever, or platelets <10,000/mm3 on morethan one occasion despite transfusion. Response was assessed by modified EBMTand Uniform criteria. A total of 76 patients have been enrolled (18 patients inPhase 1 and 58 patients in Phase 2) comprised of 45 men and

 

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31 women, median age 63years old, (range 41-89). 84% of patients had relapsed/refractory MM, with amedian of 6 lines of prior treatment (range 2-13).  Prior therapy includedbortezomib (100%), dexamethasone (95%), thalidomide (79%), lenalidomide (71%)and stem cell transplant (57%).  63 patients have completed at least onecycle and were evaluable for safety (13 patients are currently not evaluable; 3were removed in cycle 1 and 10 are too early in their treatment). Most common(>10%) grade 1 / 2 events were nausea, diarrhea, fatigue andmyelosuppression, which were manageable with supportive care and growthfactors. Grade 3 / 4 adverse events >5% included thrombocytopenia (40%);lymphopenia (36%); neutropenia (21%); anemia (14%); hyponatremia (13%);leukopenia (11%); proteinuria (8%), and upper respiratory infection (6%). No deep vein thrombosis has been seen, and only one worsening peripheralneuropathy from grade 1 to 3 has been reported to date.  Two patients hadperifosine reduced to 50 mg (nausea, fatigue) in the Phase 1 cohort, and 7patients had bortezomib dose reductions primarily due to hematologictoxicity.  57 patients have completed at least 2 cycles and are evaluablefor response, with best response to perifosine + bortezomib (+/- dexamethasone)as follows:

 
| ** **                      | ** ** | ** ** | ** ** | **CR** | ** ** | **PR** | ** ** | **MR** | ** ** | **ORR** | ** ** | **SD** | ** ** |
|---------------------------------|------------|------------|------------|--------|------------|--------|------------|--------|------------|---------|------------|--------|------------|
| **All Patients: Best Response** | ** ** | **N=57**   | ** ** | **2**  | ** ** | **4%** | ** ** | **7**  | ** ** | **12%** | ** ** | **14** | ** ** | **25%** | ** ** | **23** | ** ** | **40%** | ** ** | **23** | ** ** | **40%** | ** ** |
| perifosine  + bortezomib        |       | 57         |       | 1      |       | 2%     |       | 5      |       | 9%      |       | 8      |       | 14% |   | 14 |   | 24% |   | 17 |   | 30% |   |
| With  dexamethasone added*      |       | 31         |       | 1      |       | 2%     |       | 2      |       | 3%      |       | 6      |       | 11% |   | 9 |   | 16% |   | 6 |   | 11% |   |

 

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(* as a subset of the evaluable population)

 

9of 76 patients (12%) rapidly progressed without response or stable disease,including 6 patients in whom dexamethasone was also added.  As of August 2008,the median time to progression (TTP) for patients achieving > PR is34 weeks, and for all patients achieving > MR is 33 weeks. Perifosinein combination with bortezomib (+/- dexamethasone) was generally well toleratedand is remarkably active in a heavily pre-treated Bortezomib-exposed patientpopulation, with an ORR of 40%, including an ORR of 37% and a median TTP of9.25 months in responding but previously bortezomib-refractory patients.

 

Updateddata for the effect of perifosine in combination with bortezomib +/-dexamethosone were reported at the 12th International Multiple Myeloma Meeting in February 2009by our partner Keryx.Eighty-four patients were enrolled in a combined Phase I/II study (18 patientsin the Phase I component and 66 patients in the Phase II component). At thetime of this analysis, 73 patients were evaluable for response. Median priorlines of therapy was 5 (range 1 - 13), including; 100% of patients had beentreated with bortezomib (50% of the patients were previously treated with atleast 2 bortezomib-based therapies and 81% were previously treated withbortezomib plus dexamethasone); 98% of patients were previously treated withdexamethasone; 99% of patients were previously treated with lenalidomide(Revlimid) and/or thalidomide (Thalomid); and 57% of patients had prior stemcell transplant. No unexpected adverse events have been seen. Toxicities weremanageable with supportive care and/or dose reductions as required.

 

Best response (MR or better) and stable disease(no progression for 3 months) to either perifosine + bortezomib(+/-dexamethasone) for patients previously relapsed from or refractory to priorbortezomib treatment was as follows:

 
| **Evaluable  Patients**        | ** ** | **CR** | ** ** | **PR** | ** ** | **MR** | ** ** | **ORR** | ** ** | **SD  > 3 mos** | ** ** |
|--------------------------------|------------|--------|------------|--------|------------|--------|------------|---------|------------|--------------------|------------|
| Bortezomib Relapsed  (n=20)    |       | 2      |       | 10%    |       | 6      |       | 30%     |       | 3                  |       | 15% |   | 11 |   | 55% |   | 9 |   | 45% |   |
| Bortezomib Refractory  (n=53)  |       | 1      |       | 2%     |       | 6      |       | 11%     |       | 10                 |       | 19% |   | 17 |   | 32% |   | 24 |   | 45% |   |
| All Evaluable  Patients (n=73) |       | 3      |       | 4%     |       | 12     |       | 16%     |       | 13                 |       | 18% |   | 28 |   | 38% |   | 33 |   | 45% |   |

 

Patients who hadpreviously relapsed on a bortezomib-based treatment had a median time toprogression (TTP) of 8.5 months. The median TTP for all 73 evaluable studypatients (both bortezomib relapsed and refractory) was 6.4 months. As stated inKeryx’s February 26, 2009 press release, there were 16 patients remain onactive treatment.

 

Updated efficacy and safety data as well asnew survival data on the clinical activity of perifosine in combination withbortezomib (Velcade®) +/- dexamethasone in patients withrelapsed/refractory multiple myeloma were presented by ourpartner Keryx during the ASH 2009 meeting in December 2009. Of the 73 evaluable patients, 53 patients(73%) were previously refractory to bortezomib (defined as progression on orwithin 60 days of treatment to a bortezomib-based regimen), including 44patients who were refractory to the combination of bortezomib + dexamethasone.Twenty evaluable patients (27%) were relapsed to a prior bortezomib-basedregimen. Best response for all 73 evaluable patients was as follows:

 

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| **Evaluable Patients**        | ** ** | **CR /nCR*** | ** ** | **PR** | ** ** | **MR** | ** ** | **ORR** | ** ** | **SD**** | ** ** |
|-------------------------------|------------|--------------|------------|--------|------------|--------|------------|---------|------------|----------|------------|
| All Evaluable Patients (n=73) |       | 3            |       | 4%     |       | 13     |       | 18%     |       | 14       |       | 19% |   | 30 |   | 41% |   | 30 |   | 41% |   |
| Bortezomib Relapsed (n=20)    |       | 2            |       | 10%    |       | 7      |       | 35%     |       | 4        |       | 20% |   | 13 |   | 65% |   | 7 |   | 35% |   |
| Bortezomib Refractory (n=53)  |       | 1            |       | 2%     |       | 6      |       | 11%     |       | 10       |       | 19% |   | 17 |   | 32% |   | 23 |   | 43% |   |

 

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*                 nCR = Near Complete Response is defined as meeting thecriteria for CR (non-detectable monoclonal protein by serum and urine), exceptwith detectable monoclonal protein by immunofixation.

**          SD = Stable Disease for aminimum of 3 months.

 

Approximately 60% (45 /73) of patients demonstrated progression (or SD for 4 cycles) at some point intheir treatment and received 20 mg dexamethasone, four times per week, inaddition to perifosine plus bortezomib. Responses occurred both with patientstaking perifosine in combination with bortezomib and with patients receivingthe combination plus dexamethasone. Best response for each group was asfollows:

 
| **Best Response**              | ** ** | **CR /nCR** | ** ** | **PR** | ** ** | **MR** | ** ** | **ORR** | ** ** | **SD** | ** ** |
|--------------------------------|------------|-------------|------------|--------|------------|--------|------------|---------|------------|--------|------------|
| Perifosine + Bortezomib (n=73) |       | 2           |       | 3%     |       | 10     |       | 14%     |       | 6      |       | 8% |   | 18 |   | 25% |   | 19 |   | 26% |   |
| Dexamethasone added (n=45)     |       | 1           |       | 2%     |       | 6      |       | 13%     |       | 10     |       | 23% |   | 17 |   | 38% |   | 14 |   | 31% |   |

 

Five patients achieved aninitial response on perifosine + bortezomib alone, and subsequently respondedagain with the addition of dexamethasone. Three additional patients achievedstable disease on perifosine + bortezomib alone, and subsequently achievedstable disease again with the addition of dexamethasone.

 

Reported for the firsttime was median Progression-Free Survival (PFS) and Overall Survival (OS) datafor all evaluable patients, as follows:

 
| **Evaluable Patients**         | ** ** | **Median PFS***             | ** ** | **Median OS****            |
|--------------------------------|------------|-----------------------------|------------|----------------------------|
| All  Evaluable Patients (n=73) |       | 6.4 months95% CI (5.3, 7.1) |       | 25 months95% CI (15.5, NR) |

 

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NR = Not Reached

*                 Median PFS and median TTP were identical, as nopatient deaths occurred prior to progression.

**          Kaplan Meier methodology wasused to determine overall survival figures.

 

Ofparticular interest was the comparison of evaluable patients who werepreviously refractory and the patients who were relapsed to a bortezomib-basedregimen. Median PFS and OS for bortezomib relapsed vs. refractory were asfollows:

 
| **Bortezomib Relapsed vs. Refractory** | ** ** | **Median PFS***                  | ** ** | **Median OS****                              |
|----------------------------------------|------------|----------------------------------|------------|----------------------------------------------|
| Bortezomib  Relapsed (n=20)            |       | 8.8  months

95% CI  (6.3, 11.2) |       | Not  Reached at 38+ months

95%  CI (25, NR) |
| Bortezomib  Refractory (n=53)          |       | 5.7  months

95% CI  (4.3, 6.4)  |       | 22.5  months

95% CI  (12.3, NR)             |

 

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*                 Median PFS and median TTP were identical, as nopatient deaths occurred prior to progression.

**          Kaplan Meier methodology was used to determine overallsurvival figures.

 

No unexpected adverse events have been observed.Toxicities were manageable with supportive care.

 

In August 2009, ourpartner Keryx announced that it has reached an agreement with the FDA regardinga Special Protocol Assessment (“SPA”) on the design of a Phase 3 trial forperifosine, in relapsed or relapsed/refractory multiple myeloma patientspreviously treated with bortezomib (Velcade®).The SPA provides agreement that the Phase 3 study design adequately addressesobjectives in support of a regulatory submission. The study, entitled, “A Phase3 Randomized Study to Assess the Efficacy and Safety of Perifosine Added to theCombination of Bortezomib and Dexamethasone in Multiple Myeloma PatientsPreviously Treated with Bortezomib”, will be a double-blind, placebo-controlledstudy comparing the efficacy and safety of perifosine vs. placebo when combinedwith bortezomib and dexamethasone. The trial, powered at 90%, will enrollapproximately 400 patients with relapsed or relapsed/refractory multiplemyeloma (patients can be relapsed from and refractory to all non-bortezomibbased therapies, however, patients can only be relapsed (progressed > 60days after

 

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discontinuing therapy)from prior bortezomib-based therapies). The primary endpoint isprogression-free survival and secondary endpoints include overall responserate, overall survival and safety. The Phase 3 trial is a randomized (1:1),double-blind trial comparing the efficacy and safety of perifosine to placebowhen combined with bortezomib and dexamethasone. Patients must have beenpreviously treated with both bortezomib (Velcade®)and an immunomodulatory agent (Revlimid® or Thalidomid®)and previously treated with one to four prior lines of therapy. The primaryendpoint is progression-free survival and secondary endpoints include overallresponse rate, overall survival and safety. We announced the initiation, by our partner Keryx, of the enrollment ofpatients for this Phase 3 trial on December 16, 2009. Enrolled patientswill be randomized to bortezomib (Velcade®)at 1.3 mg/m2 days 1, 4, 8 and 11 every 21 daysin combination with dexamethasone 20 mg on the day of and day after bortezomib(Velcade®) treatment, and either perifosine 50 mgdaily or placebo. We expect a patient recruitment period of approximately 16-18months, with study completion expected within approximately 20-22 months fromtoday. Approximately 265 events (defined as disease progression or death) willtrigger the un-blinding of the data.

 

In September 2009,our partner Keryx announced that it had received orphan-drug designation forperifosine from the FDA for the treatment of multiple myeloma. Orphan-drugdesignation is granted by the FDA Office of Orphan Drug Products to novel drugsor biologics that treat a rare disease or condition affecting fewer than200,000 patients in the U.S. The designation provides the drug developer with aseven-year period of U.S. marketing exclusivity if the drug is the first of itstype approved for the specified indication or if it demonstrates superiorsafety, efficacy or a major contribution to patient care versus another drug ofits type previously granted the designation for the same indication.

 

On December 2, 2009,we announced that the FDA had granted Fast Track designation for perifosine forthe treatment of relapsed/refractory multiple myeloma. The Fast Track programof the FDA is designed to facilitate the development and expedite the review ofnew drugs that are intended to treat serious or life-threatening conditions andthat demonstrate the potential to address unmet medical needs. Fast Trackdesignated drugs ordinarily qualify for priority review, thereby expediting theFDA review process.

 

In March 2010, weannounced that we had received a positive opinion for orphan medicinal productdesignation for perifosine from the Committee for Orphan Medicinal Products ofthe European Medicines Agency, for the treatment of multiple myeloma. Orphanmedicinal product designation is granted by the European Commission, followinga positive opinion from the COMP, to a medicinal product that is intended forthe diagnosis, prevention or treatment of a life-threatening or a chronicallydebilitating condition affecting not more than five in 10,000 persons in theEuropean Community when the application for designation is submitted.

 

Orphan medicinal productdesignation provides the sponsor with access to the Centralized Procedure forthe application for marketing authorization, protocol assistance, up to a 100%reduction in fees related to a marketing authorization application,pre-authorization inspection and post-authorization activities, and couldprovide ten years of market exclusivity in EU, once approved for the treatmentof multiple myeloma.

 

**Competitors for Perifosine inMultiple Myeloma Indication**

 

Products on the market:

 

Major products available on the market for the treatment of multiplemyeloma are the following:

 

Velcade® (bortezomib —manufactured by Millenium: The Takeda Oncology Company), a proteasome inhibitorapproved in combination with melphalan (Alkeran® - manufactured by Celgene) and prednisone as a1st-line treatment and as a monotherapy for 2nd-linetreatment in both U.S. and E.U. Millennium reported more than $1 billion inglobal Velcade® sales in 2008.[Velcade® is co-developedby Millennium Pharmaceuticals, Inc. and Johnson & JohnsonPharmaceutical Research & Development, L.L.C. Millennium isresponsible for commercialization of VELCADE in the U.S., Janssen-Cilag isresponsible for commercialization in Europe and the rest of the world. JanssenPharmaceutical K.K. is responsible for commercialization in Japan.]

 

Caelyx®/Doxil® (pegylated liposomal doxorubicin —manufactured by Schering Plough), a topoisomerase II inhibitor and DNAintercalating agent, is approved as a 2nd-linetreatment in combination with Velcade® in patients with advanced multiple myeloma.

 

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Thalomid® (thalidomide — manufactured by Celgene), anantiangiogenic compound has been approved by the FDA for use in combinationwith dexamethasone for the treatment of patients with newly diagnosed multiplemyeloma. The Australian Therapeutic Goods Administration, or TGA, approved asupplemental filing granting Thalomid® marketing approval for use in combination withmelphalan and prednisone for patients with untreated multiple myeloma orineligible for high-dose chemotherapy, and also granted Thalomid® marketing approval in combination withdexamethasone for induction therapy prior to high-dose chemotherapy withautologous stem cell rescue, for the treatment of patients with untreatedmultiple myeloma. In addition, Thalomid® was granted full marketing authorization bythe European Commission, or EC, for use in combination with melphalan andprednisone as a treatment for patients with newly diagnosed multiple myeloma.Internationally, Thalomid® is also distributed under mandatoryrisk-management distribution programs tailored to meet local competentauthorities’ specifications to help ensure the safe and appropriatedistribution and use of Thalomid®. According toCelgene’s 2009 Annual Report, Thalomid® sales were down 13.4% to approximately $436.9million in 2009.

 

Revlimid® (lenalidomide — manufactured by Celgene):Revlimid® is an oral immunomodulatory drug approved bythe FDA and a number of other regulatory agencies in Europe, Latin America,Middle East and Asia/Pacific for treatment in combination with dexamethasone formultiple myeloma patients who have received at least one prior therapy and inAustralia and New Zealand in combination with dexamethasone for the treatmentof patients whose disease has progressed after one therapy. Revlimid® is distributed internationally under mandatoryrisk-management distribution programs tailored to meet local competentauthorities’ specifications to help ensure the safe and appropriatedistribution and use of Revlimid®.  Revlimid® continues to be evaluated in numerous clinicaltrials worldwide either alone or in combination with one or more othertherapies in the treatment of a broad range of hematological malignancies,including multiple myeloma, MDS, non-Hodgkin’s lymphoma, or NHL, chroniclymphocytic leukemia, or CLL, other cancers and other diseases. According toCelgene’s 2009 Annual Report, Revlimid® sales were up 28.8% to approximately $1.7billion in 2009.

 

Products in Phase 3 development:

 

Panobinostat (LBH5893) — Novartis: Panobinostat is a highly potentpan-deacetlyase inhibitor (pan-DACi) developed by Novartis. Panobistat’smechanism of action involves disrupting aggresome function, promotingaccumulation of cytotoxic misfolded protein aggregates and triggering of mylomacell death. Combination of pan-DAC and protease inhibition by co-treatment withpanobinostat and bortezomib as demonstreated synergistic cytotoxicity *in vitro* and *in vivo* inpreclinical experiments. Clinical experience in advanced multiple myelomapatients treated by oral panobinostat and i.v. bortezomib +/- dexamethasoneshowed efficacy and manageable toxicity profile. Panobinostat is currently inPhase 3 trial in patients with relapsed multiple myeloma in combination withBortezomib.

 

Idamycin (Idarubicin) — Pfizer: Idarubicin is an oral anthracyclines andan analogue of daunorubicin (but 5 to 6 times more potent than daunorubicin)developed by Pfizer. The mechanism of action of anthracyclines is poorlyunderstood and cytotoxicity is generally attributed to intercalation of thedrug into DNA and inhibition of DNA topoisomerase II activity resulting indouble and single strand DNA breaks. Idarubicin is already approved in Canadafor Acute lymphocytic leukemia in adults and children as a second-linetreatment and in Acute non-lyphocytic leukemia in adults as a front-linetreatment or for refractory/relapsed disease. Idarubicin is currently in Phase3 clinical trial for patients with Stage I or Stage II multiple myeloma incombination with dexamethasone.

 

Zolinza (vorinostat — MK0683) — Merck: Zolanza is an oral histonedeacetylase (HDAC) inhibitor developed by Merck. Zolinza works by inhibitingthe enzymatic activity of HDAC1, HDAC2, HDAC3 (Class 1) and HDAC6 (Class II).Inhibition of HDAC may result in anti-cancer effects since HDAC inhibitors,like zolinza, have the ability to induce antiproliferative effects includingcyto-differentiation, cell cycle growth arrest or apoptosis in various cancercell lines. The exact mechanism of the anticancer effect of Zolinza has notbeen fully characterized. Phase 1 results showed early anti-tumor activity inpatients with releaspsed and/or refractory multiple myeloma when zolenza wasadministered in combination with bortezomib, including in patients previouslytreated with and no longer responding to bortezomib. A Phase 3 randomized,double-blind, placebo-controlled trial of zolinza in combination withbortezomib in patients with relapsed and/or refractory multiple myeloma iscurrently enrolling patinents. Pulmonary embolism and deep vein thrombosis havebeen reported as adverse reactions following treatment with zolenza.

 

Carfilzomib — Onyx Pharmaceuticals: Carfilzomib is the first in a new class of selective,irreversible proteasome inhibitors being developed by Proteolix (now part of Onyx Pharmaceuticals) for the treatment of hematologic malignancies and solidtumors. Carfilzomib produces specific and sustained inhibition of theproteasome, leading to apoptosis in cancer cells with minimal off-targeteffects. In Phase 1 and Phase 2 clinical trials, carfilzomib has demonstratedsingle-agent activity in hematologic malignancies and solid tumors, includingmultiple myeloma, Waldenstrom’s macroglobulinemia, mantle cell lymphoma andrenal cell carcinoma. Carfilzomib was generally well tolerated and toxicitieswere manageable. A Phase 3 international randomized trial evaluating theefficacy of carfilzomib in combination with lenalidomide and dexamethasone

 

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versus lenalidomide and dexamethasone as apotential treatment option for patients with relapsed multiple myeloma isexpected to begin in April 2010. Orphan Drug designation was granted by EMA in June 2008 for thetreatment of multiple myeloma.

 

Multiple myeloma is the second most-commonhematologic cancer, representing 1% of all cancer diagnoses and 2% of allcancer deaths.

 

According to the International Myeloma Foundation,more than 85,000 men and women in Europe underwent treatment for multiplemyeloma in 2007 and 25,000 people were expected to die from multiple myeloma in2007. According to the American Cancer Society, an estimated 20,580 new casesof multiple myeloma were diagnosed in the United States and 10,500 people wereexpected to die from multiple myeloma in the United States in 2009.

 

Perifosine— Colon Cancer

 

In June 2009, our partner Keryx presentedresults of a randomized Phase 2 study of perifosine in combination withcapecitabine versus capecitabine alone in patients with second- or third-linemetastatic colon cancer.

 

This randomized, double-blind,placebo-controlled study was conducted at 11 centers across the United States.Patients with 2nd or 3rd line metastatic colon cancer were randomized toreceive capecitabine (Xeloda®), an approved drug for metastatic colon cancer, at adose of 825 mg/m2 BID (total daily dose of 1650 mg/m2) ondays 1 - 14 every 21 days, plus either perifosine or placebo at 50 mg daily.Treatment was continued until progression. The study enrolled a total of 38patients, 34 of which were third-line or greater. Of the 38 patients enrolled,35 were evaluable for response (20 patients on the capecitabine + perifosinearm and 15 patients on the capecitabine + placebo arm). The three patients notevaluable for response were all in the capecitabine + placebo arm; 2 patientswere inevaluable due to toxicity (days 14, 46) and 1 patient was inevaluabledue to a new malignancy on day 6. All patients in the perifosine + capecitabinearm were evaluable for response.

 

The patients in the study were heavilypre-treated, with the arms well-balanced in terms of prior treatment regimens.The median number of prior treatment regimens for all 38 patients was two, withprior treatment regimens as follows: 91% of the patients received prior FOLFIRI(Irinotecan + 5FU + Leucovorin); 74% prior FOLFOX (Oxaliplatin + 5FU +Leucovorin); 63% were previously treated with both FOLFIRI and FOLFOX; 77% receivedprior Avastin; and 43% prior Erbitux®. Prior treatment with singleagent capecitabine was excluded.

 

The primary endpoints of this study were tomeasure 1) Time to Progression (TTP); 2) Overall Response Rate (ORR), definedas the percentage of patients achieving a Complete Response (CR) or PartialResponse (PR) by RECIST, and 3) Clinical Benefit Rate (CBR) defined as thepercentage of patients on treatment for greater than three months with at leaststable disease. Safety of perifosine + capecitabine vs. capecitabine + placeboin this patient population was evaluated as a secondary endpoint. Perifosine incombination with capecitabine was well tolerated with hand/foot syndrome (14%)and anemia (11%) as the highest reported grade 3/4 adverse events.

 

Best response and median time to progression ofcapecitabine + perifosine vs. capecitabine + placebo were as follows:

 
| **Group**                  | ** ** | **N** | ** ** | **CR  N(%)** | ** ** | **PR  N(%)** | ** ** | **ORR  N(%)** | ** ** | **SD  > 12  wks N(%)** | ** ** | **CBR  N(%)** | ** ** | **Median  TTP  (wks)**        | ** ** |
|----------------------------|------------|-------|------------|--------------|------------|--------------|------------|---------------|------------|---------------------------|------------|---------------|------------|-------------------------------|------------|
| Capecitabine +  Perifosine |       | 20    |       | 1

(5%)      |       | 3

(15%)     |       | 4

(20%)      |       | 11

(55%)                 |       | 15

(75%)     |       | 28.9 weeks{95% CI (13, 48.1)} |       |
| Capecitabine + Placebo     |       | 15    |       | 0            |       | 1

(7%)      |       | 1

(7%)       |       | 5

(33%)                  |       | 6

(40%)      |       | 11 weeks{95% CI (9, 15.9)}    |       |

 

Perifosine + capecitabine more than doubled timeto progression vs. capecitabine + placebo with a statistically significantp-value = 0.0006. In addition, perifosine + capecitabine more than doubled theORR and almost doubled the Clinical Benefit Rate vs. capecitabine + placebo.

 

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Although not a primary endpoint in the study,overall survival was analyzed with results as follows:

 
| **Group**                 | ** ** | **Median  Overall Survival*(months)** | ** ** | **%  change**  |
|---------------------------|------------|---------------------------------------|------------|----------------|
| Capecitabine + Perifosine |       | 22 {95% CI (12.1, NR)}                |       | 26% Increase** |
| Capecitabine + Placebo    |       | 16.3 {95% CI (5.3, 17.1)}             |       |           |

 

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*                 Survival calculated from date of randomization untildate of death from any cause, whether or not additional therapies were receivedafter removal from treatment.

**          As of May 2009, median overall survival in theperifosine + capecitabine patient group is ongoing with 10 of the 20 patientsin this arm still alive.

 

Updatedresults of this Phase 2 study were presented in January 2010 by ourpartner Keryx during the ASCO Gastrointestinal Cancers symposium. The primaryendpoint of this study was to measure TTP. ORR, defined as CR+PR by RECIST, andoverall survival (OS) was measured as a secondary endpoint. Updated resultsdemonstrated astatistically significant advantage in the combination arm of perifosine +capecitabine for TTP and OS, as well as for the percentage of patientsachieving Stable Disease (SD) lasting 12 or more weeks or better, as comparedto the capecitabine arm. The perifosine + capecitabine arm demonstrated agreater than 60% improvement in OS, a more than doubling of median TTP, andalmost a doubling of the percentage of patients achieving SD or better. Inaddition, the ORR was 20% (including one CR, and durable responses) in theperifosine + capecitabine arm vs 7% in the capecitabine arm. The updatedefficacy results for all evaluable patients are as follows:

 
| **Group**                 | ** ** | **N** | ** ** | **ORR %  CR / PR********(Duration of Response)** | ** ** | **> SD (min 12 wks)********N (%)********p=0.036** | ** ** | **Median TTP********Weeks********p=0.0012** | ** ** | **Median OS*  Months********p=0.0136** |
|---------------------------|------------|-------|------------|--------------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------|
| Perifosine + Capecitabine |       | 20    |       | 20%1 CR (34 mos - ongoing)3 PR (21, 19, 11 mos)  |       | 15 (75%)                                             |       | 28 [95% CI (12-48)]                         |       | 18 [95% CI (10.8-25.7)]                |
| Capecitabine              |       | 15    |       | 7%1 PR (7 mos)                                   |       | 6 (40%)                                              |       | 11 [95% CI (9-15.9)]                        |       | 11 [95% CI (5.3-16.9)]                 |

 

Of notable interest, andfor the first time presented, were data showing a highly statisticallysignificant benefit in median OS (more than doubling) and TTP for the subset ofpatients who were refractory to a 5-FU (Fluorouracil) chemotherapy-basedtreatment regimen. 5-FU is a core component of the standard of care FOLFIRI andFOLFOX regimens, and capecitabine is a 5-FU pro-drug. These results are shownbelow:

 
| **Group**                 | ** ** | **5-FU Ref********N (%)** | ** ** | **> SD (min 12 wks)********N (%)********p=0.066** | ** ** | **Median TTP********Weeks********p=0.0004** | ** ** | **Median OS   Months********p=0.0088** |
|---------------------------|------------|---------------------------|------------|------------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------|
| Perifosine + Capecitabine |       | 14 (70%)                  |       | 1 PR / 8 SD (64%)                                    |       | 18 [95% CI (12-36)]                         |       | 15.3 [95% CI (8.4-26)]                 |
| Capecitabine              |       | 11 (73%)                  |       | 0 PR / 3 SD (27%)                                    |       | 10 [95% CI (6.6-11)]                        |       | 6.8 [95% CI (4.8-11.7)]                |

 

All 38patients were evaluable for safety. The perifosine + capecitabine combinationwas well-tolerated with Grade 3 and Grade 4 adverse events of > 10%incidence for perifosine + capecitabine arm versus capecitabine arm as follows:anemia (15% vs. 0%), fatigue (0% vs. 11%), abdominal pain (5% vs. 11%) andhand-foot syndrome (30% vs. 0%). Of note, incidence of Grade 1 and Grade 2hand-foot syndrome was similar in both the perifosine + capecitabine andcapecitabine arms (25% vs. 22%, respectively). Hand-foot syndrome is a reportedadverse event with capecitabine monotherapy. Patients who remained on treatmentlonger in the Phase 2 study had a greater chance to develop hand-foot syndromeas illustrated by a median time to onset of Grade 3 and Grade 4 hand-footsyndrome in the perifosine + capecitabine arm of 19 weeks.

 

On February 3, 2010,our  partner Keryx announced that it hadreached an agreement with the FDA regarding a SPA on the design of a Phase 3trial for perifosine in patients with refractory metastatic colorectal cancer.The Phase 3 X-PECT (Xeloda® + Perifosine Evaluation in Colorectal cancerTreatment) trial will be a randomized (1:1), double-blind trial comparing theefficacy and safety of perifosine + capecitabine (Xeloda®) vs. placebo + capecitabine in approximately 430patients with refractory metastatic colorectal cancer. Patients must havefailed available therapy including 5-fluorouracil, oxaliplatin (Eloxatin®), irinotecan, bevacizumab (Avastin®) and, if K-Ras wild-type, failed therapy with priorcetuximab (Erbitux®) or panitumumab (Vectibix®). For oxaliplatin-based therapy, failure of therapywill also include patients who discontinued due to toxicity. The primaryendpoint is overall survival, with secondary endpoints including overallresponse rate (complete

 

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responses + partialresponses), progression-free survival and safety.  Approximately 40 to 50 U.S. sites willparticipate in the study. The study is expected to begin in 2Q 2010, andenrollment is expected to take approximately 12 months, with  study completion expected in 2H 2011. Dr. JohannaBendell, Director of GI Oncology Research for the Sarah Cannon ResearchInstitute, Nashville, Tennessee, will lead the Phase 3 investigational team.

 

**Competitors for Perifosine incolon cancer indication:**

 

Products on the market:

 

Standard 1st-line therapies for treatmentof colon cancer are usually the FOLFOX (5-fluorouracil; leucovorin;oxaliplatin) or the FOLFIRI (5-fluorouracil; leucovorin; irinotecan)combination.

 

The current therapies also include:

 

Xeloda® (Capecitabine — manufacture by Roche) is anoral fluoropyrimidine which generates fluorouracil preferentially in tumortissues by enzymatic cascade and is used in 1st or 2nd-linesetting for treatment of metastatic colorectal or colon cancer in monotherapyand also in combination with any chemotherapy in all lines with or withoutAvastin. According to Roche’s 2009 Annual Report, sales of Xeloda forcolorectal, stomach and breast cancer increased 7% to 1.3 billion Swiss francsin 2009.

 

Avastin® (Bevacizumab, a humanized monoclonal antibodytargeting vascular endothelial growth factor — manufactured by Genentech/Roche)is also used in 1st or 2nd —line treatment of metastatic colorectalcancer combined with available Standard therapy FOLFOX. According to Roche’s2009 Annual Report, sales of Avastin® for advanced colorectal, breast, lung andkidney cancer, and for relapsed glioblastoma (a type of brain tumour), rose21% to6.2 billion Swiss francs in 2009.

 

Erbitux® (Cetuximab) is a chimeric monoclonalantibody that specifically blocks the epidermal growth factorreceptor (EGFR). Cetuximab is indicated for the treatment of patients withEGFR-expressing, KRAS wild-type metastatic colorectal cancer in combinationwith Standard chemotherapy FOLFIRI, and in patients who have failedoxaliplatin- and irinotecan-based therapy. Erbitux® is manufactured and distributed in NorthAmerica by ImClone and Bristol-Myers Squibb, while in the rest of the worlddistribution is by Merck KGaA.

 

Vectibix® (Panitumumab) is a recombinant, humanIgG2 kappa monoclonal antibody manufactured by Amgen that binds specifically tothe human epidermal growth factor receptor (EGFR). Vectibix® is indicated as a single agent for thetreatment of EGFR-expressing, metastatic colorectal carcinoma with diseaseprogression on or following fluoropyrimidine-, oxaliplatin-, andirinotecan-containing chemotherapy regimens. There are 2 boxed warnings forVectibix®: dermatologic toxicity andinfusion reactions.

 

Product in Phase 3 development:

 

Aflibercept — Sanofi + Regeneron: Aflibercept is an anti-angiogenesisinhibitor with a unique mechanism of action being developed by Sanofi andRegeneron. This fusion protein binds all forms of Vascular Endothelial GrowthFactor-A (VEGF-A), as well as VEGF-B and placental growth factor (PIGF),additional angiogenic growth factors that appear to play a role in tumorangiogenesis and inflammation. Aflibercept has been shown to bind VEGF-A, VEGF-B,and PlGF with higher affinity than their natural receptors. Three Phase 3studies are actually ongoing, each of which is currently over 70 percentenrolled:

 

·                  VELOURstudy: 2nd-line metastatic colorectal cancer in combination with fluorouracil,leucovorin, and irinotecan (FOLFIRI);

·                  VITALstudy: 2nd-line non-small cell lung cancer in combination with docetaxel;

·                  VENICEstudy: 1st-line hormone-refractory metastatic prostate cancer in combinationwith docetaxel and prednisone.

 

Aptocine — Light Sciences Oncology: Aptocine is a water-soluble drugtargeted by a single-use, disposable drug activator included with the drug.Aptocine has three mechanisms of action: direct tumor cytotoxicity, apoptosiscaused by vascular shutdown and potential anti-tumor immune stimulation.Enrollment of a Phase 3 trial for aptocine in metastatic colorectal cancer isnearly completed. This Phase 3 trial is a 450-patient trial, conductedprimarily at sites in Europe and India, to assess the progression-free survivaland overall survival of patients treated with Aptocine plus chemotherapy versuschemotherapy alone.

 

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Brivanib — Bristol-Myers Squibb: Brivanib, developed by Bristol-MyersSquibb, is an oral prodrug of BMS-540215, a dual tyrosine kinase inhibitor ofVEGFR and FGFR signaling. Brivanib strongly binds to and inhibits VEGFR2, atyrosine kinase receptor expressed almost exclusively on vascular endothelialcells. The inhibition of VEGFR2 may result in inhibition of tumor angiogenesis,inhibition of tumor cell growth, and tumor regression. Brivanib is currently inPhase 3 randomized trial investigating Brivanib Alaninate in combination withcetuximab (Erbitux®) vs. placebo in combinationwith cetuximab (Erbitux®) in patients withK-RAS tumors previously treated with combination chemotherapy for metastaticcolorectal carcinoma. It is not yet known whether giving brivanibtogether with cetuximab is more effective than cetuximab alone in treatingpatients with metastatic colorectal cancer.

 

OncoVax — Vaccinogen: OncoVax is an autologous tumour cell vaccine and preparedfor each patient using the patient’s own surgically removed tumor. The activespecific immunotherapy falls within the classification of Advanced TherapeuticMedicinal Product (ATMP). The patient received the first of four vaccinationsseveral weeks after surgery. The vaccine consists of a portion of the tumorcells that has been thawed and combined with a proprietary formulation of BCGthat serves as an immunogenic enhancer. This formulation is also used for the 2nd inoculation. The 3rd and the final booster incolucations areprepared the same way but without the addition of BCG. Phase 3a resultsdemonstrated efficacy of Oncovax® in Stage II colon cancer patients with astatistical significant increased 5-year overall survival rate and increasedrecurrence-free survival by log-rank analysis. OncoVAX® currently has a marketing authorization fromSwissmedic, Switzerland’s medical authority, in the category of “procedestherapeutiques”. A pre-submission meeting to request Scientific Advice from theEMA for submission of a Conditional Marketing Autorization was done in December 2009.

 

Accordingto the American Cancer Society, colorectal cancer is the third most common formof cancer diagnosed in the United States. It is estimated that over 146,000people were diagnosed with some form of colorectal cancer with over 49,000patients dying from colorectal cancer in 2009. Surgery is often the maintreatment for early stage colorectal cancer. When colorectal cancermetastasizes (spreads to other parts of the body such as the liver),chemotherapy is commonly used. Treatment of patients with recurrent or advancedcolorectal cancer depends on the location of the disease. Chemotherapy regimens(i.e. FOLFOX or FOLFIRI either with or without bevacizumab) have been shown toincrease survival rates in patients with metastatic/advanced colorectal cancer.Currently, there are seven approved drugs for patients with metastaticcolorectal cancer: 5-fluorouracil (5-FU), capecitabine (Xeloda®), irinotecan(Camptosar®), oxaliplatin (Eloxatin®), bevacizumab (Avastin®), cetuximab(Erbitux®), and panitumumab (Vectibix®). Depending on the stageof the cancer, two or more of these types of treatment may be combined at thesame time or used after one another. For example, FOLFOX combines 5-FU,leucovorin and oxaliplatin, and FOLFIRI combines 5-FU, leucovorin andirinotecan. Bevacizumab, a VEGF monoclonal antibody, is commonly administeredwith chemotherapy. Typically, patients who fail 5-FU, oxaliplatin, irinotecan,and bevacizumab-containing therapies, and who have wild-type KRAS statusreceive EGFR monoclonal antibody therapy with either cetuximab or panitumumab.Once patients progress on these agents, there are no further standard treatmentoptions.

 

Perifosine— Waldenstrom’s Macroglubulinemia

 

Results of a Phase 2 studyon perifosine in patients with Waldenstrom’s Macroglubulinemia (“WM”) werepresented by Keryx in June 2008 at ASCO and in December 2008 duringthe ASH meeting. Perifosine showed clinical activity as a single agent inpatients with relapsed/refractory WM, with an ORR (partial response [PR] +minimal response [MR]) of 36%. PR occurred in 2 patients (6%), with a medianduration of response of 9+ and 18+ months, MR occurred in 11 patients (30%),with a median duration of response of 7 months (2-21+ months). Stable disease[SD] occurred in 21 patients (58%) and progressive disease [PD] in 2 patients(6%) at 2 and 4 months. The most common adverse events were GI toxicities(nausea, vomiting and diarrhea) with grade 1 and 2 in 36% of the patients.Grade 3 and 4 events included anemia (9%) and leucopenia (9%). Grade 3arthritis occurred in 9% of the patients; was considered likely related totherapy, (especially in rapidly responding patients), and reversed with symptomatictreatment as well as dose reduction. Dose reductions to 100 mg occurred in atotal of 36% of the patients and were otherwise due to GI toxicity orcytopenias. Perifosine monotherapy induces a prolonged time to progression inrelapsed or refractory WM, with a promising response rate of 36%, stabilizationof disease in 58% of patients, and manageable toxicity, as well as theconvenience of oral administration. Future clinical trials in combination withrituximab are planned.

 

In January 2010,we announced that an article entitled “*Clinicaland Translational Studies of a Phase II Trial of the Novel Oral Akt InhibitorPerifosine in Relapsed or Relapsed/Refractory Waldenstrom’s Macroglobulinemia,*”reporting Phase 2 data demonstrating the single agent activity of perifosinefor the treatment of advanced Waldenstrom’s Macroglobulinemia, appeared in the February 1,2010 issue of the Journal of Clinical Cancer Research.  Dr. Irene Ghobrial, Assistant Professorof Medicine, Bing Center for Waldenstrom’s Macroglobulinemia at Dana-FarberCancer Institute, led the Phase 2 study, in which 37 patients were treated withperifosine 150 mg daily for 6 cycles. In this study, 41% of the patients had 3or more lines of prior therapy and 78% had 2 or more prior lines of therapy.Such prior therapies include nucleoside analogues,

 

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bortezomib,alkylating agents and rituximab, which are not approved for, but are often usedin the treatment of Waldenstrom’s. Stable or responding patients were allowedto continue therapy until progression. Of the 37 patients, 4 achieved a partialresponse (11%), 9 achieved a minimal response (24%), and 20 showed stabledisease (54%). Overall, 89% (33/37) of patients treated with single agentperifosine were reported to have stable disease or better, while 11% (4patients) demonstrated progression. The median progression-free survival in thestudy was 12.6 months (90% C.I. (10.2, 22.7)), with a median overall survivalof 26 months (90% C.I. (26 — upper limit not reached)). Perifosine wasgenerally well tolerated with gastrointestinal symptoms and fatigue reported asthe most common adverse events related to therapy.

 

Perifosine— Renal Cell Carcinoma

 

InJune 2006, we announced positive data of perifosine in patients withadvanced renal cell carcinoma (“RCC”). Keryx disclosed results from an interimanalysis performed at the end of the first year of accrual, from a Phase 2,multi-center trial of perifosine that included multiple types of tumor and theresults of the RCC group met protocol requirements for expansion of thiscohort. Of the 13 patients with RCC, seven were evaluable for response. Threeof them (43%) had a partial response and an additional two patients (29%)achieved long-term stable disease. Two patients (29%) had progressive disease.Results of a Phase 1 multicenter trial of perifosine in combination withsorafenib or in combination with sunitinib for patients with advanced cancersincluding RCC were disclosed by Keryx in June 2007 during the ASCO meetingand in November 2007.  The trial was designed to accrue 3-6 patientsin each of four cohorts. Response by RECIST criteria was a secondary endpoint.Perifosine was escalated from 50 mg once per day to 50 mg three times per day;sorafenib dose was escalated from 400 mg once per day to 400 mg twice per day;and sunitinib dose was escalated from 25 mg to 50 mg once per day for 4 weeksof treatment out of 6. Dose limiting toxicity (“DLT”) was defined as grade (G) 3non-hematologic or G4 hematologic toxicity. Maximal tolerated dose (“MTD”) wasthe dose below that at which 2 out of 6 patients experienced a DLT.

 

Forthe combination perifosine + sorafenib, 20 patients were enrolled (12 males / 8females, median age 64 (range 44-87)) with a median number of 2 prior therapies(range 1-4). Three patients were inevaluable due to rapid disease progression.Diagnosis was as follows; RCC (11 pts), sarcoma (5), colorectal (2),hepatocellular (1) and neuroendocrine (1). 17 patients were evaluable fortoxicity: no drug related Grade 4 adverse events (AE) were seen. Suspected DLTof hand-foot syndrome was seen in cohort 4 and additional patients wereenrolled. There was no increase in hand-foot syndrome compared to sorafenibalone. Of interest, 6/9 evaluable RCC patients (67%) had stable disease (SD)>12 weeks (median 26 weeks, range 12-62+). One hepatocellular patient had SDfor 36 weeks. The combination of perifosine + sorafenib was well tolerated withno increased hand-foot syndrome compared to sorafenib alone. Six out of 9 RCCpatients (67%) achieved SD up to 62+ weeks. Future studies are currently indevelopment.

 

Forthe combination perifosine + sunitinib, 14 patients (8 males / 6 females; mediarange 62 years old, range 28-81) were enrolled. Disease type was as follows:RCC (3), Sarcoma (3), Other (8).  Six patients were evaluable forresponse. After 2 treatment cycles, one patient had a partial response (PR), 3 patientsshowed a SD and 2 patients had disease progression (PD). In the sub-group RCC,three out of three patients were evaluable for response: one patient had a PR,1 patient showed a SD and 1 patient had a PD. Results indicated that patientsto date have tolerated well the treatment combination of perifosine + sunitinibwith no unexpected toxicities and clinical activity has been noted within thefirst 3 cohorts with 4 of 6 (67%) evaluable patients with advanced cancerachieving at least SD for more than 6 months.

 

Resultsfrom a Phase II trial of perifosine in patients with advanced RCC who havefailed tyrosine kinase inhibitors (TKI) were also presented at the ASCO meetingin June 2009 by our partner Keryx. The goal of this multi-center Phase IItrial was to determine the safety and efficacy of perifosine in patients withadvanced RCC refractory to VEGFR TKI.

 

The study enrolled a total of 50 patients, ofwhich 46 patients were evaluable for response. Evaluable patients were definedas those who had greater than 7 days of treatment. The primary endpoint of thisstudy was clinical benefit, defined as response rate (RECIST), andprogression-free survival (PFS) in RCC patients who failed a prior VEGFreceptor inhibitor (sunitinib or sorafenib). Safety of perifosine in thispatient population was evaluated as a secondary endpoint. The best response tosingle-agent perifosine was as follows:

 
| **Group** | ** ** | **N** | ** ** | **PR    N (%)** | ** ** | **SD  > 12 wks   N (%)** | ** ** | **CBR*    N (%)** | ** ** | **Median  PFS  (SD or >)** |
|-----------|------------|-------|------------|-----------------|------------|-----------------------------|------------|-------------------|------------|-------------------------------|
| All Pts   |       | 46    |       | 5 (11%)         |       | 16 (35%)                    |       | 21 (46%)          |       | 33 weeks[95% CI (24, 60)]     |

 

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*                 CBR: Clinical Benefit Ratedefined as patients with Stable Disease or Partial Response

 

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The median PFS for all 46 patients was 12.5weeks [95% CI (11.9, 19)]. The median overall survival has not been reachedwith 33 of 46 patients (72%) still alive.

 

Also of interest was the patient subgroup whohad failed both a VEGF receptor inhibitor (sunitinib or sorafenib) and an mTORinhibitor (either everolimus or temsirolimus). For this group, the bestresponse and median PFS to single agent perifosine was as follows:

 
| **Group**   | ** ** | **N** | ** ** | **PR    N (%)** | ** ** | **SD  > 12 wks   N (%)** | ** ** | **CBR    N (%)** | ** ** | **Median  PFS**                 |
|-------------|------------|-------|------------|-----------------|------------|-----------------------------|------------|------------------|------------|---------------------------------|
| VEGF + mTOR |       | 16    |       | 1 (6%)          |       | 7 (44%)                     |       | 8 (50%)          |       | 16 weeks  [95% CI (11.7, 33.6)] |

 

Three patients out of the group of patientspreviously treated with and failed both a VEGF and an mTOR inhibitor remain onactive treatment, now out 5, 9 and 17 months.

 

Updated clinical resultsof this Phase II study of perifosine as a single-agent treatment for advanced metastaticRCC were presented in September 2009by our partner Keryx at the 8th InternationalKidney Cancer Symposium. Those updated data included results from a subgroup ofpatients who failed both a VEGF receptor inhibitor (sunitinib or sorafenib) andan mTOR inhibitor (temsirolimus or everolimus). Evaluable patients (n=16) weredefined as those who had greater than 7 days of treatment (2 additionalpatients withdrew consent within 7 days). Patients received 100 mg ofperifosine daily until progression or unacceptable toxicity. The primaryendpoint of this study was clinical benefit, defined as response rate (CR / PRby RECIST) or percent of patients progression-free for at least 3 months.Median progression-free survival (PFS) and overall survival were also analyzedfor efficacy. Safety was a secondary endpoint. Perifosine was well-toleratedwith the most common adverse events being gastrointestinal discomfort andfatigue. Best response to single agent perifosine was as follows:

 
| **N**  | ** ** | **PR    N (%)**                     | ** ** | **SD  > 12 wks   N (%)** | ** ** | **PD  < 12 wks   N (%)** | ** ** | **Median  PFS**            | ** ** | **Overall  Survival**     |
|--------|------------|-------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|----------------------------|------------|---------------------------|
| 16     |       | 1 (6%)                              |       | 7 (44%)                     |       | 8 (50%)                     |       | 16 wks [95% CI (11.7, 28)] |       | Not Reached (14/16 alive) |
|   |       | Median PFS for patients SD  or > |       | 33 wks [95% CI (19, NR)]    |       | at 22+ months               |

 

Perifosine— Sarcoma

 

In June 2007, ourpartner Keryx presented results of Phase 1 and 2 studies for the treatment ofpatients with advanced sarcoma at the ASCO meeting. The dose schedules in thePhase 1 trials were weekly 100-800mg or loading dose 300-1800mg on Day 1followed by 50-150 mg daily for Days 2-21 every 28 days or loading dose 400-900mg and daily 50-100 mg continuously. In the Phase 2 trial, doses were loadingdose 900 mg on Day 1 and 150mg daily for days 2-21 every 28 days; loading dose900 mg and 100 mg daily continuously; 50 mg daily continuously without aloading dose; and 900-1,500 mg weekly. 145 patients with sarcoma were enteredinto studies and were assessed for clinical benefit rate (“CBR”). Partialresponses were seen, in one patient each, with chondrosarcoma, extra-skeletalmyxoid chondrosarcoma, leiomyosarcoma and a desmoid tumor. At lower doses with52 patients fully evaluable for CBR, the CBR was 52% with four partialresponses and 23 stable diseases at > 4 months. At higher doses with30 patients fully evaluable for CBR, CBR was 53% with 16 stable diseases at >4 months. Toxicities were mainly gastrointestinal and/or fatigue. Thepercentage of patients with grade 0 nausea, vomiting, diarrhea and fatigue forlower dose perifosine (76 patients) was 46%, 49%, 38% and 55%, respectively,compared to 26%, 32%, 20%, and 58% for higher dose perifosine (69 patients).The proportion of patients with grade 2+ nausea, vomiting, diarrhea and fatiguewas 20%, 13%, 15%, and 21% for lower dose perifosine and 49%, 35%, 42%, and 25%for higher dose perifosine.

 

InNovember 2007, Keryx announced positive preliminary Phase 2 data ofperifosine in patients with chemo-insensitive sarcoma. Data demonstrated the tolerabilityand clinical activity of perifosine as a single agent with an overall clinicalbenefit of 40% (stable disease > 3 months) in patients with refractory raresarcomas. Perifosine was well tolerated with the most common grade 1 &2 adverse events reported as nausea, vomiting, diarrhea and fatigue.

 

Perifosine— Gliomas

 

InNovember 2007, Keryx announced early results of a Phase 2 trial ofperifosine as a single agent for the treatment of recurrent malignant gliomas(malignant glioblastoma and malignant anaplastic gliomas). Twenty-five patientswith advanced malignant gliomas were treated with a loading dose of 600 mg (150mg x4) followed by a 100 mg daily dose of perifosine.

 

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Themedian progression free survival and overall survival in the anaplastic gliomagroup was nine weeks (range 2-50 weeks) and 49 weeks, respectively. Toxicitywas minimal with the following reported events: one grade 1 nausea, one grade 1diarrhea, one grade 2 pain, and one grade 4 gout exacerbation. The study wasdesigned to enroll at least 12 evaluable malignant glioblastoma patients and atleast 10 evaluable malignant anaplastic gliomas patients. If at least onepatient achieves six month progression free survival, the study would continueto enroll an additional subset of patients. Therefore, the malignantglioblastoma arm has been halted and the malignant anaplastic gliomas arm willcontinue to enroll.

 

Perifosine— Other indications

 

OnMarch 2, 2006, our North American partner, Keryx, announced the initiationof a corporate-sponsored Phase 2 trial, multi-cancer, clinical program toevaluate perifosine as a treatment for leukemia. Dr. Frank Giles,Professor, Department of Leukemia, at the MD Anderson Cancer Center in Houston,TX, is the principal investigator. This Phase 2 trial will assess the objectiveresponse rate and evaluate the pharmacokinetics and safety and tolerability ofperifosine as a single agent in relapsed or refractory acute myeloid leukemia,acute lymphocytic leukemia, chronic lymphocytic leukemia, high-riskmyelodysplastic syndrome and chronic myeloid leukemia in the blastic phase.

 

InNovember 2006, Keryx presented intermediary results of the Phase 2 studyof imatinib plus perifosine in patients with imatinib-resistantgastrointestinal stromal tumor (“GIST”). The primary endpoint of this study isto evaluate the efficacy and toxicity of the combination imatinib and perifosinein patients with imatinib-resistant GIST. To date, 16 patients have beenenrolled in the current study. Of the 12 patients with evaluable disease, therewere two partial responses by Choi criteria (17% objective response rate (ORR))and one partial response by RECIST criteria (8% objective response rate). Grade3 and 4 adverse events were rare and included fatigue, myalgias, oculartoxicity and nausea/emesis. The early data from the current study suggest thatthe addition of perifosine to imatinib is well-tolerated and may have efficacyin the treatment of patients with imatinib-resistant GIST.

 

Updatedresults of this trial were presented in June 2009 by our partner Keryx,during the ASCO meeting. Patients with Kit (+) advanced GIST who have progressedon imatinib were eligible. Patients continued their current dose of imatiniband were randomized to one of two dosing schedules of perifosine (Arm A: 100 mgp.o. qd x 28 + imatinib or Arm B: 900 mg [300 mg p.o. tid] qweekly + qdimatinib). A Bayesian approach was utilized to assess a target response rate of20% with an unacceptable toxicity rate of 15% or less. Response was measuredevery 8 weeks by RECIST and Choi criteria. The primary endpoint was todetermine the efficacy of perifosine with imatinib in patients with advancedGIST who progressed while receiving imatinib. 41 patients were enrolled from August 2005to July 2008. After 1 patient exclusion and 2 cross-overs, 22 patientswere in Arm A and 18 patients in Arm B. Median age was 58 (range, 32-82), 51%were male, and median ECOG performance status was 1. The most common primarysite of disease and metastasis was the stomach (29%) and liver (66%),respectively. KIT genotype was available for 22 patients (54%); 5(12%) WT,13(32%) exon 11 mutations, and 4(10%) exon 9 mutations. The median number ofcycles was 2 (range, 1-24). By Choi and RECIST, 30 patients (73%) and 36patients (87%) were available for response, respectively. No complete response(CR) was identified but the partial response (PR) rate was 4/36 (11%) by Choi(4 PR, 9 stable disease (SD)) and 0/36 (0%) by RECIST (16 SD). 4/5 (80%) ofpatients with WT KIT appeared to benefit (Choi: 1 PR, 3 SD; RECIST: 4 SD).Median PFS and OS for 40 patients were 2.2 months and 18.3 months. No differencein PFS was noted for the 2 schedules. Toxicity was assessed in 39 patients; 46grade 3 events and 4 grade 4 events (ALT elevation, blurred vision, fatigue,and mood alteration) were noted. The most common grade 3 event was fatigue(20%). Three patients (7%) were removed from the study for toxicity (Arm A:1patient, Arm B:2 patients).

 

On July 14, 2009, our partner Keryx announced theinitiation of a Phase 1 clinical study to evaluate perifosine as a single agenttreatment for recurrent solid tumors in pediatric patients. This single-centeropen-label study, fully funded by an external grant provided by a privateorganization, will be conducted at Memorial Sloan-Kettering Cancer Center inNew York City. Oren Becher, MD, Instructor, Department of Pediatrics, incoordination with Eric Holland, MD, PhD, Director of the Brain Tumor groupat Memorial Sloan-Kettering Cancer Center, will act as the study’s PrincipalInvestigator. Perifosine is beingevaluated as a single-agent in pediatric patients with any solid tumor that hasfailed standard therapy. Patients up to 18 years of age with a performancestatus of greater than 40% are eligible for this study. The study has beendesigned as a dose escalation study to determine the maximum tolerated dose(MTD) of perifosine alone in recurrent/progressive pediatric tumors. A standard3+3 dose escalation design will be employed with 3 to 6 patients at each doselevel. All patients will receive perifosine at a loading dose on the first day,followed by a maintenance dose to start on day two until progression ofdisease. A minimum of 4 and a maximum of 24 patients will be required tocomplete the study.

 

On October 8, 2009, Keryx announced theinitiation of a Phase 2 clinical study to evaluate perifosine as a single agenttreatment for relapsed or refractory Chronic Lymphocytic Leukemia (CLL) andSmall Lymphocytic Lymphoma (SLL). This externally funded Phase 2 study wasdesigned by Daphne Friedman, MD, Instructor and Principal Investigator, incoordination with J. Brice Weinberg, Professor, and Mark Lanasa, AssistantProfessor, Divisions of Medical Oncology and

 

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Hematology, Duke University Medical Center, and isopen for enrollment at Duke University. The single-center, open-label, study entitled, “Phase 2 Trial of Perifosinein Patients with Relapsed or Refractory Chronic Lymphocytic Leukemia/SmallLymphocytic Lymphoma”, will enroll approximately 30 patients. Perifosine willbe given orally at a dose of 50 mg twice daily, for a total of six 28-daycycles. The patients will be formally restaged upon completion of the trial.Overall Response Rate is the primary endpoint with overall survival,progression-free survival and safety as secondary endpoints. Correlativestudies will also be conducted and evaluated as a secondary endpoint.

 

***Perifosine — Radio-enhancer***

 

Aproof-of-concept Phase 1 study of perifosine in combination with radiotherapyconducted by the National Cancer Institute of the Netherlands was completed in2004. Results from this trial were presented at ASCO 2004. A total of 21radiotherapy-naïve patients, of whom 17 had advanced non-small cell lung cancer(NSCLC) and 14 had become refractory to prior chemotherapy, received oralperifosine doses ranging from 50 mg to 200 mg/day concurrently with standarddoses of radiotherapy. The trial data demonstrated an acceptable safety andtolerability profile, with 150 mg/day established as the dose recommended foruse in subsequent clinical trials. Also demonstrated was preliminary evidenceof anti-tumor activity at all dosage levels, including complete or partialresponses (complete disappearance and decreased tumor size, respectively), orstable disease, with a median follow-up for responders of eight months.Importantly, in the cohort of 10 patients who were treated with 150 mg/day, theestablished dose recommended for use in subsequent clinical trials, there werethree complete responses, three partial responses and four patients with stabledisease.

 

OnSeptember 22, 2005, we announced the initiation of a multi-center Phase 2randomized, double-blind, placebo-controlled trial with perifosine incombination with radiotherapy for NSCLC.  Patients received perifosine 150mg daily for five to six weeks and are followed for at least 12 months. Theprimary endpoint of this trial is the extent and duration of local control,i.e., the absence of tumor recurrence or progression in the area that has beenirradiated. The trial is being conducted in collaboration with the NetherlandsCancer Institute. The lead investigator is Marcel Verheij, M.D., Ph.D., of theDepartment of Radiation Oncology / Division of Cellular Biochemistry, at theNetherlands Cancer Institute in Amsterdam.  We announced completion ofrecruitment of 160 patients with inoperable Stage III NSCLC on November 14,2007.

 

Wedisclosed preliminaryresults for this European multi-center Phase 2 trial in NSCLC in June 2009.Starting one week before the onset of a 4-week course of radiotherapy (51 Gy in17 fractions), 177 patients with non-metastatic but inoperable NSCLC, mainlyStage III, received a 5-week course of 150 mg perifosine daily or placebo.After end of radiotherapy, patients were followed up to determine the time totumor recurrence or progression in the area that had been irradiated, the socalled “local control”. The primary endpoint of this trial was the extent andduration of local control, specifically the proportion of patients with absenceof recurrence or progression 12 months after the end of treatment. The studywas planned under the basic assumption that radiotherapy alone would result ina 35% local control rate, one year after end of therapy in the placebo group. Itwas hypothesized that the addition of perifosine would sensitize tumor cells tothe tumor-killing effect of the radiotherapy, leading to a 15% higher rate oflocal control. Secondary efficacy parameters included the times toloco-regional or distant/systemic failure, the tumor response rate, and overallsurvival. Safety investigations included the monitoring of clinical laboratory,electrocardiograms, lung function, and adverse events.

 

In all, 22 study sites inThe Netherlands, Bulgaria, Romania, Macedonia, and Belarus participated in thistrial. A total of 177 patients were randomized and treated, of whom only 26reached the milestone of one year post-treatment follow-up without diseaserelapse or progression, 14 of 95 patients (14.7%) in the perifosine and 12 of82 patients (14.6%) in the placebo control group. No difference betweentreatment groups could be shown for local, loco-regional and overall diseasecontrol. Also, the tumor response rate, as assessed after the end of theradiotherapy, was not different between the groups.

 

In contrast to the lackof an observed local effect, patients in the perifosine group, particularly thesubgroup of patients who entered the study without prior chemotherapy, showed atrend towards longer survival than patients of the placebo control groupdespite the short duration of treatment (5-week course of 150 mg perifosinedaily).

 

There were no safetysignals that would lead to an amendment of the current safety data or riskbenefit assessments of perifosine. The type and severity of side effects werein the expected range. Following  theseneutral results and an unchanged safety profile, we announced that we willconcentrate our efforts for perifosine on the disease targets of both multiplemyeloma and metastatic colon cancer.

 

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***Partners for perifosine***

 

ACooperative Research and Development Agreement (CRADA) was put in place withthe National Institute of Health/the National Cancer Institute in May 2000.A cooperation and license agreement was signed in September 2002 withAccess Oncology, Inc. (“AOI”), for the use of perifosine as an anti-canceragent covering the United States, Canada and Mexico. In January 2004, AOIwas acquired by Keryx, which is pursuing the clinical development of perifosineunder the same conditions as AOI. The agreement, in particular, provides usfree access to all data from Keryx and its partner’s studies, as well asmilestone payments and scale-up royalties to be paid to us on future net salesof perifosine in the United States, Canada and Mexico. In April 2009 weentered into an agreement to out-license the rights of perifosine to Handok inSouth Korea. We own rest of the world rights to perifosine.

 

**AEZS-127 erucylphosphocholine**

 

OnJanuary 6, 2005, we announced the initiation of preclinical development oferucylphosphocholine (AEZS-127), an analog of perifosine which is suitable for i.v. administration.Like perifosine, AEZS-127 belongs to a new class of compounds based onalkylphosphocholines. AEZS-127 possesses distinctive reduced haemolyticactivity thus allowing for i.v. injection.

 

OnJanuary 6, 2005, we also licensed to Keryx certain rights to develop andmarket AEZS-127 in North America, South Africa, Israel, Australia and NewZealand while keeping rights for the rest of the world. According to theagreement with Keryx, the preclinical development costs of AEZS-127 are sharedbetween Keryx (50%) and us (50%). In Q4 2008, we repatriated all rights forAEZS-127 from Keryx.

 

In 2006, studies for acutetoxicity and dose range finding of erucylphosphocholine were actively pursued.The 4-week toxicity studies in rats and dogs as well as the safety pharmacologypackage was completed in 2007. These preclinical data are a prerequisite forthe performance of a Phase 1 clinical study.

 

**Erk/PI3K inhibitors and dual kinase inhibitors**

 

Inaddition to our activities with alkylphosphocholines, we are screening smallmolecules for activity as agonists and antagonists to lipid-protein signalinginteractions, which are seen as new and potentially important therapeutictargets.

 

Weare focusing our efforts on single and dual inhibitors of Ras-Raf-Mek-Erk andPI3K-Akt pathways. The Ras-Raf-Mek-Erk and the PI3K-Akt pathways areconstitutively activated in many cancer types, and influence both tumordevelopment and progression.

 

Bothsignaling pathways represent promising therapeutic targets for the treatment oftumors. We have now identified a new compound class with inhibitory activityagainst both the Erk and PI3K kinases. These small molecules inhibit thekinases at nanomolar concentrations in a dose-dependent manner by competingdirectly at the ATP binding site. In a broad kinase panel, the molecules arevery selective against other kinases. In cellular experiments the compoundsinhibit the activation of downstream targets Akt and Rsk1, and can stop theproliferation of various human cancer cell lines. Moreover, a new generation ofaniline-substituted pyridopyrazine-urea derivative shows highly selective PI3Kinhibition. We are currently performing *invivo* studies with front-runner compounds in four mouse xenograftmodels (HCT116, U87, A549 and PC3) as well as pharmacokinetic studies inrodents using an oral pre-formulation. On the basis of these studies, AEZS-126was selected as a preclinical development candidate for *in vivo*pharmacology and pharmacokinetic studies.

 

***AEZS-126***

 

Thefirst *in vitro* and*in vivo*data for AEZS-126 were presented in April 2009 at the AACR meeting. Thefirst poster, entitled,“AEZS-126, a new orally bioavailablePI3K inhibitor with antitumor effects”, focuses on ADMET and safetyprofiling of the compound, as well as *invivo* pharmacokinetic experiments and mouse xenograft antitumorstudies. Results indicated that AEZS-126 was identified as a potent inhibitorof class I PI3Ks in biochemical and cellular assays and demonstrated favorableproperties in early *in vitro*ADMET screening including microsomal stability, plasma stability and screeningagainst a large safety profile composed of receptors, enzymes and cardiacion-channels. During the course of *in vivo*pharmacokinetic experiments and mouse xenograft antitumor studies, the oralbioavailability in mice was determined to be about 60%, leading to micromolarplasma levels which are well above the nanomolar IC50 values in*vitro* studies. Significant antitumoractivity was observed at 30mg/kg daily oral administration in Hct116 and A549models. These data suggest that AEZS-126 is a promising compound for clinicalintervention of the PI3K/Akt pathway in human tumors.

 

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The 2nd poster,entitled “*In vitro* profiling of the potent and selective PI3Kinhibitor, AEZS-126”, outlines the key*in vitro* characteristics of this compound that led to its selectionfor*in vivo* development. AEZS 126inhibits PI3Ka with an IC50 value of 10nM and proved to be a potent inhibitorof Akt phosphorylation in cellular assays. Mode-of-action studies showed thatAEZS-126 acts as an ATP competitive compound. The *in vitro*antiproliferative activity against different humantumor cell lines (MDA-MB 468, U87, Hct116, PC-3, A549 and others) wasdetermined, with EC50 values in the nanomolar range.

 

Based on those resultspresenting a favorable *in vitro*pharmacologicprofile for AEZS-126, further *in vivo*profiling experiment will be performed.

 

**AEZS-129**

 

On April 21, 2009,we presented two posters on AEZS-129, a promising compound for clinicalintervention of the PI3K/ Akt pathway in human tumors, at the AmericanAssociation for Cancer Research (“AACR”) Annual Meeting. *In vivo*and *in vitro* data showed significantantitumor activity and a favorable *in vitro*pharmacologic profile which could lead to further *in vivo*profiling.

 

**TUMORTARGETING CYTOTOXIC CONJUGATES AND CYTOTOXICS**

 

**Cytotoxicconjugates**

 

Inview of the non-specific toxicity of most chemotherapeutic agents againstnormal cells, targeting such drugs to cancerous tissue offers a potentialbenefit for patients with advanced or metastatic tumors. Targeted cytotoxicpeptide conjugates are hybrid molecules composed of a cytotoxic moiety linkedto a peptide carrier which binds to receptors on tumors. Cytotoxic conjugatesare designed to achieve differential delivery, or targeting, of the cytotoxicagent to cancer vs. normal cells.

 

Ourcytotoxic conjugates represent a novel oncological strategy to control andreduce toxicity and improve the effectiveness of cytotoxic drugs. Thedevelopment strategy was to create targeted conjugates with high cytotoxicactivity based on doxorubicin, an approved and commercialized product or2-pyrrolino-doxorubicin which is 500 to 1,000 times more active than the parentcompound. We are exploring several candidates in which doxorubicin or2-pyrrolino-doxorubicin are coupled to the peptide carriers targeting LHRH(AEZS-108 & AN-207), somatostatin (AN-238 & AN-162) orbombesin (AN-215) receptors. These conjugates are less toxic and more effective*in vivo* than the respectiveradicals in inhibiting tumor growth in LHRH receptor positive models of humanovarian, mammary or prostatic cancer.

 

 

InAEZS-108, the most advanced of the cytotoxic conjugates, doxorubicin ischemically linked to an LHRH agonist, a modified natural hormone with affinityfor the LHRH receptor. This design allows for the specific binding andselective uptake of the cytotoxic conjugate by LHRH receptor positive tumors.Potential benefits of this targeted approach include a more favorable safetyprofile with lower incidence and severity of side effects, as normal tissuesare spared from toxic effects of doxorubicin. In addition, the targetedapproach may enable treatment of LHRH receptor positive cancers that havebecome refractory to doxorubicin which has been administered in itsnon-targeted form.

 

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Inpreclinical studies conducted to date in several animal models of LHRH receptorpositive human cancer cell lines, AEZS-108 anti-tumor activity and tolerabilitywere shown to be superior to that of doxorubicin. As would be expected,AEZS-108 was not active or was significantly less active than doxorubicin inLHRH receptor negative cancer cell lines. On January 18, 2005, weannounced the initiation of a company-sponsored Phase 1 dose-ranging study withthe targeted anti-cancer agent AEZS-108.

 

InJune 2006, we announced positive Phase 1 results for AEZS-108 in patientswith gynaecological and breast cancers which showed that the compound has agood safety profile and no dose-limiting toxicities. Eight patients receivedAEZS-108 by i.v. infusion. Infusion was welltolerated at all dosages, without supportive treatment. Pharmacokineticanalyses showed dose-dependent plasma levels of AEZS-108 and only minor(10-20%) release of doxorubicin. Stabilization of disease was observed in oneout of eight patients in the ongoing Phase 1 study.

 

OnNovember 27, 2006, we disclosed additional positive Phase 1 resultsregarding AEZS-108 in patients with gynaecological and breast cancers. Furtherdata showed the compound’s good safety profile and established the maximumtolerated dose at 267 mg/m2, which is equimolar to adoxorubicin dose of 77 mg/m2. This dose will be therecommended dose for a Phase 2 trial. The Phase 1 open-label, multi-center,dose-escalation, safety and pharmacokinetic study conducted in Europe included17 patients suffering from breast, endometrial and ovarian cancers with provenLHRH receptor status. Evidence of anti-tumor activity was found at 160 mg/m2 and 267mg/m2 doses of AEZS-108, where 7 out of 13 patients showed signs oftumor response, including 3 patients with complete or partial responses. ThePhase 2 trials will focus on advanced or recurrent ovarian and endometrialcancers, two forms of cancer where LHRH receptors are highly expressed.Recommended dose will be 267 mg/m2 given once everythree weeks.

 

**AEZS-108— Ovarian and Endometrium Cancer**

 

In2007, a Phase 2 open-label, non-comparative, multicenter two indication trialstratified with two stages Simon Design was prepared. The enrollment of 82patients is planned for this trial with up to 41 patients with either adiagnosis of platinum-resistant ovarian cancer (stratum A) or disseminatedendometrial cancer (stratum B). Under coordination by Prof. Günter Emons, MD, Chairmanof the Department of Obstetrics & Gynaecology at the University ofGöttingen, Germany, this open-label, multi-center and multi-national Phase 2study “AGO-GYN 5” is being conducted by the German AGO Study Group(Arbeitsgemeinschaft Gynäkologische Onkologie / Gynaecological Oncology WorkingGroup), in cooperation with clinical sites in Europe. Patients with tumors expressing LHRHreceptors administered will be an i.v. infusion of 267 mg/m2 of AEZS-108 over a period of 2 hours, every Day1 of a 21-day (3-week) cycle. The proposed duration of the study treatment is6, 3-week cycles. Study AGO GYN 5 will be performed with 14 centers of theGerman Gynaecological Oncology Working Group, in cooperation with 3 clinicalsites in Europe. The primary efficacy endpoint at the end of stage 2 wasdefined as 5 or more patients with partial or complete tumor responsesaccording to Response Evaluation Criteria in Solid Tumors (RECIST) and/orGynaecologic Cancer Intergroup (GCIG) guidelines. Secondary endpoints includetime to progression, survival, toxicity, as well as adverse effects. On February 12,2008, we reported that the treatment of first patients had commenced in thisPhase 2 trial.  In October 2008, we announced that we have enteredthe second stage of patient recruitment for the Phase 2 trial inplatinum-resistant ovarian cancer indication. This decision was taken followingthe report of two partial responses among patients with a diagnosis ofplatinum-resistant ovarian cancer.  The second stage of patientrecruitment for the endometrial cancer indication was reached in November 2008and was based on the report of one complete response and two partial responsesamong 14 patients with a diagnosis of disseminated endometrial cancer.

 

In November 2009, weannounced positive efficacy data from this Phase 2 study in patients withplatinum-resistant and taxane-pretreated ovarian cancer. In a personalizedhealthcare approach, the study selected patients with tumors expressing LHRHreceptors, the key element in the targeting mechanism of AEZS-108. All 43patients with LHRH-receptor positive ovarian cancer who entered study AGO-GYN 5have completed their study treatment. A preliminary evaluation shows that thestudy met its primary efficacy endpoint of 5 or more responders in 41 evaluablepatients. Responders, as well as patients with stable disease after completionof treatment with AEZS-108, will now be followed to assess the duration ofprogression-free survival and, ultimately, overall survival.

 

Weannounced positiveefficacy data from the Phase 2 study with the targeted cytotoxic peptideconjugate, AEZS-108, in patients with advanced or recurrent endometrial canceron November 24, 2009. A preliminary evaluation has shown that the studyAGO-GYN 5 met its predefined primary efficacy endpoint of 5 or more responderpatients with endometrial cancer. The study is currently ongoing, andresponders, as well as patients with stable disease after completion oftreatment with AEZS-108, will be followed to assess the duration ofprogression-free survival and, ultimately, overall survival.

 

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**AEZS-108— Prostate Cancer**

 

In May 2009, weannounced that results supporting the evaluation of AEZS-108, in prostatecancer, will be presented as a poster at the ASCO 2009 meeting.  Expression of LHRH receptors was determinedusing immunohistochemistry and the intensity was graded on a scale from zero to3. The expression was analyzed in three cohorts of patients: (1) 47 menwith localized prostate cancer treated with radical prostatectomy with nohormone therapy, (2) 61 men with localized prostate cancer treated withneoadjuvant LHRH agonists for varying duration prior to prostatectomy, and (3) 22men with metastatic prostate cancer who received a palliative transurethralresection of the prostate after clinical progression. In the final cohort, 15men were treated with castration and 7 were treated with LHRH agonists. 45 of47 hormone naïve samples (95.7%) demonstrated LHRH receptor expression.Statistical analysis revealed a correlation between strong receptor expressionand higher pathologic tumor stage as well as shorter overall survival. 60 of 61samples treated with neoadjuvant LHRH agonist therapy (98.4%) demonstrated LHRHreceptor expression. All 22 samples from patients with metastatic diseasedemonstrated LHRH receptor expression. The majority of these samplesdemonstrated moderate to strong intensity. LHRH receptors are expressed onprostate cancers cells of hormone naïve and castrated patients. The expressionof these receptors appears to persist despite prolonged treatment with LHRHagonists. The new results show continued expression of LHRH receptors inprostate cancer specimens after prolonged use of LHRH agonists; these dataprovide further support to the investigation of the drug in hormone-refractoryprostate cancer, a major genitourinary cancer indication in male patients.

 

**AEZS-105 - Lobaplatin**

 

Lobaplatinis a platinum derivative that has demonstrated lower toxicity in preclinicalstudies compared with cisplatinum, specifically renal toxicity, and incompletecross-resistance with other platinum derivatives suggesting potentialtherapeutic use even in tumor indications not routinely treated with platinumderivatives.

 

Clinically,lobaplatin was well tolerated at recommended dosages. Treatment was notassociated with typical side effects often seen with cisplatinum, such asnephrotoxocity (impairment of kidney function), otoxicity (loss of hearingcapacity), and neurotoxicity (effects on sensory function). In addition,vomiting was less severe than published data from both cisplatinum andcarboplatinum. Characteristic toxicity of lobaplatin is a short-lasting,spontaneously reversible drop in thrombocyte count (blood platelets).

 

Ina Phase 2 study conducted in China that included 284 patients with a broadrange of solid and non-solid tumors, safety and particularly good therapeuticefficacy were demonstrated in patients with breast cancer, small cell lungcancer (“SCLC”), and chronic myeloid leukemia (“CML”) (a cancer of thehematopoietic system). The primary endpoint in solid tumor patients was theremission rate according to WHO criteria, while response in CML was assessedaccording to the disease-specific criteria of Talpaz. The favorable results ofthis study were the basis for approval of lobaplatin by the Chinese healthauthorities for the treatment of inoperable, advanced breast cancer, SCLC andCML.

 

InDecember 2002, we signed a contract with Hainan Chang An PharmaceuticalsLtd. for the marketing in China of lobaplatin. The contract includes theworldwide manufacturing rights of lobaplatin by Hainan Chang An Pharmaceuticals.The technology transfer agreement provided us with a first payment uponsignature and a later manufacturing-related payment.

 

In2007, lobaplatin was licensed to Atani for the territory of Japan. The licenseagreement was terminated in 2009.

 

**TUBULIN INHIBITORS / VASCULAR TARGETING AGENTS**

 

**AEZS-112 - Development of a low molecular weighttubulin inhibitor with anti-angiogenic properties**

 

Tubulinis a protein found in all cells that plays an important role during celldivision, in that it helps to transmit genetic information to the daughtercells. Inhibition of this process leads to the death of the affected cell. Theanti-tumor agent taxol and vincristine, which are widely used in cancertherapy, are based on this principle. Both compounds are expensive naturalsubstances and cause severe side effects when used in humans.

 

Weare currently identifying and developing novel tubulin inhibitors which,compared with currently used products, exhibit in animal models improvedefficacy, have a more acceptable side effect profile, an incomplete or nocross-resistance and are administered orally.

 

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AEZS-112is a drug development candidate with an excellent tolerability profile showingexcellent *in vivo* activity invarious tumor models including mammary, colon, melanoma and leukemia cancersafter oral administration. This compound acts through three mechanisms ofaction. Strong anti-cancer activity is combined with pro-apoptotic andanti-angiogenic properties. AEZS-112 inhibits the polymerization of cancertubulin rather than bovine brain tubulin, it destroys the mitotic spindle ofthe cancer cells and it inhibits topoisomerase II activity. AEZS-112 arreststhe cancer cells in the G2M phase at a nanomolar concentration and inducedapoptosis. AEZS-112 is not cross-resistant to cisplatin, vincristine anddoxorubicine in cell lines resistant to these drugs. Given orally once weekly,AEZS-112 proved to be a potent inhibitor of*in vivo* tumor growth in melanoma, mammary, colon, lung, renal aswell as in leukemia cancers at acceptable and very well tolerated doses.Furthermore AEZS-112 showed favorable safety and toxicity profiles. No findingswith respect to cardiotoxicity and neurotoxicology parameters could be observedduring the toxicological evaluation in mice, rats and dogs. With this profileof activity, AEZS-112 is a promising candidate for further clinicaldevelopment.

 

OnJanuary 8, 2007, we announced the initiation of a Phase 1 trial forAEZS-112 in patients with solid tumors and lymphoma. This open-label,dose-escalation, multi-center, intermittent treatment Phase 1 trial is beingconducted in the United States with Daniel D. Von Hoff, MD, Senior Investigatorat the Translational Genomics Research Institute in Phoenix, AZ, as the leadinvestigator. The trial includes up to 50 patients with advanced solid tumors and lymphoma who haveeither failed standard therapy or for whom no standard therapy exists. Patients will receive a once-a-week oraladministration of AEZS-112 for three consecutive weeks, followed by a one-weekperiod without treatment. The cycles will be repeated every four weeks based ontolerability and response, basically planned for up to four cycles, butallowing for continuation in case of potential benefit for the patient. Thestarting dose of AEZS-112 in this study is 13 mg/week, with doubling of dosesin subsequent cohorts in the absence of significant toxicity. Primaryendpoint of the Phase 1 trial focuses on determining the safety andtolerability of AEZS-112 as well as establishing the recommended Phase 2 doseand regimen. Secondary endpoints are aimed at establishing the pharmacokineticsand determining the efficacy based on standard response criteria.

 

Results of this Phase I study were presentedin April 2009 at the AACR meeting.**** In part I, 22 patients (12 men / 10women) were studied on 7 dose levels ranging from 13 to 800 mg/week. In all, 62treatment cycles were administered. In part II, the weekly dose was split into3 doses taken 8 hours apart. Ultimately, 22 patients (12 men / 10 women) werestudied on 5 dose levels ranging from 120 to 600 (=200x3) mg/week. As of April 1,2009, 62 treatment cycles were administered (mean 3.2/patient); treatment wasongoing in 8 patients. Stable disease (SD) for more than 12 weeks was observedin 16 patients; 4 more patients were ongoing at less than 12 weeks. Prolongedcourses of SD ranging from 20 to 39+ weeks were observed in 9 patients with thefollowing primary cancer types: trachea (39+), tongue (30+), thyroid (29+),prostate and melanoma (28), non-small cell lung cancer (26+), pancreas and 2xcolorectal (20).  Except for one patientwith a background of gastrointestinal problems (GI) who had dose-limiting GIreactions and electrolyte loss at a dose of 200x3mg/week, no clinicallyrelevant drug-related adverse events or changes in laboratory parameters wereobserved. AEZS-112 was shown to be metabolically stable in human plasma. Aspredicted by pharmacokinetic modelling based on data from part I of the study,the split-dose scheme leads to a higher Cmax and trough values afteradministration of comparable doses. Those preliminary results showed that amaximum tolerated dose for weekly dosing has not been defined so far. However,prolonged courses of stable disease in both parts of the study are anencouraging observation.

 

Completionof this Phase 1 trial was announced on September 21, 2009. Stable disease with time tofailure ranging from 20 to 60+ weeks was achieved in 12 patients with variouscancer types, including melanoma and cancers of the colon/rectum, lung,pancreas, prostate, tongue, trachea and thyroid. In several of these patients,the duration of stabilization exceeded the duration of disease control onprevious treatment regimens. Except for a dose-limiting gastrointestinalreaction in a patient with pre-existing GI problems, no clinically relevantdrug-related adverse events or changes in laboratory safety parameters wereobserved.

 

**IMMUNOTHERAPY / VACCINES**

 

Cellularproteins expressed by oncogenes have been recognized as a major cause of tumordevelopment. One of the central oncoproteins involved in cancer formation arethe Raf proteins. Based on these proteins, new unique therapeutic strategies,new predictive animal models and new development products have been generatedto efficiently combat cancer. These consist of virulence attenuated,genetically modified bacteria expressing tumor antigens, including oncoproteinsor enzymes. Such bacteria are used for vaccination as well as tumor targetingand delivery of antitumoral compounds towards the tumor tissues. Therefore,this new vaccine approach exploits the ability of bacteria to induce potentimmune responses as well as direct these responses against malignancies. Theimmunogenicity of the vaccine will be further enhanced by the capacity ofbacteria to colonize tumor tissues. This property will be used to transportsubstances, e.g. proteins, into the tumor tissue, which are capable ofconverting non-toxic pro-drugs into active drugs. The use of bacterial carriersfor therapeutic vaccination against tumors and the concept of bacterial tumortargeting will be further developed with the Julius-

 

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Maximilians-Universityof Würzburg, including the highly recognized researchers Prof. Dr. Ulf R.Rapp, who is a member of our Scientific Advisory Board, and Prof. Dr. WernerGoebel. Prof. Rapp is a known expert in the field of cell and tumor biology andProf. Goebel is a pioneer in the field of vaccines based on recombinantbacteria.

 

Thepreclinical proof of principle has already been shown in a transgenic animalmodel and is supported by several patent applications that we have filed. Themost advanced products are bacterial tumor vaccines which are based on theapproved human vaccine strain *Salmonellatyphi* Ty21a. The principle of these recombinant vaccine strains isthe secretion of the tumor antigen using a so-called Type I secretion machineryderived from *Escherichia coli*. Todate, two different vaccine strains have been generated up to GMP scaleproduction — a melanoma vaccine encompassing a mutated form of the oncogeneB-Raf, which is present in more than 65% of melanomas, and a prostate cancervaccine strain expressing and secreting PSA. For both vaccines, the preclinicalproof of principle has been demonstrated in distinct animal models and theimmunogenicity could be further enhanced compared to our already publishedstrains (patent application filed in November 2006).

 

In2007, the PSA vaccine (AEZS-120) was selected as the first preclinicaldevelopment candidate of an anti-tumor vaccine. In September, scientific advicefrom the Paul Ehrlich Institute, the German health authority for vaccines, wassought and the preclinical development program presented by us was in principleaccepted.

 

Agrant application was filed in Germany and was approved in 2008. In accordancewith this grant, 50% of our preclinical development costs and 100% of those ofour university partner will be reimbursed by the German Ministry of Science andEducation. The preclinical development and manufacture of material for clinicaltrial was initiated in 2008.

 

**ENDOCRINOLOGY**

 

**Growth hormone secretagogue**

 

Ghrelinligand AEZS-130 (“ghrelin agonist”)

 

Growthhormone secretagogues (“GHS”) represent a new class of pharmacological agentsthat directly stimulate growth hormone (“GH”) secretion from the pituitarygland without the involvement of growth hormone-releasing hormone (GH-RH) orsomatostatin. We believe that there is currently no GHS on the pharmaceuticalmarket. Since GH is a potent regulator of lipid, sugar and protein metabolism,the potential clinical uses of GHS are numerous. They include growthretardation in children and treatment of cachexia in AIDS patients, which arecurrently the only approved uses of therapy of GH. The administration of GH,which has to be injected every day, is cumbersome. Therefore, we believe thatthere would be a demand for new orally active drugs like GHS.

 

As part of our universitycollaboration, we accessed new peptidomimetic compounds with GH secretagogueproperties. The lead development candidate, AEZS-130, is a novel peptidomimeticGHS with potent and selective GH-releasing activity in humans. AEZS-130underwent limited clinical pharmacology tests that demonstrated a potentstimulation of the GH secretion after oral administration in human volunteers.This product has been licensed to Ardana Bioscience Ltd. (“Ardana”) (ARD-07),which initiated an open, randomized, placebo-controlled Phase 1 dose-rangingstudy in April 2004. Thirty-six healthy subjects were included in thisstudy to receive either the reference hormone GH RH by i.v. route or oneof the following dose levels of AEZS-130: 0.005, 0.05 or 0.5 mg/kg by oralroute. AEZS-130 at the dose of 0.5 mg/kg orally caused an increase in growthhormone release equivalent to that induced by GH RH i.v.. The compoundwas well tolerated and no other hormones showed a significant modificationafter any dose of AEZS-130.

 

InJune 2006, Ardana presented results regarding AEZS-130 at the 2006 EndoConvention. These results referred to the Phase 1 trial regarding thestimulating effects of AEZS-130 on growth hormone following both oral andintra-duodenal administration in healthy males. This study showed that AEZS-130was well tolerated by the 36 volunteers enrolled and no adverse events werereported. Administration of AEZS-130 either orally or via intra-duodenalinfusion results in increased levels of growth hormone in the blood. Thisstimulation of growth hormone appears to be selective as no otherhormones/analytes that were measured (cortisol, ghrelin, prolactin, insulin,glucose and ACTH (adrenocorticotropic hormone)) were affected in adose-dependent or statistically significant way by administration of AEZS-130either orally or via intra-duodenal infusion.

 

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InMay 2007, Ardana gained orphan drug status for AEZS-130 (SolorelTM)as a diagnostic for growth hormone deficiency in adults. The clinicaldevelopment and toxicology programs for this indication are ongoing and Ardanaannounced the commencement in the United States of the planned pivotalregistration study and the enrolment of the first patient in August 2007.

 

InJune 2008, Ardana announced that the company stopped its operations andentered into voluntary administration. Consequently, the clinical study ofAEZS-130 (SolorelTM) as a diagnostic test for adult growthhormone deficiency (“AGHD”) was suspended.

 

Weannounced the recovery of worldwide rights from Ardana for the compoundAEZS-130 in the third quarter of 2008. Future development options are currentlybeing evaluated for the use of this compound in growth hormone deficienciestherapy. In June 2009, we reported that, after regaining from Ardana theworldwide rights to the growth hormone secretagogue, AEZS-130, we had enteredinto an agreement with the administrators of Ardana to acquire all Ardanaassets relating to AEZS-130 for $232,000. These assets include developmentdata, inventory of compound, regulatory authorizations, including IND andorphan drug status as a diagnostic test granted in the United States, as wellas a patent application protecting the use of AEZS-130 (SolorelTM) for the diagnostic of growth hormone secretiondeficiency.

 

During the same month,the first clinical data relating to the use of AEZS-130 (SolorelTM) as a simple diagnostic test for adult growth hormonedeficiency were presented at the ENDO 2009 meeting by the main investigators DrG. Merriam and Dr B.M.K. Biller. Data showed that in adult growth hormonedeficient patients, the responses to the orally administered AEZS-130 (SolorelTM) compound were comparable to currently validatedagents and clearly separated patients from normal control subjects.

 

InOctober 2009, we announcedthat we have initiated activities intended to complete the clinical developmentof AEZS-130 (SolorelTM) which could be the first oraldiagnostic test approved for growth hormone deficiency (“GHD”). Æterna Zentarishas already assumed the sponsorship of the Investigational New Drug application(IND) and is discussing with the FDA the best way to complete the ongoing Phase3 clinical trial, and subsequently file a New Drug Application for approval ofAEZS-130 (SolorelTM) as a diagnostic test for GHD in adults.

 

The pivotal Phase 3 trial(listed in clinicaltrials.gov, study # NCT00448747) is designed to investigatethe safety and efficacy of the oral administration of AEZS-130 (SolorelTM)  as a growthhormone stimulation diagnostic test compared to GHRH + L-arginine, administeredi.v. Currentlyavailable results from this study demonstrated no safety issues and betterdiscrimination between adult GHD patients and normal controls with AEZS-130(SolorelTM) oral solution, compared to the currently used test with GHRH-Arginine i.v. administration.

 

Oral administration ofAEZS-130 (SolorelTM) offers more convenience and simplicityover the current GHD tests used, requiring either i.v. or i.m. administration. Additionally, AEZS-130(SolorelTM) may demonstrate a more favorable safetyprofile than existing diagnostic tests, some of which may be inappropriate forcertain patient populations e.g. diabetes mellitus or renal failure, and havedemonstrated a variety of side effects which AEZS-130 (SolorelTM) has not thus far. These factors may be limiting theuse of GHD testing and may enable AEZS-130 (SolorelTM)to become the diagnostic test of choice for GHD. AEZS-130 (SolorelTM) has been granted Orphan Drug Designation for thediagnosis of growth hormone deficiency by the FDA, and Æterna Zentaris is nowthe sponsor of this orphan designation.

 

**Competition for AEZS-130**

 

Competitors for AEZS-130 (SolorelTM)

 

Competitors for AEZS-130 (SolorelTM) as adiagnostic test for adult GHD are principally the diagnostic tests currentlyperformed by endocrinologists. Most commonly used diagnostics tests for GHDare:

 

Measurement of blood levels of Insulin Growth Factor (“IGF”)-1, which isoften used as the first test when GHD is suspected. However, this test is notused to definitively rule out GHD as many growth hormone deficient patientshow normal IGF-1 levels.

 

Insulin Tolerance Test (ITT), which is considered to be the “goldstandard” for GH secretion provocative tests but requires constant monitoringand is contra-indicated in patients with seizure disorders, with cardiovasculardisease and in brain injured patients and elderly patients. ITT is administeredi.v.

 

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GHRH+Arginine test, which is an easier test to perform in an officesetting and has a very good safety profile but is considered to be costly toadminister compared to ITT and Glucagon. This test is contra-indicated inpatients with renal failure. GHRH +Arginine is approved in the EU and has beenproposed to be the best alternative to ITT, but it is not frequently used inthe U.S. This test is administered i.v.

 

Glucagon test, which is simple to perform and is considered very safe byendocrinologists but is contraindicated in malnourished patients and patientswho have not eaten for more than 48 hours. Since there is a suspicion that thistest may cause hypoglycemia, it may not be appropriate in diabetic populations.This test is administered i.m.

 

Ghrelin receptor ligands

 

Ghrelinis a peptide predominantly produced by the stomach.  Apart from a potentGH-releasing action, ghrelin has other activities including stimulation oflactotroph and corticotroph function, influence on the pituitary gonadal axis,stimulation of appetite, control of energy balance, influence on sleep andbehavior, control of gastric motility and acid secretion, and influence onpancreatic exocrine and endocrine function as well as on glucose metabolism.The recent discovery of ghrelin and its receptors opens up new opportunitiesfor the development of drugs that will treat metabolic disorders. There isindeed a possibility that ghrelin analogs, acting as either agonists or antagonists,might have a clinical impact without affecting GH level.  The use ofghrelin antagonists as appetite suppressants or inhibitors of lipogenesis couldopen up new opportunities for the treatment of obesity and associated diseases(e.g. diabetes, cardiovascular diseases).  The use of ghrelin agonistscould have therapeutic benefits which are expected to offer hope for cachexicor anorexic patients.

 

In2004, we established a research and license collaboration agreement with LeCentre National de la Recherche Scientifique and University Montpellier I andII, France, acting in their own names, as well as in the name and on behalf ofthe Laboratoire des Aminoacides, Peptides et Protéines (LAPP) (UMR 5810),directed by Dr. Jean Martinez, for the synthesis and characterization ofnew chemical entities acting as ghrelin receptor ligands. According to theagreement, we have the worldwide rights to develop and exploit the newcompounds for any indication. Compounds with the most potent affinity for the ghrelinreceptors will be investigated further through an international network ofacademic investigators with expertise in the field of endocrinology in order toidentify clinical development candidates.

 

Additionally,we also established a research contract with the Department of Experimental andEnvironmental Medicine of the University of Milan, Italy, under the directionof Prof. Vittorio Locatelli, for the pharmacological characterization ofpotentially ghrelin receptor ligands.

 

InAugust 2005, we filed a first patent application to protect a series ofnew chemical entities characterized as ghrelin receptor ligands.

 

InMay 2006, we established a research project agreement with the Universityof Montreal. This research project will focus on the characterization ofghrelin receptor ligands on fat tissue. This project is led by Huy Ong,Professor at the Faculty of Pharmacy, at the University of Montreal.

 

InAugust 2006, we also initiated a research collaboration with the Centre derecherche de l’Hôpital Laval (Québec) under the direction of Dr. DenisRichard. This research collaboration will focus on the pharmacologicalcharacterization of ghrelin receptor ligands *invivo*(e.g. the effects in diet-induced obesity models).

 

InOctober 2006, we presented for the first time our *in vivo* data on the capacity of ghrelinantagonists of selectively inhibiting food intake. This study, using a ratmodel, outlined the capacity of ghrelin antagonists’ ability to inhibitappetite without affecting growth hormone secretion and represents evidencethat ghrelin antagonist compounds can selectively inhibit food intake. Itfurther supports the hope that ghrelin antagonist compounds have the potentialto be useful for the treatment of obesity.

 

In2007 and 2008, we presented at scientific meetings preclinical candidateshaving the interesting property to decrease body weight gain and fataccumulation in diet induced obesity models. The ongoing work will focus on theimprovement of oral bioavailability.

 

InJuly 2009, new data supporting the use of AEZS-123 (JMV-2959), a ghrelinreceptor antagonist, for the treatment of alcohol dependence that involvedghrelin were published. Data were published in the renowned American scientificjournal, Proceedings of the National Academy of Sciences (PNAS). Data show that mice treated with ghrelinincrease their alcohol consumption. When ghrelin’s actions are blocked byadministering ghrelin receptor antagonists such as AEZS-123, mice no longershow preference for an alcohol-associated environment - in other words, alcoholis no longer able to produce its

 

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addictive effects thatinclude reward searching behaviour (akin to craving in alcoholic patients). Thework, coordinated by Æterna Zentaris, emerged from an internationalcollaboration between the research groups of Prof. Suzanne Dickson and Prof.Jörgen Engel who performed the pharmacology work at the Sahlgrenska Academy,Gothenburg, Sweden, and the research group of Prof. Jean Martinez whosynthesized the tested compound AEZS-123 at the Institut des biomolécules Max Mousseron, Montpellier, France.

 

**LHRHANTAGONISTS**

 

**Cetrorelix**

 

Cetrorelixis a peptide-based active substance which was developed in cooperation withNobel Laureate Professor Andrew Schally presently of the United States VeteransAdministration-Miami, University of Miami, and formerly of Tulane University inNew Orleans. This compound is a luteinising hormone releasing hormone (LHRH,also known as GnRH) antagonist that blocks the pituitary LHRH receptorsresulting in a rapid decrease of sexual hormone levels. Moreover, Cetrorelixallows the LHRH receptors on the pituitary gland to be blocked gradually.Conversely, the side effects usually associated with the use of agonists andresulting from total hormone withdrawal can be avoided in conditions that donot require a castrating degree of hormone withdrawal. Therefore, in contrastto treatment with agonists, LHRH antagonists permit dose-dependent hormonesuppression which is of critical importance for the tolerability of hormonaltherapy.

 

***Cetrorelix in vitro fertilization (COS/ART)***

 

**Cetrotide****®**

 

Cetrorelixis the first LHRH antagonist which was approved for therapeutic use as part offertilization programs in Europe and was launched on the market under the tradename Cetrotide® (cetrorelix acetate) in 1999. In womenwho undergo controlled ovarian stimulation for recovery of ovocytes forsubsequent fertilization, Cetrotide® helps preventpremature ovulation. LHRH is a naturally occurring hormone produced by thebrain to control the secretion of LH and, therefore, final egg maturation andovulation. Cetrotide® is designed to prevent LH productionby the pituitary gland and to delay the hormonal event, known as the “LH surge”which could cause eggs to be released too early in the cycle, thereby reducingthe opportunity to retrieve the eggs for the assisted reproductive techniquesprocedure.

 

Incomparison with LHRH agonists that require a much longer pre-treatment, the useof our LHRH antagonist, Cetrotide®, permits the physician tointerfere in the hormone regulation of the women undergoing treatment much moreselectively and within a shorter time.

 

Theeffectiveness of Cetrotide® has been examined infive clinical trials (two Phase 2 and three Phase 3 trials). Two dose regimenswere investigated in these trials: either a single dose per treatment cycle ormultiple dosing. In the Phase 2 studies, a single dose of 3 mg was establishedas the minimal effective dose for the inhibition of premature LH surges with aprotection period of at least four days. When Cetrotide® isadministered in a multi-dose regimen, 0.25 mg was established as the minimaleffective dose. The extent and duration of LH suppression was found to bedose-dependent. In the Phase 3 program, efficacy of the single 3 mg doseregimen and the multiple 0.25 mg dose regimen was established separately in twocontrolled studies utilizing active comparators. A third non-comparative studyevaluated only the multiple 0.25 mg dose regimen of Cetrotide®. In the fivePhase 2 and Phase 3 trials, 184 pregnancies were reported out of a total of 732patients (including 21 pregnancies following the replacement of frozen-thawedembryos). In these studies, drug-related side effects were limited to a lowincidence of injected site reactions; however, none of them was serious — suchas an allergic type of reaction —  or required withdrawal from treatment.In addition, no drug-related allergic reactions were reported from theseclinical studies.

 

Cetrotide® is theonly LHRH antagonist that is available in two dosing regimens. With animmediate onset of action, Cetrotide® permits precisecontrol — a single dose (3 mg), which controls the LH surge for up to fourdays, or a daily dose (0.25 mg) given over a short period of time (usually fiveto seven days). The treatment with Cetrotide® can be accomplishedduring a one-month cycle with a simplified, more convenient and shortertreatment requiring fewer injections than LHRH agonists.

 

Cetrotide® ismarketed in a 3 mg and a 0.25 mg subcutaneous injection as Cetrorelix acetateby Merck Serono in the United States and Europe. Approval for Cetrotide® in Japanwas gained in April 2006. In September 2006, we announced the launchof Cetrotide® in Japan for *in vitro*fertilization. Cetrotide® is marketed in Japan by our partnerShionogi. We receive revenue from the supply of Cetrotide® to ourJapanese partners. The market competitor is ganirelix (AntagonTM/Orgalutran®) from

 

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Schering-Plough(Organon) indicated for the inhibition of premature LH surges in womenundergoing controlled ovarian hyperstimulation.

 

***Partners for Cetrotide******®***

 

InAugust 2000, we entered into a commercialization agreement with MerckSerono for Cetrotide®. Under the terms of this agreement, wegranted an exclusive license to Merck Serono to commercialize Cetrotide® forIVF/COS/ART worldwide ex-Japan and we are entitled to receive fixed and salesroyalties from Merck Serono. The Japanese rights for this indication are heldby Shionogi whereby, according to a commercialization agreement, we receivedtransfer pricing from Shionogi.

 

InDecember 2008, we sold our rights to royalties on future sales ofCetrotide® covered by our license agreement with Merck Serono for $52.5million to CowenHealthcare Royalty Partners (“CHRP”) less transactioncosts of $1.0 million, resulting in initial net proceeds to us of $51.5million. In addition, contingent on 2010 net sales of Cetrotide® reachinga specified level, we may receive an additional payment of $2.5 million fromCHRP. Under the terms of the agreement, we agreed to make a one-time cashpayment to CHRP in an amount ranging from $5 million up to a maximum of $15million in the event Cetrorelix is approved for sale by the European regulatoryauthorities in an indication other than *invitro* fertilization. The amount which would be due to CHRP will behigher the earlier the product receives European regulatory approval.

 

***Clinical development overview of Cetrorelixin benign prostatic hyperplasia (“BPH”), endometriosis and uterine myoma***

 

*Cetrorelix in BPH*

 

BPHis a hormone-driven enlargement of the male prostate gland. The prostate islocated directly at the vesicle outlet in the male surrounding the first partof the urethra. The enlargement puts pressure on the urethra, causingdifficulty in urinating. BPH is classified into three stages according tosymptoms: 1) the irritant phase, where the patient suffers dysuria (pain whenurinating) and nocturia (the urge to urinate during the night); 2) residualurine occurring in the bladder thus increasing problems during urinating; and3) overflow of the bladder. These can result in formation of bladder stones,congestion of urine and engorged kidneys which can in turn lead tolife-threatening kidney damage.

 

BPHclinical trials

 

On August 17, 2009, wereported Phase 3 results for our North American efficacy trial Z-033 (includingcertain sites in Europe) and safety trial Z-041 in BPH, with cetrorelix. Thestudy Z-033 failed to achieve its primary endpoint, being an improvement inInternational Prostate Symptom Score (“IPSS”) as compared to placebo, and itdemonstrated no clear differences in overall efficacy with all 3 groups showingan improvement in IPSS of approximately 4 points that was maintained throughoutthe 52 weeks. There was a slight advantage in favor of the main activetreatment arm (Arm A) up to Week 46 of the follow-up, which was no longerdemonstrated at Week 52. These differences did not achieve statisticalsignificance. Furthermore, a statistically significant effect on the IPSS, as comparedto placebo, was seen in a sub-group of patients with large prostate glands(greater than 50 cm3) on entry to thestudy. Tolerability of cetrorelix in study Z-033 was very good, as evidenced bythe absence of major differences to placebo with regard to both clinicaladverse events and changes in laboratory parameters.

 

On December 7, 2009, we reported the Phase3 results for cetrorelix from the European efficacy trial Z-036, involving 420patients. Study Z-036 did not reach itsprimary endpoint. There were no clear differences in overall efficacy, with all3 groups (including placebo) showing an improvement in IPSS of approximately 6points that was maintained throughout the 52 weeks. There was observation of animprovement in uroflow, both maximum and mean, and in residual volume in alltreatment groups. These favorable changes are reflected in an overallimprovement in Quality of Life measures. Furthermore, a favorable trend on theIPSS, as compared to placebo, was seen in a sub-group of patients with largeprostate glands (greater than 50 cm3) on entry to the study.Cetrorelix was well tolerated, there were no relevant differences to placebowith regard to both clinical adverse events or changes in laboratory parameterswith the exception of the anticipated hormonal changes.

 

On December 18, 2009, following the unsuccessful results of ourPhase 3 program in BPH with cetrorelix, weannounced the termination of our agreement with sanofi dated March 5,2009, for the development, commercialization and licensing of cetrorelix in BPHfor the U.S. market. Termination of the agreement took effect as of January 9,2010.

 

*Cetrorelix in endometriosis and uterine myoma*

 

Thereis no active program ongoing at present.

 

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***Partners for Cetrorelix***

 

Wepreviously licensed Cetrorelix to Solvay worldwide (ex-Japan) for allindications with the exception of IVF/COS/ART, which rights belong to MerckSerono and Japanese rights are held by Shionogi. In the BPH indication, forwhich we regained exclusive worldwide (ex-Japan) rights, Japanese rights areheld by Shionogi. On May 8, 2007, we and Solvay announced the terminationof the license and cooperation agreement for Cetrorelix for all remainingindications, including endometriosis, effective on that date, as a result ofwhich we regained exclusive worldwide (ex-Japan) rights for Cetrorelix in allindications without any financial compensation payable to Solvay.

 

OnMarch 22, 2007, we announced that Nippon Kayaku had terminated itsdevelopment agreement pertaining to Cetrorelix pamoate to focus solely inoncology.

 

Wesigned a license and cooperation agreement for the commercialization of Cetrorelix(BPH indication) with Handok for the Korean market during the third quarter of2008.

 

OnMarch 5, 2009, we entered into a development, commercialization andlicense agreement with sanofi-aventis for the development, registration andmarketing of Cetrorelix in BPH for the US market. Under the terms of theagreement, sanofi-aventis made an initial upfront payment to us of$30.0 million. Following the announcement of the negative results for theefficacy trial in North America (study Z-033) and in Europe (study Z-036), we announced the termination of ouragreement with sanofi-aventis dated March 5, 2009 for the development,commercialization and licensing of Cetrorelix in BPH for the U.S. market.Termination of the agreement was effective January 9, 2010.

 

Followingthe negative Phase 3 results for cetrorelix in BPH, our Japanese partner,Shionogi, also agreed with the Company to cease the development of cetrorelixin this indication.

 

**Ozarelix**

 

Ozarelix is a modified LHRHantagonist which is a linear decapeptide sequence. Ozarelix is afourth-generation LHRH antagonist aiming at extended suppression oftestosterone levels that does not require a sophisticated depot formulation forlong-lasting activity.

 

OnAugust 12, 2004, we entered into a licensing and collaboration agreementwith Spectrum for Ozarelix and its potential to treat hormone-dependent cancersas well as benign proliferative disorders, such as BPH and endometriosis. Underthe terms of the agreement, we granted an exclusive license to Spectrum todevelop and commercialize Ozarelix for all potential indications in NorthAmerica (including Canada and Mexico) and India while keeping the rights forthe rest of the world. In addition, Spectrum is entitled to receive 50% ofupfront and milestone payments and royalties received from our Japanesepartner, Nippon Kayaku,****that aregenerated in the Japanese market for oncological indications.During the third quarter of 2008, we entered into a commercializationagreement with Handok for Ozarelix (BPH indication) for the Korean market.

 

***BPH clinical trials***

 

InOctober 2006, we announced positive and highly statistically significantPhase 2 results for Ozarelix in BPH. The primary efficacy endpoint of improvingclinical symptoms of BPH at week 12, as measured by significant changes inIPSS, was achieved at all dosage regimens. Secondary efficacy parameters suchas uroflow, residual urinary volume, quality of life and circulatingtestosterone levels were also measured and showed good results. The outcome ofthe trial demonstrated an excellent safety profile with Ozarelix as patientshad no serious side effects. The erectile function was also not affected at anydose regimens.

 

OnMay 23, 2007 and September 5, 2007, Spectrum disclosed detailed Phase2 results for Ozarelix in BPH at two medical conferences. Results indicate thatOzarelix was well tolerated and demonstrated statistically significant as wellas clinically meaningful efficacy in the treatment of LUTS secondary to BPH.

 

On January 3, 2007,Spectrum announced the FDA’s acceptance of an IND for Ozarelix in BPH. Spectruminitiated a Phase 2b study in January 2007. On April 22, 2008, ourpartner Spectrum released the nine-month Phase 2b results for ozarelix.Spectrum indicated that ozarelix demonstrated sufficient clinical activity tojustify its continued development in BPH. Based on these results, Spectruminitiated in September 2008 the recruitment of 860 patients for a new BPHstudy, as mentioned on the www.clinicaltrials.gov website. In January 2010, Spectrum Pharmaceuticalsannounced the discontinuation of Ozarelix development in BPH, stating that themixed results of their Phase 2b study and the recently announced negativeresults of our Phase 3 registrational trial of Cetrorelix in BPH does not supportcontinued development of Ozarelix in this indication.

 

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***Prostate cancer clinical trials***

 

InAugust 2006, we announced positive Phase 2 results for Ozarelix inhormone-dependent inoperable prostate cancer. This open-label,randomized-controlled dose-finding trial enrolled 64 patients receivingdifferent IM dosage regimens of Ozarelix to assess its safety and efficacy. Thestudy achieved its primary endpoint of defining a tolerable dosage regimen ofOzarelix that would ensure continuous suppression of testosterone at castrationlevel for a three-month test period. A secondary efficacy endpoint aimed atassessing tumor response as determined by a 50% or greater reduction of serumPSA level, compared to baseline, was also achieved. The best results regardingthe primary endpoint of continuous suppression were obtained with a dose of 130mg per cycle where all patients remained suppressed to castration until atleast day 85. In patients with continuous testosterone suppression belowcastration level, tumor response as measured by PSA levels was 97%. Followingthese results, we, in collaboration with Spectrum, initiated an additionalPhase 2 study in European centers to verify and optimize the findings derivedfrom the cohort of patients having received 130 mg of Ozarelix per cycle.

 

OnAugust 3, 2006, we announced a licensing and collaboration agreement withNippon Kayaku for Ozarelix. Under the terms of the agreement, we granted NipponKayaku an exclusive license to develop and market Ozarelix for all potentialoncological indications in Japan. In return, we received an upfront paymentupon signature and are eligible to receive payments upon achievement of certaindevelopment and regulatory milestones, in addition to low double-digitroyalties on potential net sales. Spectrum is entitled to receive 50% of theupfront, milestone payments and royalties received from Nippon Kayaku.

 

**Non-peptide LHRH antagonists**

 

Asoutlined above, the LHRH receptor plays an important role in a number of benignand malignant tumors. Our drug discovery unit searches for small, non-peptidemolecules which have the same effect on the receptor. Their advantage lies inthe potential for oral administration.

 

AEZS-115is a new orally bioavailable LHRH antagonist with LHRH-receptor bindingaffinity in the nanomolar range which is developed for hormone therapy ofendocrinological disorder and of benign and malignant tumors. The compounddemonstrates excellent selectivity to LHRH-receptor and has advanced to apreclinical stage where the *in vivo*activity has been confirmed. Major advantages are the dose-dependent reductionof sexual hormones without flare-up effect whereas no decrease down tocastration level is necessary and therefore side effects are reduced.

 

InJanuary 2006, we regained the exclusive worldwide rights to develop andcommercialize AEZS-115 from Solvay. Attractive *invivo* activity of this orally available peptidomimeticLHRH-antagonist was demonstrated with a single, oral administration (20mg/kg)in rats which led to efficient and revocable suppression of plasma testosteronelevels for up to 12 hours. Furthermore, a repeat of the dosing of AEZS-115increased the suppression time without accumulation in the plasma.

 

In2007, an oral formulation was selected and pharmacokinetic data were obtained.

 

Firstpreclinical results were presented at the 2008 San Antonio Breast CancerSymposium on December 12, 2008 and showed substantial anti-tumor activityof AEZS-115 in human ovarian and breast cancer cell lines, as evidenced byexposure of human cell lines SKOV3, Ovcar 3 (human ovarian cancer cell lines)and MDA-MB 468 (human breast cancer cell line) to increasing concentrations ofAEZS-115, peptidic GnRH-antagonist Cetrorelix and GnRH-agonist Triptorelin (1,10, and 100 μM) for 48 days. The number of viable cells was determined bycrystal violet staining as well as by ATP-dependent luminometric assays.Results showed that both GnRH-antagonists dose-dependently inhibited growth ofall three cell lines, whileGnRH-agonist Triptorelin showed marginal growth inhibition. Cell growth wasinhibited by 40-60% following exposure to a concentration of 10 μM of AEZS-115and by 60-80% when cells were exposed to 100 μM. Inhibition with Cetrorelix at100 μM ranged from 20-40%, while only minor effects on cell growth were seen at10μM.  Optimization is ongoing.

 

**RAW MATERIALS**

 

Raw materials and supplies are generallyavailable in quantities adequate to meet the needs of our business. We aredependent on third-party manufacturers for the pharmaceutical products that wemarket. An interruption in the availability of certain raw materials oringredients, or significant increases in the prices paid by us for them, couldhave a material adverse effect on our business, financial condition, liquidityand operating results.

 

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**DISTRIBUTION**

 

We currently have a lean sales and marketing staff. Inorder to commercialize our product candidates successfully, we need to makearrangements with third parties to perform some or all of these services incertain territories.

 

We contract with third parties for the sales andmarketing of our products.  We arecurrently dependent on strategic partners and may enter into futurecollaborations for the research, development and commercialization of ourproduct candidates. Our arrangements with these strategic partners may notprovide us with the benefits we expect and may expose us to a number of risks.

 

**REGULATORY COMPLIANCE**

 

Governmental authorities inCanada, the United States, Europe and other countries extensively regulate thepreclinical and clinical testing, manufacturing, labeling, storage, recordkeeping, advertising, promotion, export, marketing and distribution, amongother things, of our product candidates. In Canada, the Canadian TherapeuticProducts Directorate is the Canadian federal authority that regulatespharmaceutical drugs and medical devices for human use.  Prior to being given market authorization, amanufacturer must present substantive scientific evidence of a product’ssafety, efficacy and quality as required by the Food and Drugs Act and otherregulations. In the United States, the FDA under the Federal Food, Drug, andCosmetic Act, the Public Health Service Act and other federal statutes andregulations, subject pharmaceutical products to rigorous review.  For more information about the regulatoryrisks associated with the Company’s business operations, see “Item 3—KeyInformation—Risk Factors”.

 

**DRUG DISCOVERY**

 

Thereis an increasing demand on the world market for active substances. Our internaldrug discovery unit provides an important prerequisite for the provision of newpatented active substances, which can then be developed further or licensed tothird parties.

 

Our drug discovery unitconcentrates on the search for active substances for innovative targets whichopen the door to the introduction of new therapeutic approaches. Further, thisunit searches for new active substances having improved properties forclinically validated targets for which drugs are already being used in humansand which produce inadequate effects, cause severe side effects, are noteconomical or are not available in a patient-friendly form.

 

Tothis end, we possess an original substance library for the discovery of activecompounds with a comprehensive range of promising natural substances which canserve as models for the construction of synthetic molecules. The initial testsinvolve 120,000 samples from our internal substance library in the form of high-throughputscreening. The hits, i.e. the first active compounds found in the library, aretested further and built up specifically into potential lead structures. Basedon two to three lead structures, they are then optimized in a further step topotential development candidates.

 

**INTELLECTUAL PROPERTY — PATENTS**

 

We believe that we have a solid intellectualproperty portfolio that covers compounds, manufacturing processes, compositionsand methods of medical use for our lead drugs and drug candidates. Our patentportfolio consists of about 55 owned and in licensed patent families (issued,granted or pending in the United States, Europe and other jurisdictions). Independentfrom the original patent expiry date additional exclusivity is possible in theUnited States, Europe and several other countries by data protection for newchemical entities, by orphan drug designation, or by patent term extensionrespective supplementary protection certificate.

 

Of the issued or granted patents, theprotective rights described below form the core of our patent portfolio withregard to our lead drugs and drug candidates.

 

***Perifosine:***

 

·                  U.S.patent 6,172,050 provides protection in the United States for the compoundperifosine and other related alkyl phospholipid derivatives, pharmaceuticalcompositions comprising the compounds as well as their medical use for thetreatment of tumors. This U.S. patent expires in July 2013. A patent termextension of up to five years may be possible and will be requested uponreceiving marketing approval of perifosine.

 

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·                  Europeanpatent 0 579 939 provides protection in European countries for the compoundperifosine and other related alkyl phospholipid derivatives, pharmaceuticalcompositions comprising the compounds as well as their medical use for thetreatment of tumors. This European patent expires in June 2013. A patentterm extension of up to five years by SPC may be possible and will be requestedupon receiving marketing approval of perifosine.

 

·                  Japanesepatent 3 311 431 provides protection in Japan for the compound perifosine andother related alkyl phospholipid derivatives. This Japanese patent expires in July 2013.A patent term extension of up to five years may be possible and will berequested upon receiving marketing approval of perifosine

 

***AEZS-108:***

 

·                  U.S. patent5,843,903 provides protection in the United States for the compound AN-152 andother related targeted cytotoxic anthracycline analogs, pharmaceuticalcompositions comprising the compounds as well as their medical use for thetreatment of tumors. This U.S. patent expires in November 2015.  Apatent term extension of up to five years may be possible and will be requestedupon receiving marketing approval of AEZS-108.

 

***AEZS-130:***

 

·                  U.S.patent 6,861,409 protects the compound AEZS-130 and U.S. patent 7,297,681protects other related growth hormone secretagogue compounds, pharmaceuticalcompositions comprising the compounds as well as their medical use forelevating the plasma level of growth hormone. This U.S. patent 6,861,409expires in August 2022.  A patent term extension of up to five yearsmay be possible and will be requested upon receiving marketing approval ofAEZS-130.

 

·                  Europeanpatent 1 289 951 protects the compound AEZS-130 and European patent 1 344 773protects other related growth hormone secretagogue compounds, pharmaceuticalcompositions comprising the compounds as well as their medical use forelevating the plasma level of growth hormone. This European patent 1 289 951expires in June 2021.  A patent term extension of up to five years bysupplementary protection certificates (“SPC”) may be possible and will berequested upon receiving marketing approval of AEZS-130.

 

·                  Japanesepatent 3 522 265 protects the compound AEZS-130 and pharmaceutical compositionscomprising the compounds as well as their medical use for elevating the plasmalevel of growth hormone. This Japanese patent expires in June 2021. A patent term extension of up to five years may be possible and will berequested upon receiving marketing approval of AEZS-130.

 

***Cetrorelix:***

 

·                  U.S.patent 5,198,533 provides protection in the United States for the compoundcetrorelix and other LHRH antagonists. This U.S. patent will expire in October 2010pursuant to a granted request for patent term extension.

 

·                  Europeanpatent 0 299 402 provides protection in European countries for the compoundcetroelix and other LHRH antagonists. This patent will expire in July 2013pursuant to granted requests for SPC.

 

·                  U.S.patent 6,828,415 protects a method for preparing sterile lyophilizateformulations of cetrorelix. It specifically protects the lyophilization processused to manufacture Cetrotide. This U.S. patent will expire in December 2021.

 

·                  Europeanpatent 0 611 572 protects a method for preparing sterile lyophilizateformulations of cetrorelix. It specifically protects the lyophilization processused to manufacture Cetrotide. This patent will expire in February 2014.

 

·                  U.S.patent 7,005,418 is a method-of-use patent covering the therapeutic managementof extrauterine proliferation of endometrial tissue (endometriosis), chronicpelvic pain and/or fallopian tube obstruction by administering an LHRHantagonist in the form of a short-term induction treatment for a period ofabout 4 to 12 weeks. The U.S. patent will expire in August 2022.

 

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***AEZS-112:***

 

·                  U.S.patent 7,365,081 provides protection in the United States for the compoundAEZS-112 and other related indole derivatives, and medicaments comprising them.This U.S. patent will expire in July 2021. A patent term extension of upto five years may be possible and will be requested upon receiving marketingapproval of AEZS-112.

 

***Ozarelix:***

 

·                  U.S.patent 6,627,609 provides protection in the United States for the compoundozarelix and related third-generation LHRH antagonists and pharmaceuticalcompositions comprising them. This U.S. patent will expire in March 2020.A patent term extension of up to five years may be possible and will berequested upon marketing approval of ozarelix.

 

The table below listssome of our issued or granted patents in the United States and Europe:

 
| **Patent  No.**    | ** ** | **Title**                                                                                                           | ** ** | **Country**                                             | ** ** | **Expiry Date*** |
|--------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|------------------|
| ** **         | ** ** | ** **                                                                                                          | ** ** | ** **                                              | ** ** | ** **       |
| **Perifosine**     | ** ** | ** **                                                                                                          | ** ** | ** **                                              | ** ** | ** **       |
| U.S. 6,172,050     |       | Phospholipid derivatives                                                                                            |       | United States                                           |       | 2013-07-07***    |
| ** **         | ** ** | ** **                                                                                                          | ** ** | ** **                                              | ** ** | ** **       |
| **AEZS-108**       | ** ** | ** **                                                                                                          | ** ** | ** **                                              | ** ** | ** **       |
| U.S. 5,843,903     |       | Targeted cytotoxic anthracycline analogs                                                                            |       | United States                                           |       | 2015-11-27***    |
| ** **         | ** ** | ** **                                                                                                          | ** ** | ** **                                              | ** ** | ** **       |
| **AEZS-130**       | ** ** | ** **                                                                                                          | ** ** | ** **                                              | ** ** | ** **       |
| U.S. 6,861,409     |       | Growth hormone secretagogues                                                                                        |       | United States                                           |       | 2022-08-01***    |
| ** **         | ** ** | ** **                                                                                                          | ** ** | ** **                                              | ** ** | ** **       |
| **Cetrorelix**     | ** ** | ** **                                                                                                          | ** ** | ** **                                              | ** ** | ** **       |
| EP

0 299 402 |       | LHRH antagonists                                                                                                    |       | Germany, United Kingdom, France,Switzerlandand  others  |       | 2013-07-10       |
| U.S. 5,198,533     |       | LHRH antagonists                                                                                                    |       | United States                                           |       | 2010-10-24       |
| EP

0 611 572 |       | Process to prepare a cetrorelix lyophilised composition                                                             |       | Germany, United Kingdom, France, Switzerland and others |       | 2014-02-04***    |
| U.S. 6,828,415     |       | Oliogopeptide lyophilisate, their preparation and use                                                               |       | United States                                           |       | 2021-12-07***    |
| U.S. 6,716,817     |       | Method of treatment of female infertility                                                                           |       | United States                                           |       | 2014-02-22***    |
| U.S. 6,863,891     |       | Oligopeptide lyophilisate, their preparation and use                                                                |       | United States                                           |       | 2014-02-22***    |
| U.S. 6,867,191     |       | Preparation and use of oligopeptide lyophilisate for gonad protection                                               |       | United States                                           |       | 2014-02-22***    |
| EP

1 309 607 |       | Method for producing LHRH antagonists                                                                               |       | Germany, United Kingdom, France, Switzerland and others |       | 2021-08-09***    |
| U.S. 6,780,972     |       | Method for the synthesis of peptide salts, their use and the  pharmaceutical preparations, containing peptide salts |       | United States                                           |       | 2021-08-24***    |
| U.S. 5,773,032     |       | Long-acting injection suspensions and a process for their preparation                                               |       | United States                                           |       | 2014-11-25***    |
| ** **         | ** ** | ** **                                                                                                          | ** ** | ** **                                              | ** ** | ** **       |
| **AEZS-112**       | ** ** | ** **                                                                                                          | ** ** | ** **                                              | ** ** | ** **       |
| U.S. 7,365,081     |       | Indole derivatives and their use as medicaments                                                                     |       | United States                                           |       | 2021-07-20***    |
|               |       |                                                                                                                |       |                                                    |       |             |
| **Ozarelix**       | ** ** | ** **                                                                                                          | ** ** | ** **                                              | ** ** | ** **       |
| U.S. 6,627,609     |       | LHRH antagonists having improved solubility properties                                                              |       | United States                                           |       | 2020-03-14***    |

 

----

*excluding any Patent Term Extension

 

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### ***C.            Organizational structure***

### *** ***

The following chartpresents our corporate structure, the jurisdiction of incorporation of ourdirect and indirect subsidiaries and the percentage of shares that we held inthose subsidiaries as of December 31, 2009.

 

|                                         |                          |                               |
|----------------------------------------------|-------------------------------|------------------------------------|
|                                         | **Æterna Zentaris Inc.** | ** **                         |
|                                         | **(Canada)**                  | ** **                         |
| ** **                                   | ** **                    | ** **                         |
| ** **                                   | ** **                    | ** **                         | ** ** |
|                                         |                          |                               |   |   |   |
|                                         |                          |                               |   |   |   |
|                                         | 100%                          |                               |   | 100% |   |
|                                         |                          |                               |
| **Æterna Zentaris GmbH**                | ** **                    | **Æterna Zentaris, Inc** |
| **(Germany)**                                | ** **                    | **(Delaware)**                     |
|                                         |                          |                               |
|                                         |                          |                               |   |
|                                         | 100%                          |                               |   |
|  

Zentaris IVF GmbH

(Germany)

  |                          |                               |

### *** ***

### ***D.            Property, plants and equipment***

### *** ***

Our corporate head office and facilities are locatedin Quebec City, Province of Quebec, Canada. The following table sets forthinformation with respect to our main facilities as of March 22, 2010.

 
| **Location**                                                     | ** ** | **Use of space**                                                                 | ** ** | **Square  Footage** | ** ** | **Type of  interest** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|---------------------|------------|-----------------------|------------|
|                                                             |       |                                                                             |       |                |       |                  |       |
| 1405 Parc Technologique Blvd. 

Quebec City (Quebec), Canada     |       | Fully  occupied for management, R&D and administration                       |       | 4,400               |       | Leased                |       |
|                                                             |       |                                                                             |       |                |       |                  |       |
| 20  Independence Blvd 

Warren,  New Jersey, United States       |       | Partially  occupied for management, R&D and business development             |       | 10,741              | (1)        | Leased                |       |
|                                                             |       |                                                                             |       |                |       |                  |       |
| Weismüllerstr.  50 

D-60314  

Frankfurt-am-Main,  Germany |       | Fully  occupied for management, R&D, business development and administration |       | 46,465              |       | Leased                |       |

 

----

(1)          ÆternaZentaris, Inc. sub-lets out to a sub-tenant approximately 7,500 squarefeet of adjacent premises.

 

## **Item 4A.         Unresolved Staff Comments**

## ** **

None.

 

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## **Table of Contents**

 

## **Item 5.            Operating and Financial Review and Prospects**

## ** **

**Highlights**

 

*Perifosine*

 

·                  June 1,2009: Positive Phase 2 data on perifosine in advanced metastatic coloncancer and in advanced renal cell carcinoma were presented at the AmericanSociety of Clinical Oncology’s (“ASCO”) annual meeting. The data demonstratedperifosine’s anti-cancer activity and efficacy both as a single agent and incombination therapy. Data were generated by our North American partner, KeryxBiopharmaceuticals (“Keryx”).

 

·                  August 3,2009: An agreement was reached with the United States Food and DrugAdministration (“FDA”) regarding a Special Protocol Assessment (“SPA”) on thedesign of a double-blind, placebo-controlled Phase 3 trial with perifosine inrelapsed or relapsed/refractory multiple myeloma patients previously treatedwith bortezomib (Velcade®). The Phase 3trial is to be conducted by Keryx.

 

·                  September 16,2009: Perifosine was granted Orphan Drug designation from the FDA for thetreatment of multiple myeloma.

 

·                  December 2, 2009: Perifosine was granted FastTrack designation by the FDA for the treatment of relapsed/refractory multiplemyeloma.

 

·                  December 7, 2009: Updated positive Phase 2efficacy and safety data, as well as new survival data for perifosine in combinationwith bortezomib (Velcade®) (+/- dexamethasone) in patients withrelapsed/refractory multiple myeloma, were presented at the American Society ofHematology’s (“ASH”) annual meeting. Results showed that the overall responserate was 41% and median overall survival was reported at 25 months for allevaluable patients. The combination therapy maintained an acceptable safetyprofile and no unexpected adverse events were reported. Data were presented byKeryx.

 

·                  December 16, 2009: The Phase 3 registrationclinical trial with perifosine in relapsed/refractory multiple myeloma wasinitiated by Keryx.

 

***AEZS-108***

 

·                  May 31,2009: Presentation at the ASCO’s Annual Meeting of results supporting theevaluation of AEZS-108 in prostate cancer.

 

·                  November 2, 2009: Disclosure of positivepreliminary results for the Phase 2 study with AEZS-108 in patients withplatinum-resistant and taxane-pretreated ovarian cancer.

 

·                  November 24, 2009: Disclosure of positiveefficacy data from a Phase 2 study with AEZS-108 in patients with advanced orrecurrent endometrial cancer.

 

***AEZS-112***

 

·                  September 21,2009: Disclosure of results from a Phase 1 study with AEZS-112 in patients withadvanced solid tumors or lymphoma.****Results showed prolonged courses of stable disease,excellent tolerability and potential for long-term use as a combinationtreatment for cancer.

 

***AEZS-130***

 

·                  June 11,2009: Poster presentation on AEZS-130 (SolorelTM) atthe annual meeting of the Endocrine Society, reporting the first clinical datarelating to the use of AEZS-130 (SolorelTM) as asimple diagnostic test for adult growth hormone deficiency.

 

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***Cetrorelix***

 

·                  August 17,2009: Disclosure of results from twoPhase 3 studies with cetrorelixin BPH. The efficacy study Z-033 (mainly conducted in North America) did notachieve its primary endpoint. Results from the safety study Z-041 werepositive and exhibited a similar level of efficacy as the previously disclosedPhase 2 studies.

 

·                  December 7, 2009: Disclosure of Phase 3 resultsfor our European efficacy trial Z-036 in BPH with cetrorelix. The study did notreach its primary endpoint.

 

***Corporate Developments***

 

·                  June 23,2009: Completion of a registered direct offering of $10.0 million to certainU.S. institutional investors.

 

·                  October 23, 2009: Completion of a$5.5 million registered direct offering with U.S. institutional investors.

 

·                  December 9, 2009: Appointment of Pierre Lapalmeto our Board of Directors.

 

***Cetrorelix Development,Commercialization and License Agreement***

 

·                  March 4,2009: Announcement of a development, commercialization and licensing agreementwith sanofi-aventis U.S. LLC (“sanofi”) for the development, registration andmarketing of cetrorelix in BPH for the U.S. market. The agreement provided uswith a $30.0 million gross upfront payment.

 

·                  December 18, 2009: Announcement of thetermination of our agreement with sanofi for the development, commercializationand licensing of cetrorelix in BPH for the U.S. market, subsequent to negativePhase 3 results.

 

**Subsequent to Year-End**

 

January 22, 2010: Notification from NASDAQ indicating that we werenot in compliance with the minimum closing bid price rule.

 

January 25, 2010: Updated results of a Phase 2 study of perifosinein the treatment of advanced metastatic colon cancer showing a statisticallysignificant benefit in survival, were reported by Keryx.

 

January 27, 2010: Our partner, Spectrum Pharmaceuticals, Inc.(“Spectrum”) announced the discontinuation of its development program forozarelix in BPH.

 

January 29, 2010: A publication in the February 2010 issue ofthe *Journal of Clinical Cancer Research*reported positive Phase 2 results for perifosine as a single agent for thetreatment of advanced Waldenstrom’s macroglobulinemia.

 

February 3, 2010: The FDA granted a SPA for the Phase 3 trial ofperifosine in combination with capecitabine (Xeloda®) inrefractory metastatic colorectal cancer. The trial is to be conducted by Keryx.

 

March 1, 2010: Disclosure that the Committee for Orphan MedicinalProducts of the European Medicines Agency issued a positive opinion for orphanmedicinal product designation for perifosine for the treatment of multiple myeloma.

 

March 12, 2010: We filed a Canadian short-form base shelfprospectus, as well as a registration statement on Form F-3 with theUnited States Securities and Exchange Commission (“SEC”), which were declaredeffective by both the Canadian authorities and the SEC, and which would permitus to issue up to $60.0 million of freely tradeable common shares andwarrants to purchase common shares.

 

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**Introduction**

 

The following Management’sDiscussion and Analysis (“MD&A”) provides a review of the results ofoperations, financial condition and cash flows of Æterna Zentaris Inc. for theyear ended December 31, 2009. Inthis MD&A, the “Company”, “we”, “us”, and “our” mean Æterna Zentaris Inc.and its subsidiaries. This discussion should be read in conjunction withthe information contained in the Company’s consolidated financial statementsand related notes as at and for the years ended December 31, 2009, 2008and 2007. Our consolidatedfinancial statements, reported in United States dollars (“US dollars”), exceptwhere otherwise noted, have been prepared in accordance with Canadian GenerallyAccepted Accounting Principles (“Canadian GAAP”) for financial information,which differ in certain respects from United States Generally AcceptedAccounting Principles (“US GAAP”)*.* The recognition, measurement and disclosuredifferences as they relate to the Company are described in note 26 to our2009 consolidated financial statements included elsewhere in this annualreport.

 

**AboutForward-Looking Statements**

 

This document contains forward-looking statements, which reflect ourcurrent expectations regarding future events. Forward-looking statements mayinclude words such as anticipate, believe, could, expect, goal, guidance,intend, may, objective, outlook, plan, seek, should, strive, target and will.

 

Forward-looking statements involve risks and uncertainties, many ofwhich are discussed in this MD&A. Results or performance may differsignificantly from expectations. For example, the results of current clinicaltrials cannot be foreseen, nor can changes in policy or actions taken by suchregulatory authorities as the FDA, the Therapeutic Products Directorate ofHealth Canada or any other organization responsible for enforcing regulationsin the pharmaceutical industry.

 

Given these uncertainties and risk factors, readers are cautioned not toplace undue reliance on any forward-looking statements. We disclaim anyobligation to update any such factors or to publicly announce any revisions toany of the forward-looking statements contained herein to reflect futureresults, events or developments, unless required to do so by a governmental authorityor by applicable law.

 

**AboutMaterial Information**

 

This MD&A includes the information we believe to be material toinvestors after considering all circumstances, including potential marketsensitivity. We consider information and disclosures to be material if theyresult in, or would reasonably be expected to result in, a significant changein the market price or value of our shares, or where it is quite likely that areasonable investor would consider the information and disclosures to beimportant in making an investment decision.

 

The Company is a reportingissuer under the securities legislation of all of the provinces of Canada andits securities are registered with the United States Securities and ExchangeCommission and is therefore required to file or furnish continuous disclosuredocuments such as interim and annual financial statements, an MD&A, a ProxyCircular, an Annual Report on Form 20-F, material change reports and pressreleases with the appropriate securities regulatory authorities. Copies ofthese documents may be obtained free of charge on request from the office ofthe Secretary of the Company or on the Internet at the following addresses:www.aezsinc.com, www.sedar.com and www.sec.gov.

 

**Company Overview**

 

Æterna Zentaris Inc. (TSX: AEZ, Nasdaq: AEZS)is a late-stage drug development company specialized in oncology and endocrinetherapy.

 

Our pipeline encompasses compounds at all stages of development, fromdrug discovery through marketed products. The highest priorities in oncology areour Phase 3 program with perifosine in multiple myeloma and ourPhase 2 program in multiple cancers, including metastatic colon cancer, aswell as our Phase 2 program with AEZS-108 in advanced endometrial andadvanced ovarian cancer combined with potential developments in other cancerindications. In endocrinology, our lead program is the reactivation of a Phase3 trial with AEZS-130 (SolorelTM) as a growthhormone (“GH”) stimulation test for the diagnosis of GH deficiency in adults(“AGHD”).

 

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**Key Developments for theYear Ended December 31, 2009**

 

**Drug Development**

 

**Status of our drug pipeline as at December 31,2009**

 
| **Discovery**             | ** ** | **Preclinical**                                                                                                                                                                                                                                                                                  | ** ** | **Phase 1**                                                                                            | ** ** | **Phase 2**                                                                                                                                                                                                                                                                                                                                                                           | ** ** | **Phase 3**                                                                                                                                                                                                                                                              | ** ** | **Commercial**                                                                                     |
|---------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|
| 120,000

compound library |       | AEZS-120

Prostate cancer vaccine  (oncology)

 

AEZS-129  Erk & PI3K Inhibitors (oncology)

 

AEZS-127

ErPC (oncology)

 

AEZS-123

Ghrelin receptor antagonist (endocrinology)

 

AEZS-115

Non-peptide LHRH antagonists

(endometriosis & urology) |       | AEZS-112  (oncology)

 

AEZS-130 Therapeutic in tumor induced cachexia   (endocrinology)

  |       | Perifosine

·           Metastatic colon  cancer

·           Kidney cancer

 

AEZS-108

·           Ovarian cancer

·           Endometrial cancer |       | Perifosine

·           Multiple myeloma

 

AEZS-130 (SolorelTM)

·           Diagnostic in  adult growth hormone deficiency (endocrinology)

  |       | Cetrotide®  (*in vitro* fertilization)

                                                 |
| **Partners**              |       |                                                                                                                                                                                                                                                                                             |       |                                                                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                  |       |                                                                                                                                                                                                                                                                     |       |                                                                                               |
|                      |       |                                                                                                                                                                                                                                                                                             |       |                                                                                                   |       | Perifosine: **Keryx**North America

 

**Handok**Korea (oncology)                                                                                                                                                                                                                                                                                                                |       | Perifosine: **Keryx**North America

 

**Handok**Korea (oncology)                                                                                                                                                                                                   |       | Cetrotide®:**Merck Serono** (World ex-Japan)

 

**Nippon Kayaku  / Shionogi**Japan |

 

**ONCOLOGY**

 

***Perifosine***

 

Perifosineis the first orally active Akt inhibitor in a Phase 3 trial for multiplemyeloma, as well as in multiple Phase 2 trials for other types of cancer. Thecompound modulates several key signal transduction pathways, including Akt,MAPK, and JNK that have been shown to be critical for the survival of cancercells. Perifosine has demonstrated single agent antitumor activity in Phase 1and Phase 2 studies and is currently being studied as a single agent and incombination with several forms of anti-cancer treatments for various forms ofcancer.

 

In June 2009, our partner Keryx reportedpositive Phase 2 results in metastatic colon cancer and advanced renalcell carcinoma, which demonstrated perifosine’s anti-cancer activity andefficacy both as a single agent and in combination therapy.

 

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On July 14, 2009, our partner Keryx announced theinitiation of a Phase 1 clinical study to evaluate perifosine as a singleagent treatment for recurrent solid tumors in pediatric patients. Thissingle-center open-label study, fully funded by an external grant provided by aprivate organization, will be conducted at Memorial Sloan-Kettering CancerCenter in New York City. Oren Becher, MD, Instructor, Department of Pediatrics,in coordination with Eric Holland, MD, Ph.D., Director of the Brain Tumor groupat Memorial Sloan-Kettering Cancer Center, will act as the study’s PrincipalInvestigator. Perifosine is beingevaluated as a single-agent in pediatric patients with any solid tumor that hasfailed standard therapy. Patients up to 18 years of age with a performancestatus of greater than 40% are eligible for this study. The study has beendesigned as a dose escalation study to determine the maximum tolerated dose(MTD) of perifosine alone in recurrent/progressive pediatric tumors. A standard3+3 dose escalation design will be employed with 3 to 6 patients at each doselevel. All patients will receive perifosine at a loading dose on the first day,followed by a maintenance dose to start on day two until progression ofdisease. A minimum of 4 and a maximum of 24 patients will be required tocomplete the study.

 

On August 3,2009, we announced that Keryx had reached an agreement with the FDA regarding aSPA on the design of a Phase 3 registration trial for perifosine, in relapsedor relapsed/refractory multiple myeloma patients previously treated withbortezomib (Velcade®). Under the SPA, it is agreed with the FDA that thePhase 3 study design adequately addresses objectives in support of a regulatorysubmission. The study, entitled *A Phase 3 Randomized Studyto Assess the Efficacy and Safety of Perifosine Added to the Combination ofBortezomib and Dexamethasone in Multiple Myeloma Patients Previously Treatedwith Bortezomib* and powered at 90%, is a randomized (1:1),double-blind trial comparing the efficacy and safety of perifosine to placebowhen combined with bortezomib and dexamethasone in approximately 400 patientswith relapsed or relapsed/refractory multiple myeloma. The primary endpoint isprogression-free survival and secondary endpoints include overall responserate, overall survival and safety.

 

Inaddition, in September 2009, perifosine received Orphan Drug designationfrom the FDA for the treatment of multiple myeloma, which provides a seven-yearperiod of U.S. marketing exclusivity for perifosine if the drug is the first ofits type approved for the specified indication or if it demonstrates superiorsafety, efficacy, or a major contribution to patient care versus another drugof its type previously granted the designation for the same indication.

 

On September 29,2009, we also reported updated clinical results from the Phase 2 study ofperifosine from renal cell cancer patients who failed both a VEGF receptorinhibitor [sunitinib (Sutent®) or sorafenib (Nexavar®)] and an mTOR inhibitor[temsirolimus (Torisel®) or everolimus (Afinitor®)]. Evaluable patients(n=16) were defined as those who had greater than 7 days of treatment (2additional patients withdrew consent within 7 days). Patients received 100 mgof perifosine daily until progression or unacceptable toxicity. The primaryendpoint of this study was clinical benefit, defined as response rate(complete/partial by RECIST) or percentage of patients progression-free for atleast 3 months. Median progression-free survival (PFS) and overall survivalwere also analyzed for efficacy. Safety was a secondary endpoint. Perifosinewas well tolerated with the most common adverse events being gastrointestinaldiscomfort and fatigue. Fifty percent (50%) of evaluable patients had a partialresponse or a stable disease with a progression for survival of 16 weeks.

 

On October 8,2009, Keryx also announced the initiation of a Phase 2 single-center,open-label, clinical study entitled “*Phase 2 Trial of Perifosinein Patients with Relapsed or Refractory Chronic Lymphocytic Leukemia/SmallLymphocytic Lymphoma*” to evaluate perifosine as a single agenttreatment for relapsed or refractory Chronic Lymphocytic Leukemia (CLL) andSmall Lymphocytic Lymphoma (SLL). This Phase 2 study was designed byDaphne Friedman, MD, Instructor and Principal Investigator, in coordinationwith J. Brice Weinberg, Professor, and Mark Lanasa, Assistant Professor,Divisions of Medical Oncology and Hematology, Duke University Medical Center,and is currently open for enrollment at Duke University. In this study, whichwill enroll approximately 30 patients, perifosine will be given orally at adose of 50 mg twice daily, for a total of six 28-day cycles. The patientswill be formally restaged upon completion of the trial. Overall Response Rateis the primary endpoint with overall survival, progression-free survival andsafety as secondary endpoints. Correlative studies will also be conducted andevaluated as a secondary endpoint.

 

On November 9, 2009, we announced thepublication of a scientific article in the renowned Journal of Urology,supporting the development of perifosine for the treatment of cancer. Thearticle outlines the pivotal role of PI3K and Akt signalling pathways in renalcell carcinoma pathogenesis thus, representing an ideal target for therapeuticintervention. Perifosine is described as the most advanced PI3K/Akt pathwayinhibitor, which has already proved to be clinically active, as well as anideal compound to combine with other anticancer agents.

 

On December 2, 2009, we announced thatthe U.S. Food and Drug Administration (FDA) had granted Fast Track designationfor perifosine for the treatment of relapsed/refractory multiple myeloma. TheFast Track program is designed to facilitate the development and expedite thereview of new drugs that are intended to treat serious or life-threateningconditions and that demonstrate the potential to address unmet medical needs.Fast Track designated drugs ordinarily qualify for priority review, therebyexpediting the FDA review process.

 

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On December 7, 2009, we announced thatKeryx had reported updated Phase 2 efficacy and safety data as well as newsurvival data on the clinical activity of perifosine in combination withbortezomib (Velcade®) (+/- dexamethasone) in patients with relapsed/refractorymultiple myeloma at the 51st annualmeeting of the American Society of Hematology. Reported for the first time forall 73 evaluable patients, was median progression-free survival (6.4 months/95%CI (5.3, 7.1) and overall survival (25 months/95% CI (15.5, not reached).Of particular interest was the comparison of evaluable patients who werepreviously refractory and the patients who were relapsed to a bortezomib-basedregimen. Median progression-free survival (“PFS”) and overall survival (“OS”)for bortezomib relapsed vs. refractory were as follows:

 
| **Bortezomib Relapsed vs.  Refractory** | ** ** | **Median  PFS***               | ** ** | **Median  OS****                           |
|-----------------------------------------|------------|--------------------------------|------------|--------------------------------------------|
| Bortezomib Relapsed  (n=20)             |       | 8.8 months

95% CI (6.3, 11.2) |       | Not Reached at 38+ months

95% CI (25, NR) |
| Bortezomib  Refractory (n=53)           |       | 5.7 months

95% CI (4.3, 6.4)  |       | 22.5 months

95% CI (12.3, NR)             |

 

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*       Median PFS and median TTP were identical, as no patient deathsoccurred prior to progression.

**     Kaplan Meier methodology was used to determine overall survivalfigures.

 

On December 16, 2009, we announced theinitiation, by Keryx, of the Phase 3 registration clinical trial withperifosine in relapsed/refractory multiple myeloma which will involveapproximately 400 patients. It is a double-blind, placebo-controlled trialcomparing the efficacy and safety of perifosine vs. placebo when combined withbortezomib (Velcade®) and dexamethasone. The primary endpoint isprogression-free survival and secondary endpoints include overallresponse-rate, overall survival and safety. The trial is being conductedpursuant to a SPA granted by the FDA.

 

On January 25, 2010, we announced that Keryx reported astatistically significant benefit in survival from updated results of a Phase 2study of perifosine in the treatment of advanced metastatic colon cancer.Results showed improvement in both timeto tumor progression and overall survival in the perifosine + capecitabine armversus placebo + capecitabine arm. Of notable interest, and for the first timepresented, were data showing a statistically significant benefit in medianoverall survival (15.3 months vs. 6.8 months — p=0.0088) and time to progression (18 weeks vs. 10 weeks — p=0.0004) for the subset of patients who were refractory toa 5-FU (Fluorouracil) chemotherapy-based treatment regimen.

 

On January 29, 2010, we announced the publication of positivePhase 2 results for perifosine as a single agent for the treatment ofadvanced Waldenstrom’s macroglobulinemia in the February 2010 issue of theJournal of Clinical Cancer Research. Datademonstrated a 35% overall response rate with a median progression-freesurvival of 12.6 months in patients with relapsed or relapsed/refractoryWaldenstrom’s macroglobulinemia.

 

On February 3, 2010, we announced that Keryx had reached anotherSPA with the FDA for the Phase 3 trial of perifosine in refractory metastaticcolorectal cancer.

 

March 1, 2010: Disclosure that the Committee for Orphan MedicinalProducts of the European Medicines Agency issued a positive opinion for orphanmedicinal product designation for perifosine for the treatment of multiplemyeloma.

 

***AEZS-108***

 

AEZS-108 represents a new targeting concept in oncology using acytotoxic peptide conjugate which is a hybrid molecule composed of a syntheticpeptide carrier and a well-known cytotoxic agent, doxorubicin. The design ofthis product allows for the specific binding and selective uptake of thecytotoxic conjugate by LHRH-receptor-positive tumors. Phase 2 studies withAEZS-108, involving up to 82 patients with advanced endometrial cancer andadvanced ovarian cancer, are being conducted and final results are expected in2010.

 

On May 31, 2009, we presented results supporting the evaluation ofAEZS-108 in prostate cancer at the American Society of Clinical Oncology(“ASCO”) Annual Meeting, which was held in Orlando, Florida.

 

On November 2, 2009, we disclosed positive preliminary results for the ongoing Phase 2 study inovarian cancer. All 43 patients with LHRH-receptor positive ovarian cancer whoentered study AGO-GYN-5 finished their study treatment, and a preliminaryevaluation showed that the study met its primary efficacy endpoint of 5 or moreresponders in 41 evaluable patients. Responders, as well as patients withstable disease after completion of treatment with AEZS-108, are being followedto assess the duration of progression-free survival and, ultimately, overall survival.More detailed analyses, which will also 

 

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include efficacy data from post-treatmentfollow-up, are currently in preparation and will be presented at forthcomingscientific conferences.

 

On November 24, 2009, we disclosedpositive efficacy data from a Phase 2 study with AEZS-108, in patients withadvanced or recurrent endometrial cancer. The study met its predefined primaryefficacy endpoint of 5 or more responder patients. This open-label,multi-center and multi-national Phase 2 study AGO-GYN 5, is being conducted bythe German AGO Study Group (Arbeitsgemeinschaft Gynäkologische Onkologie/Gynaecological Oncology Working Group; www.ago-ovar.de), in cooperation withclinical sites in Europe.

 

***AEZS-112***

 

AEZS-112 is an anticancer drugin development with three mechanisms of action involved, including tubulin andtopoisomerase II inhibition. AEZS-112 also expresses actions such aspro-apoptotic and antiangiogenic properties.

 

On April 22, 2009, we presented a poster at the Annual Meeting ofthe American Association of Cancer Research (“AACR”) which outlinedPhase 1 results for AEZS-112 in patients with advanced solid tumors orlymphoma, which may potentially provide a new therapeutic approach for thetreatment of cancer.

 

On September 21, 2009, weannounced the completion of the Phase 1 study of AEZS-112. Thisopen-label, dose escalation, multi-center, intermittent treatment Phase 1study included patients with advanced solid tumors and lymphoma who had eitherfailed standard therapy or for whom no standard therapy existed.

 

Patients received aonce-a-week oral administration of AEZS-112 for three consecutive weeks,followed by a one-week period without treatment. The cycles were repeated everyfour weeks based on tolerability and response, basically planned for up to fourcycles, but allowing for continuation in case of potential benefit for thepatient. The starting dose of AEZS-112 in this study was 13 mg/week, withdoubling of doses in subsequent cohorts in the absence of significant toxicity.The study was performed in two parts and included 42 patients overall. In Part I,22 patients were studied on doses ranging from 13 to 800 mg/week. In Part II,the weekly dose was split into 3 doses taken 8 hours apart, and ultimately, 20patients received doses from 120 to 600 mg/week. Stable disease with time tofailure ranging from 20 to 60+ weeks was achieved in 12 patients with variouscancer types, including melanoma and cancers of the colon/rectum, lung,pancreas, prostate, tongue, trachea and thyroid. In several of these patients,the duration of stabilization exceeded the duration of disease control onprevious treatment regimens. Except for a dose-limiting gastrointestinal (“GI”)reaction in a patient with pre-existing GI problems, no clinically relevantdrug-related adverse events or changes in laboratory safety parameters wereobserved.

 

***AEZS-129***

 

On April 21, 2009, we presented two posters on AEZS-129, apromising compound for clinical intervention of the PI3K/ Akt pathway in humantumors, at the American Association for Cancer Research (“AACR”) AnnualMeeting. *In vivo*and *in vitro*data showed significant antitumor activity and a favorable *in vitro*pharmacologic profile which could lead to further *in vivo*profiling.

 

**ENDOCRINOLOGY**

 

***AEZS-130***

 

AEZS-130, a growth hormonesecretagogue (GHS), is a novel synthetic small molecule, acting as a ghrelinmimetic, that is orally active and stimulates the secretion of growth hormone(GH).

 

A Phase 3 clinical trial ofAEZS-130 (SolorelTM, proposed trademark fordiagnostic use), to establish it as a diagnostic test for GHD in adults, wasinitiated in the United States by our former licensee, Ardana; however, thetrial was suspended before completion because of Ardana’s insolvency.

 

On June 5, 2009, we entered into an agreement with theadministrators of Ardana to acquire all of Ardana’s assets relating to AEZS-130for $0.2 million.

 

On June 11, 2009, we presented a poster on AEZS-130 (SolorelTM) atthe annual meeting of the Endocrine Society (“ENDO”), reporting the firstclinical data relating to the use of AEZS-130 (SolorelTM) as asimple diagnostic test for adult growth hormone deficiency.

 

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On October 19, 2009, weannounced that we had initiated activities intended to complete the clinicaldevelopment of AEZS-130 (SolorelTM), which could bethe first oral diagnostic test approved for growth hormone deficiency (“GHD”).

 

We have already assumed thesponsorship of the Investigational New Drug application and are discussing withthe FDA the best way to complete the ongoing Phase 3 clinical trial, andsubsequently file a New Drug Application (“NDA”) for approval of AEZS-130(SolorelTM) as a diagnostic test for GHDin adults.

 

The pivotal Phase 3 trial(listed in www.clinicaltrials.gov study # NCT00448747) is designed toinvestigate the safety and efficacy of the oral administration of AEZS-130(SolorelTM) as a growth hormonestimulation diagnostic test compared to GHRH + L-arginine, administeredintravenously. Currently available results from this study, previously reportedby G. Merriam *et al*. (PosterP2-749, ENDO ‘09, June 2009), demonstrated no safety issues and betterdiscrimination between adult GHD patients and normal controls with AEZS-130(SolorelTM) oral solution, compared tothe currently used test with GHRH-Arginine intravenous administration.

 

Oral administration ofAEZS-130 (SolorelTM) offers more convenience and simplicity overthe current GHD tests used, requiring either intravenous or intramuscularadministration. Additionally, AEZS-130 (SolorelTM) maydemonstrate a more favorable safety profile than existing diagnostic tests, someof which may be inappropriate for certain patient populationse.g. diabetes mellitus or renal failure, and have demonstrated a varietyof side effects which AEZS-130 (SolorelTM) hasnot thus far. These factors may be limiting the use of GHD testing and mayenable AEZS-130 (SolorelTM) to become thediagnostic test of choice for GHD.

 

AEZS-130 (SolorelTM) hasbeen granted Orphan Drug designation for the diagnosis of growth hormonedeficiency by the FDA, and we are now the sponsor of this orphan designation.Orphan Drug Designation confers a number of advantages to the furtherdevelopment of the drug, such as additional exclusivity for the molecule andthe potential of waiving User fees at the time an NDA is filed.

 

***Cetrorelix***

 

Cetrorelix is a peptide with unique modes of action in BPH, which wasthe object of Phase 3 clinical trials applying an intermittent treatmentschedule for treating symptoms associated with BPH, encompassing one safetytrial (Z-041) and two efficacy trials (Z-033, Z-036) involving more than 1,600patients in North America and Europe. Furthermore, the program also includedanother safety study (Z-043) TQT to assess the impact of cetrorelix on cardiacQT interval.

 

On August 17, 2009, wereported Phase 3 results for our North American efficacy trial Z-033 (includingcertain sites in Europe) and safety trial Z-041 in BPH, with cetrorelix.

 

The study Z-033 failed toachieve its primary endpoint, being an improvement in International ProstateSymptom Score (“IPSS”) as compared to placebo, and it demonstrated no cleardifferences in overall efficacy with all 3 groups showing an improvement inIPSS of approximately 4 points that was maintained throughout the 52 weeks.There was a slight advantage in favor of the main active treatment arm (Arm A) upto Week 46 of the follow-up, which was no longer demonstrated at Week 52. Thesedifferences did not achieve statistical significance. Furthermore, astatistically significant effect on the IPSS, as compared to placebo, was seenin a sub-group of patients with large prostate glands (greater than50 cm(3)) on entry to the study. Tolerability of cetrorelix in study Z-033was very good, as evidenced by the absence of major differences to placebo withregard to both clinical adverse events and changes in laboratory parameters.

 

The multi-center safety studyZ-041 was an open-label, single-armed study involving 528 patients in NorthAmerica. Cetrorelix was generally well tolerated. Adverse events were mostlymild and transient in intensity. Serious adverse events occurred in 12patients, but none of these was assessed as possibly drug-related. The mostfrequently reported adverse experiences included hot flushes, nasopharyngitis,injection site pain, and headache. Hot flushes were reported by 49 patients andwere mild and of short duration in the majority of patients. Only one patientexperienced a severe episode.

 

Furthermore, in study Z-041,efficacy was assessed using the IPSS which showed an improvement from a meanscore of 21.2 at baseline to 15.6 at Week 26. In 63% of the patients, theimprovement was by at least 3 points. Notably, the 46% of patients who hadreceived previous treatment for BPH showed a mean improvement of 5 points,which is only slightly less than the 6 point improvement seen in treatment-naïvepatients. Maximum uroflow improved by 25%, from 10.3 to 12.5 ml/sec, and alsothe mean uroflow showed a similar improvement.

 

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On September 30, 2009, wereported the results of our safety TQT study on cetrorelix. Results showed thatthe study met its primary endpoint and cetrorelix did not increase heartrate-corrected QT interval (QTc) at either the time of observed maximalconcentration of cetrorelix (Cetromax) or at the time ofminimum level of serum testosterone (Testmin).

 

On December 7, 2009, we reported the Phase3 results for cetrorelix from the European efficacy trial Z-036, involving 420patients. Study Z-036 did not reach itsprimary endpoint. There were no clear differences in overall efficacy, with all3 groups (including placebo) showing an improvement in IPSS of approximately 6points that was maintained throughout the 52 weeks. There was observation of animprovement in uroflow, both maximum and mean, and in residual volume in alltreatment groups. These favorable changes are reflected in an overallimprovement in Quality of Life measures. Furthermore, a favorable trend on theIPSS, as compared to placebo, was seen in a sub-group of patients with largeprostate glands (greater than 50 cm(3)) on entry to the study. Cetrorelixwas well tolerated, there were no relevant differences to placebo with regardto both clinical adverse events or changes in laboratory parameters with theexception of the anticipated hormonal changes.

 

On December 18, 2009, following the unsuccessful results of ourPhase 3 program in BPH with cetrorelix, weannounced the termination of our agreement with sanofi dated March 5, 2009,for the development, commercialization and licensing of cetrorelix in BPH forthe U.S. market. Termination of the agreement took effect as of January 9,2010.

 

***Ozarelix***

 

Ozarelix is a luteinizing hormone-releasinghormone agonist. Mechanistically, LHRH antagonists exert rapid inhibition ofluteinizing hormone and follicle stimulating hormone with an accompanying rapiddecrease in sex hormones and would therefore be expected to be effective in avariety of hormonally dependent disease states including ovarian cancer,prostate cancer, BPH, infertility, uterine myoma and endometriosis.

 

On January 27, 2010, our partner, Spectrum Pharmaceuticals,announced the decision to discontinue the development of ozarelix in BPH.Spectrum reported that the mixed results of an earlier Phase 2b study and therecently announced failure of a large Phase 3 registrational trial ofcetrorelix (another LHRH antagonist) in this indication do not supportcontinued development in BPH.

 

***AEZS-123***

 

AEZS-123 is a ghrelin receptor antagonist. Since its discovery, ghrelinhas emerged as one of the most promising targets in the field of obesity andother potential indications.

 

On July 7, 2009, we announced the publication in the renownedAmerican scientific journal, *Proceedings of the NationalAcademy of Sciences*, of new data supporting the use of our ghrelinreceptor antagonist compound, AEZS-123, for the treatment of alcohol dependencethat involves ghrelin.

 

**Corporate Developments**

 

**Registered Direct Offerings**

 

On June 23, 2009, we completed a registered direct offering of5,319,149 units, with each unit consisting of one common share and awarrant to purchase 0.35 of a common share at a price of $1.88 per unit(the “First Offering”). The related warrants represent the right to acquire anaggregate of 1,861,702 common shares, as discussed below. We also grantedwarrants to the sole placement agent engaged in connection with the FirstOffering, as discussed below.

 

Total proceeds raised through the First Offering amounted to$10.0 million, less cash transaction costs of approximately$0.8 million and non-cash transaction costs of approximately$0.7 million, which represent previously deferred charges incurred inconnection with the filing of a shelf prospectus. The purchasers in the offeringwere comprised of US institutional investors, and the securities describedabove were offered pursuant to a shelf prospectus dated September 27, 2007and a prospectus supplement dated June 18, 2009.

 

We granted a total of 5,319,149 warrants (the “First InvestorWarrants”) to the institutional investors who participated in the FirstOffering. Each First Investor Warrant entitles the holder to purchase 0.35 of acommon share at an exercise price of $2.06 per share. The First InvestorWarrants are exercisable between September 23, 2009 and December 23,2011, and, upon complete exercise, would result in the issuance of an aggregateof 1,861,702 of our common shares.

 

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We estimated the fair value attributable to the First Investor Warrantsof approximately $1.6 million as of the date of grant by applying theBlack-Scholes pricing model, to which the following additional assumptions wereapplied: a risk-free annual interest rate of 1.74%, expected volatility of90.6%, an expected term of 2.5 years, dividend yield of 0.0% and anissue-date market share price of $1.75. Transaction costs allocated to theFirst Investor Warrants amounted to approximately $0.2 million.

 

The First Investor Warrants may be exercised, at the option of theholder, by cash payment of the exercise price or, upon the existence of certainconditions, by “cashless exercise”, which means that in lieu of paying theaggregate exercise price for the shares being purchased upon exercise of thewarrants in cash, the holder would receive the number of shares underlying thewarrants equal to the quotient obtained by applying a formula, as defined bythe terms of each First Investor warrant. We will not receive additionalproceeds to the extent that warrants are exercised by cashless exercise.

 

The exercise priceand number of common shares issuable on exercise of the First Investor Warrantsmay be adjusted in certain circumstances, including stock dividends or splits,subsequent rights offerings, pro-rata distributions and pursuant totransactions involving the merger or consolidation of the Company with anotherentity or other Fundamental Transaction, as defined in the warrant.

 

Additionally, andnotwithstanding anything to the contrary, in the event of any type ofFundamental Transaction, as defined in the warrant, the Company or anysuccessor entity shall, at our option, have the right to require the holdersthereof to exercise the First Investor Warrants, or, at the holder’s option,purchase the First Investor Warrants from the holders by paying the holders anamount of cash equivalent to the Black-Scholes value, as defined, of theremaining unexercised portion of the First Investor Warrant on the date of theconsummation of an aforementioned Fundamental Transaction.

 

We granted a total of 820,668 warrants (the “FirstCompensation Warrants”) to the sole placement agent and its designatedrepresentatives engaged in connection with the First Offering. Each FirstCompensation Warrant entitles the holder to purchase 0.35 of a common share atan exercise price of $2.35 per share. The First Compensation Warrants areexercisable between December 23, 2009 and December 23, 2011, and,upon complete exercise, would result in the issuance of 287,234 of our commonshares.

 

We estimated the fair value attributable to the FirstCompensation Warrants of approximately $0.2 million as of the date of grant byapplying the Black-Scholes pricing model, to which the following additionalassumptions were applied: a risk-free annual interest rate of 1.74%, expectedvolatility of 90.6%, an expected term of 2.5 years, dividend yield of 0.0%and an issue-date market share price of $1.75. The initial fair value of theFirst Compensation Warrants has been accounted for as additional transactioncosts, since the instruments were granted to the sole placement agent as partof the terms of the underlying engagement and in recognition of the efforts madein connection with the First Offering.

 

The terms of the First Compensation Warrants, with theexception of the exercise price and period of exercise, are substantially thesame as those contained in the First Investor Warrants discussed above.

 

On October 23, 2009, we completed a second registered directoffering of 4,583,335 units, with each unit consisting of one common shareand a warrant to purchase 0.40 of a common share, at a price of $1.20 perunit (the “Second Offering”). The related warrants represent the right toacquire an aggregate of 1,833,334 common shares, as discussed below.  We also granted warrants to the soleplacement agent engaged in connection with the Second Offering, as discussedbelow.

 

Total proceeds raised through the Second Offering amounted to $5.5million, less cash transaction costs of approximately $0.4 million. Thepurchasers in this offering were new and existing institutional investors, andthe securities described above were offered by the Company pursuant to a shelf prospectusdated September 27, 2007 and a prospectus supplement dated October 19,2009.

 

We granted a total of 4,583,335 warrants (the “Second InvestorWarrants”) to the institutional investors who participated in the SecondOffering.  Each Second Investor Warrantentitles the holder to purchase 0.40 of a common share at an exercise price of$1.25 per share. The Second Investor Warrants are exercisable between October 23,2009 and October 23, 2014, and, upon complete exercise, would result inthe issuance of an aggregate of 1,833,334 common shares.

 

We estimated the fair value attributable to the Second Investor Warrantsof approximately $1.3 million as of the date of grant by applying theBlack-Scholes pricing model, to which the following additional assumptions wereapplied: a risk-free annual interest rate of 2.46%, expected volatility of84.3%, an expected term of 5 years, dividend yield of 0.0% and anissue-date market share price of $1.09. Transaction costs allocated to theSecond Investor Warrants amounted to approximately $0.1 million.

 

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The Second Investor Warrants may be exercised, at the option of theholder, by cash payment of the exercise price or, upon the existence of certainconditions, by “cashless exercise”, as defined and discussed above. We will notreceive additional proceeds to the extent that warrants are exercised bycashless exercise.

 

The exercise price and number of common shares issuable on exercise ofthe Second Investor Warrants may be adjusted in certain circumstances,including stock dividends or splits, subsequent rights offerings, pro-ratadistributions and pursuant to transactions involving the merger orconsolidation of the Company with another entity or other FundamentalTransaction, as defined in the warrant.

 

Additionally, and notwithstanding anything to the contrary, in the eventof any type of Fundamental Transaction, as defined in the warrant, the Companyor any successor entity shall, at our option, have the right to require theholders thereof to exercise the Second Investor Warrants, or, at the holder’soption, purchase the Second Investor Warrants from the holders by paying theholders an amount of cash equivalent to the Black-Scholes value, as defined, ofthe remaining unexercised portion of the Second Investor Warrant on the date ofthe consummation of an aforementioned Fundamental Transaction.

 

We granted a total of 320,832 warrants (the “Second CompensationWarrants”) to the sole placement agent engaged in connection with the SecondOffering.  Each Second CompensationWarrant entitles the holder to purchase 0.40 of a common share at an exerciseprice of $1.50 per share. The Second Compensation Warrants are exercisablebetween April 23, 2010 and October 23, 2012, and, upon completeexercise, would result in the issuance of 128,333 common shares.

 

We estimated the fair value attributable to the Second CompensationWarrant of approximately $0.1 million as of the date of grant by applying theBlack-Scholes pricing model, to which the following additional assumptions wereapplied:  a risk-free annual interestrate of 1.57%, expected volatility of 103.4%, an expected term of 3 years,dividend yield of 0.0% and an issue-date market share price of $1.09. Theinitial fair value of the Second Compensation Warrants has been accounted foras additional transaction costs, since the instruments were granted to the soleplacement agent as part of the terms of the underlying engagement and inrecognition of the efforts made in connection with the Second Offering.

 

The terms of the Second Compensation Warrants, with the exception of theexercise price and period of exercise, are substantially the same as thosecontained in the Second Investor warrants discussed above.

 

**Cetrorelix Development, Commercialization andLicense Agreement**

 

On March 4, 2009, we entered into a development,commercialization and license agreement with sanofi for the development,registration and marketing of cetrorelix in BPH for the U.S. market. Under theterms of the agreement, sanofi made an upfront nonrefundable license feepayment to us of $30.0 million. Also per the agreement, we would have beenentitled to receive certain payments upon achieving certain pre-establishedregulatory and commercial milestones as well as escalating double-digitroyalties on future net sales of cetrorelix for BPH in the United States.

 

On December 18, 2009, and following the announcement that ourPhase 3 study with cetrorelix in BPH did not reach its primary endpoint,we disclosed that we had received notice from sanofi to terminate theunderlying agreement, as discussed above. As a result, we fully recognized theaforementioned upfront payment, as the culmination of the earnings process wasdeemed to be complete.

 

As a result of entering into the agreement with sanofi, we paid aroyalty to the Tulane Educational Fund (“Tulane”) pursuant to a licenseagreement whereby we obtained licenses to use Tulane’s patents to develop,manufacture, market and distribute various compounds, including cetrorelix.This royalty, amounting to $3.0 million, was charged in full to sellingexpenses during 2009 as a result of sanofi’s decision to terminate the relatedagreement.

 

Finally, as a result of both the aforementioned negative results andsanofi’s decision to terminate the related agreement, we determined thatcertain intangible assets and certain items of property, plant and equipmentwere no longer recoverable, and therefore impaired, as discussed below.

 

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**Consolidated Results of Operations**

 

**Quarterly Consolidated Resultsof Operations Information**

(in thousands, except for per share data)

(unaudited)

 
| ** **                       | ** ** | **Quarters ended**         | ** ** |
|----------------------------------|------------|----------------------------|------------|
| ** **                       | ** ** | **December 31, 2009** | ** ** | **September 30,********2009** | ** ** | **June 30,********2009** | ** ** | **March 31,********2009** | ** ** |
| ** **                       | ** ** | ** **                 | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** |
|                             | ** ** | ** **                 | ** ** | ** ** |   |   |   |   |   |
| Revenues                         | ** ** | **40,182**                 |       | 8,565 |   | 8,379 |   | 6,111 |   |
| Earnings  (loss) from operations | ** ** | **11,511**                 |       | (9,789 | ) | (12,238 | ) | (13,442 | ) |
| Net  earnings (loss)             | ** ** | **12,032**                 |       | (11,288 | ) | (13,080 | ) | (12,388 | ) |
| Net  earnings (loss) per share   | ** ** | ** **                 |       |   |   |   |   |   |   |
| Basic  and diluted               | ** ** | **0.19**                   |       | (0.19 | ) | (0.24 | ) | (0.23 | ) |

 
| ** **            | ** ** | **Quarters ended**         | ** ** |
|-----------------------|------------|----------------------------|------------|
| ** **            | ** ** | **December 31, 2008** | ** ** | **September 30,********2008** | ** ** | **June 30,********2008** | ** ** | **March 31,********2008** | ** ** |
| ** **            | ** ** | ** **                 | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** |
|                  | ** ** | ** **                 | ** ** | ** ** |   |   |   |   |   |
| Revenues              | ** ** | **7,244**                  |       | 11,029 |   | 10,457 |   | 9,748 |   |
| Loss  from operations | ** ** | **(16,315**                | **)**      | (12,386 | ) | (19,525 | ) | (14,158 | ) |
| Net  loss             | ** ** | **(14,493**                | **)**      | (13,879 | ) | (20,579 | ) | (10,866 | ) |
| Net  loss per share   | ** ** | ** **                 |       |   |   |   |   |   |   |
| Basic  and diluted    | ** ** | **(0.27**                  | **)**      | (0.26 | ) | (0.39 | ) | (0.20 | ) |

 

Net earnings (loss) per share are (is) based on each reporting period’sweighted average number of shares outstanding, which may differ on aquarter-to-quarter basis. As such, the sum of the quarterly net earnings (loss)per share amounts may not equal year-to-date net loss per share.

 

**Fourth Quarter 2009 Results**

 

**Revenues** were$40.2 million for the quarter ended December 31, 2009, compared to$7.2 million for the same quarter in 2008. The significant increase inrevenues is due primarily to our having recognized the remaining unamortizedportion, or approximately $30.4 million, of the upfront payment receivedfrom sanofi. Additionally, the increase is attributable to the recognition ofremaining deferred revenues, amounting to approximately $1.8 million,associated with agreements related to the use of ozarelix, as intangible assetsthat, like cetrorelix, we deemed to be fully impaired in December 2009, asdiscussed in greater detail below.

 

**Selling,general and administrative (“SG&A”) expenses**were$6.2 million for the quarter ended December 31, 2009, compared to$3.0 million for the same quarter in 2008. The increase in SG&Aexpenses is predominantly related to the expensing of the remaining unamortizedportion, or approximately $3.0 million, of the royalty paid to Tulane inconnection with the agreement entered into with, and subsequently terminatedby, sanofi, as discussed above.

 

**Netresearch and development (“R&D”) expenses** were$10.6 million for the quarter ended December 31, 2009, compared to$12.2 million for the same quarter in 2008. The decrease in R&Dexpenses primarily relates to lower costs having been incurred in connectionwith our Phase 3 program for cetrorelix in BPH, given the progressive completionthrough the end of 2009 of efficacy and safety studies associated with thatcompound.

 

**Depreciation and amortizationexpenses** for thequarter ended December 31, 2009 amounted to $8.1 million, compared to$3.4 million for the same quarter in 2008. The comparative increase isattributable to the fact that, in December 2009, and following ourannouncements that our second Phase 3 study with cetrorelix in BPH had notreached its primary endpoint and 

 

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that sanofi had decided to terminate the related development,commercialization and license agreement (discussed above), we recognized animpairment charge equivalent to the remaining carrying value of cetrorelix, orapproximately $3.9 million, as part of amortization expense. Also in December 2009,we determined that certain items of property, plant and equipment, utilizedexclusively in the development activities related to cetrorelix, were also nolonger recoverable. As a result, we recorded an impairment charge, as part ofdepreciation expense, of approximately $1.9 million. Lastly, in December 2009,we determined that ozarelix—another luteinizing hormone-releasing antagonistthat, despite its different formulation, works on the same mechanism of actionas cetrorelix—also was no longer recoverable. Further, in January 2010 andas noted above, Spectrum, to whom we had granted an exclusive license todevelop and commercialize ozarelix for all potential indications in NorthAmerica and India, announced that it had terminated its development programwith ozarelix in BPH. Consequently, we recognized an impairment charge ofapproximately $1.4 million as part of amortization expense.

 

The aforementioned quarter-over-quarter increases were offset in largeproportion by an impairment charge in the fourth quarter of 2008, amounting toapproximately $2.4 million, related to teverelix, an intangible asset thathad been determined to be impaired in December 2008.

 

**Netearnings**were $12.0 million, or $0.19 per basic anddiluted share, for the quarter ended December 31, 2009, compared to a netloss of $14.5 million, or $0.27 per basic and diluted share, for the samequarter in 2008. The significant increase in net earnings is largelyattributable to the significant increase in license fee revenues, combined withlower comparative R&D expenses, as discussed above, partly offset byincreased SG&A expenses and depreciation and amortization charges, asdiscussed above.

 

We expect that the net loss for the first quarter of 2010, excluding anyimpact of foreign exchange gains or losses, will return to a level that is morealigned with pre-fourth quarter 2009 operational results.

 

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**ConsolidatedStatements of Operations**

 
| ** **                                               | ** ** | **Years  ended December 31,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------|------------|
| **(in thousands, except per share  data)**               | ** ** | **2009**                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                               | ** ** | **$**                              | ** ** | **$** | ** ** | **$** | ** ** |
| **Revenues**                                             | ** ** | ** **                         |       |   |   |   |   |
| License fees                                             | ** ** | **42,221**                         |       | 8,504 |   | 12,843 |   |
| Sales and royalties                                      | ** ** | **20,957**                         |       | 29,462 |   | 28,825 |   |
| Other                                                    | ** ** | **59**                             |       | 512 |   | 400 |   |
| ** **                                               | ** ** | **63,237**                         |       | 38,478 |   | 42,068 |   |
| ** **                                               | ** ** | ** **                         |       |   |   |   |   |
| **Operating  expenses**                                  | ** ** | ** **                         |       |   |   |   |   |
| Cost of sales, excluding depreciation and  amortization  | ** ** | **16,501**                         |       | 19,278 |   | 12,930 |   |
| Research and development costs                           | ** ** | **44,217**                         |       | 57,448 |   | 39,248 |   |
| R&D tax credits and grants                           | ** ** | **(403**                           | **)**      | (343 | ) | (2,060 | ) |
| Selling, general and administrative expenses             | ** ** | **16,040**                         |       | 17,325 |   | 20,403 |   |
| Depreciation and amortization                            | ** ** | ** **                         |       |   |   |   |   |
| Property, plant and  equipment                           | ** ** | **3,285**                          |       | 1,515 |   | 1,562 |   |
| Intangible assets                                        | ** ** | **7,555**                          |       | 5,639 |   | 4,004 |   |
| Impairment of  long-lived assets held for sale           | ** ** | **—**                         |       | — |   | 735 |   |
| ** **                                               | ** ** | **87,195**                         |       | 100,862 |   | 76,822 |   |
| **Loss from  operations**                                | ** ** | **(23,958**                        | **)**      | (62,384 | ) | (34,754 | ) |
| ** **                                               | ** ** | ** **                         |       |   |   |   |   |
| **Other  income (expenses)**                             | ** ** | ** **                         |       |   |   |   |   |
| Interest income                                          | ** ** | **349**                            |       | 868 |   | 1,904 |   |
| Interest expense                                         | ** ** | **(5**                             | **)**      | (118 | ) | (85 | ) |
| Foreign exchange gain (loss)                             | ** ** | **(1,110**                         | **)**      | 3,071 |   | (1,035 | ) |
| Other                                                    | ** ** | **—**                         |       | (79 | ) | (28 | ) |
| ** **                                               | ** ** | **(766**                           | **)**      | 3,742 |   | 756 |   |
| ** **                                               | ** ** | ** **                         |       |   |   |   |   |
| **Loss before  income taxes from continuing operations** | ** ** | **(24,724**                        | **)**      | (58,642 | ) | (33,998 | ) |
| **Income tax  (expense) recovery**                       | ** ** | **—**                         |       | (1,175 | ) | 1,961 |   |
| **Net loss  from continuing operations**                 | ** ** | **(24,724**                        | **)**      | (59,817 | ) | (32,037 | ) |
| **Net loss  from discontinued operations**               | ** ** | **—**                         |       | — |   | (259 | ) |
| **Net loss  for the year**                               | ** ** | **(24,724**                        | **)**      | (59,817 | ) | (32,296 | ) |
| ** **                                               | ** ** | ** **                         |       |   |   |   |   |
| **Net loss  per share from continuing operations**       | ** ** | ** **                         |       |   |   |   |   |
| **Basic and  diluted**                                   | ** ** | **(0.43**                          | **)**      | (1.12 | ) | (0.61 | ) |
| **Net loss  per share from discontinued operations**     | ** ** | ** **                         |       |   |   |   |   |
| **Basic and  diluted**                                   | ** ** | **—**                         |       | — |   | — |   |
| **Net loss  per share**                                  | ** ** | ** **                         |       |   |   |   |   |
| **Basic and  diluted**                                   | ** ** | **(0.43**                          | **)**      | (1.12 | ) | (0.61 | ) |

 

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**Revenues** arederived primarily from license fees, as well as from sales and royalties. Salesare derived from the manufacturing of Cetrotide® (cetrorelix acetate solution for injection),marketed for reproductive health assistance for *in vitro*fertilization and, prior to March 2008, from Impavido® (miltefosine), marketed for the treatment ofleishmaniasis, as well as from active pharmaceutical ingredients. Royalties arederived from Cetrotide® and, prior to the fourth quarter of 2008, werepayable by our partner, ARES Trading S.A. (“Merck Serono”). Beginning on October 1,2008, royalty revenues derived from Merck Serono’s net sales of Cetrotide® are recognized via the periodic amortization,under the units-of-revenue method, of proceeds received in connection with thesale in December 2008 of the underlying future royalty stream to CowenHealthcare Royalty Partners L.P. (“Cowen”).

 

License fees are derived from non-periodic milestone payments, R&Dcontract fees and upfront payments (and related amortization thereof) receivedfrom our licensing partners.

 

License fee revenues increased to $42.2 million for the year ended December 31,2009, compared to $8.5 million and $12.8 million for each of theyears ended December 31, 2008 and 2007, respectively. The significantincrease from 2008 to 2009 is almost exclusively attributable to the upfrontpayment received from sanofi, as well as from the full recognition of otherpreviously deferred revenues associated with ozarelix, as discussed above.

 

The decrease in license fee revenues from 2007 to 2008 is mainlyattributable to non-recurring milestone payments received in 2007 from Ardanaand from Keryx. Also, the decrease is related to the termination of ourlicensing agreement with Solvay Pharmaceuticals BV (“Solvay”) in 2007. Weregained the worldwide ex-Japan rights for endometriosis from Solvay during2007.

 

License fee revenues are expected to decrease substantially in 2010, dueto the known absence of future amortization of deferred revenues related toupfront payments already received.

 

Sales and royalties decreased to $21.0 million for the year ended December 31,2009, compared to $29.5 million and $28.8 million for each of theyears ended December 31, 2008 and 2007, respectively. The decrease from2008 to 2009 is mainly related to lower royalty revenues having been recognizedin 2009 in connection with our agreement with Merck Serono. Amortization of theproceeds received from Cowen for the year ended December 31, 2009 waslower than the royalty revenues generated and payable directly by Merck Seronoduring 2008. Additionally, sales volumes of Cetrotide® were slightly lower during the year ended December 31,2009, as compared to 2008.

 

The increase in sales and royalties from 2007 to 2008 is mainlyattributable to a large increase in sales of Cetrotide®,partly offset by lower sales of Impavido®.

 

Excluding the impact of foreign exchange rate fluctuations,sales androyalties are expected to decrease slightly in 2010.

 

**OperatingExpenses**

 

**Costof sales**decreased to $16.5 million for the year ended December 31,2009 from $19.3 million and $12.9 million for each of the years endedDecember 31, 2008 and 2007, respectively. The decrease from 2008 to 2009is largely attributable to the absence of Impavido® sales during thefirst three months of 2009, compared to the same period in 2008, while theincrease in cost of sales from 2007 to 2008 is directly related to an overallincrease in sales and royalties, as discussed above.

 

Cost of sales as a percentage of sales and royalties increased to 79% in2009 from 65% in 2008, and from 45% in 2007. The increase in cost of sales as apercentage of sales and royalties from 2008 to 2009 is largely attributable tothe comparative decrease in royalty revenues, as discussed above, while thehigher percentage of cost of sales in 2008 compared to 2007 is largely relatedto the product mix, which includes a high concentration of sales related toCetrotide®, a product that is moreexpensive to produce. In addition, we wrote down certain elements of ourinventory to their net realizable value at the end of 2008, which contributedapproximately $0.7 million to the increase in cost of sales compared to2007.

 

We expect cost of sales as a percentage of sales and royalties todecrease to approximately 75% in 2010 due to a slight increase in our salespricing, coupled with an overall reduction in production costs due to anexpected favourable change in product mix that will result in additionalthird-party cost savings.

 

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**R&Dcosts**were $44.2 million forthe year ended December 31, 2009, compared to $57.4 million and$39.2 million for each of the years ended December 31, 2008 and 2007,respectively. The decrease in R&D costs from 2008 to 2009 is largelyattributable to a lower volume of expenses having been incurred in 2009 relatedto the continued advancement during the first nine months of 2009, followed bythe winding down of our development activities linked to cetrorelix in BPHsubsequent to our announcements that our related Phase 3 studies did notreach their primary endpoints.

 

The increase in R&D costs for the year2008 compared to 2007 is mainly attributable to the advancement of ourPhase 3 program with cetrorelix in BPH.

 

The following table summarizes primary third-party R&D costs, byproduct, incurred by the Company during the years ended December 31, 2009and 2008.

 

(in thousands, exceptpercentages)

(unaudited)

 
| **Product**                 | ** ** | **Status**     | ** ** | **Indication**             | ** ** | **Year  ended  December 31,********2009** | ** ** | **Year  ended  December 31,********2008** | ** ** |
|-----------------------------|------------|----------------|------------|----------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                  | ** ** | ** **     | ** ** | ** **                 | ** ** | **$**                                          | ** ** | **%**                                          | ** ** | **$** | ** ** | **%** | ** ** |
| Cetrorelix                  |       | Phase 3*       |       | BPH*                       |       | 23,812                                         |       | 82.3                                           |       | 25,697 |   | 71.1 |   |
| AEZS-130 (SolorelTM)        |       | Phase 3        |       | Endocrinology (diagnostic) |       | 592                                            |       | 2.0                                            |       | — |   | — |   |
| Perifosine                  |       | Phases 2 and 3 |       | Oncology                   |       | 304                                            |       | 1.1                                            |       | 2,425 |   | 6.7 |   |
| Ozarelix                    |       | Phase 2*       |       | BPH*                       |       | 366                                            |       | 1.3                                            |       | 253 |   | 0.7 |   |
| AEZS-108                    |       | Phase 2        |       | Oncology                   |       | 409                                            |       | 1.4                                            |       | 1,259 |   | 3.5 |   |
| AEZS-112                    |       | Phase 1        |       | Cancer                     |       | 430                                            |       | 1.5                                            |       | 981 |   | 2.7 |   |
| AEZS-129 / Erk PI3K    |       | Preclinical    |       | Cancer                     |       | 1,151                                          |       | 4.0                                            |       | 1,609 |   | 4.5 |   |
| AEZS-123 / Ghrelin receptor |       | Preclinical    |       | Endocrinology and oncology |       | 530                                            |       | 1.8                                            |       | 1,154 |   | 3.2 |   |
| AEZS-115 / LHRH antagonist  |       | Preclinical    |       | Endocrinology and oncology |       | 235                                            |       | 0.8                                            |       | 843 |   | 2.3 |   |
| Other                       |       | Preclinical    |       | Multiple                   |       | 1,096                                          |       | 3.8                                            |       | 1,913 |   | 5.3 |   |
|                        |       |           |       |                       |       | 28,925                                         |       | 100.0                                          |       | 36,134 |   | 100.0 |   |

 

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* Development activities terminated in the last quarter of 2009 andbeginning of 2010.

 

We expect our overall R&D investments to decrease significantlyduring 2010, largely due to the expected minimum costs associated with thewinding down of our program with cetrorelix in BPH.

 

**R&Dtax credits and grants**were $0.4 million for the year ended December 31, 2009, compared to$0.3 million and $2.1 million for each of the years ended December 31,2008 and 2007, respectively. The decrease in R&D tax credits and grants in2008 compared to 2007 is attributable to our having utilized only Quebecprovincial tax credits in 2008, while in 2007, we also reduced our income taxpayable by more than $1.6 million, following the elimination of incometaxes related to the distribution made to our shareholders in connection withour disposal of Atrium Biotechnologies Inc., now Atrium Innovations Inc.(“Atrium”).

 

**SG&Aexpenses** decreased to $16.0 million for the year ended December 31,2009, compared to $17.3 million and $20.4 million for each of theyears ended December 31, 2008 and 2007, respectively. The decrease from2008 to 2009 is related to comparative Euro-to-US dollar exchange ratefluctuations and to the absence in 2009 of certain non-recurring corporateexpenses due to cost-saving measures that were implemented beginning in the secondquarter of 2008, despite the additional selling expenses charged during 2009 aspertaining to the royalty paid to Tulane, as discussed above.

 

The decrease in SG&Aexpenses in 2008 compared to 2007 is primarily related to the organizationalchanges and cost-saving measures that were implemented beginning in the secondquarter of 2008.

 

We expect our SG&Aexpenses to decrease in 2010 by approximately $5.0 million,compared to 2009, given the absence of future amortization of the royalty paidto Tulane of $3.0 million related to our agreement with sanofi and givenadditional cost-saving measures, including workforce reduction and associatedsavings due to the expected overall decrease in development activities.

 

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**Depreciationand amortization expenses**increasedto a combined $10.8 million for the year ended December 31, 2009,compared to $7.2 million and $5.6 million for each of the years endedDecember 31, 2008 and 2007, respectively.

 

The increase in depreciation and amortization expenses from 2008 to 2009is attributable to the impairment charges related to cetrorelix, ozarelix andcertain items of property, plant and equipment utilized exclusively in thedevelopment activities related to cetrorelix, as discussed above. Thisyear-over-year increase was offset in large proportion by the impairment chargeof $2.4 million recorded in 2008 related to teverelix, as discussed below.

 

The increase from 2007 to 2008 was primarilyrelated to an impairment charge of approximately $2.4 million, recorded asamortization expense, taken in the fourth quarter of 2008 and related toteverelix, which had been determined to be impaired following Ardana’s enteringinto voluntary administration. Ardana is party to an assignment agreement uponwhich the cash recoverability of teverelix depends, and, as such, thiscustomer’s entering into voluntary administration has triggered the likelihoodthat no future cash flows will be received by the Company in connection withthe aforementioned license agreement. This increase in amortization expense waspartially offset by reductions in depreciation and amortization expensesrelated to long-lived assets held for sale, including the Quebec City buildingand land, and Impavido®, on which depreciation and amortization ceasedduring the final months of 2007. The underlying assets were sold in 2008, asdiscussed above.

 

**Impairmentof long-lived assets held for sale**amounted to $0.7million for the year ended December 31, 2007. This impairment was relatedto the building and land held for sale for which the estimated fair value hadbeen based on offers received by third parties.

 

**Lossfrom operations**amounted to $24.0 millionfor the year ended December 31, 2009, compared to $62.4 million and$34.8 million for each of the years ended December 31, 2008 and 2007,respectively.

 

The significant decrease in loss fromoperations is due to the significant year-over-year increase in license feerevenues, associated mainly with agreements for cetrorelix and ozarelix,combined with lower comparative R&D and SG&A expenses, partly offset byincreased depreciation and amortization expenses and by a lower comparativemanufacturer margin, as discussed above.

 

The increase in loss from operations in 2008as compared to 2007 is largely attributable to a combination of lower licensefee revenues, lower manufacturing margins, higher depreciation and amortizationand higher R&D costs, partly offset by lower SG&A expenses.

 

We foresee our loss from operations to increase in 2010, as compared to2009, mainly as a result of the expected non-recurrence of license feeamortization of previously deferred revenues associated with cetrorelix andozarelix, as discussed above, partly offset by an anticipated reduction inR&D and SG&A costs.

 

**Otherincome (expenses)**

 

**Interestincome**amounted to $0.3 million for the year ended December 31,2009, compared to $0.9 million and $1.9 million for each of the yearsended December 31, 2008 and 2007, respectively. Interest income is derivedfrom our cash, cash equivalents and short-term investments, which, excludingrestricted balances, totalled $38.1 million as at December 31, 2009,$49.7 million as at December 31, 2008 and $41.4 million as at December 31,2007.

 

The decrease in interest income from 2007 to 2008 is due to the factthat less cash had been invested during 2008, with the exception of a largeportion of the proceeds received in connection with our sale of rights tofuture royalties to Cowen, though only in December 2008.

 

**Foreignexchange loss** amounted to $1.1 million for the yearended December 31, 2009, compared to a gain of $3.1 million and aloss of $1.0 million for each of the years ended December 31, 2008and 2007, respectively. The increased foreign exchange loss reported for theyear ended December 31, 2009 is attributable to the comparative weakeningof the US dollar vis-à-vis both the Canadian dollar and the euro since December 31,2008, as presented below.

 

The increase in foreign exchange gains in 2008 is mainly attributable toadvances to our German subsidiary, denominated in euros, and with our US-basedsubsidiary, denominated in US dollars, and the corresponding strengthening ofthe euro and the US dollar compared to the Canadian dollar. Since January 1,2009, all foreign currency exposure risk on intra-group transactions has beeneliminated, since the Company and all of its subsidiaries now use the euro astheir functional currency 

 

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due to a change in economic facts and circumstances. This change did notresult in any significant impact on our consolidated financial statements.

 

The year-end conversion rates from the euro and Canadian dollar to theUS dollar can be summarized as follows:

 
| ** **                     | ** ** | **As at  December 31,** | ** ** |
|--------------------------------|------------|------------------------------|------------|
| **1 US dollar equivalent to:** | ** ** | **2009**                     | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                     | ** ** | **$**                        | ** ** | **$** | ** ** | **$** | ** ** |
| Euro                           | ** ** | **0.7007**                   |       | 0.7145 |   | 0.6870 |   |
| Canadian dollar                | ** ** | **1.0510**                   |       | 1.2180 |   | 0.9913 |   |

 

**I****ncome tax (expense) recovery**was$nil for the year ended December 31, 2009, compared to ($1.2 million) and$2.0 million for each of the years ended December 31, 2008 and 2007,respectively.

 

The increase in income tax expense from 2007 to 2008 is largelyattributable to a minimum tax payable in Germany due to the tax accountingramifications of the sale of future royalties to Cowen, referred to above, andto the utilization, in 2007, of some of our future income tax assets followingthe non-recurring taxable capital gain realized in connection with our disposalof Atrium.

 

In 2010, we do not expect to record anysignificant income tax recovery or expense in our foreign or domestic entities.

 

**Netloss from continuing operations**was$24.7 million for the year ended December 31, 2009, compared to $59.8million and $32.0 million for each of the years ended December 31, 2008and 2007, respectively. The significant decrease in net loss from continuingoperations is due to the significant year-over-year increase in license feerevenues, associated mainly with agreements for cetrorelix and ozarelix,combined with lower comparative R&D, SG&A and income tax expenses,partly offset by lower comparative sales and royalties and increaseddepreciation and amortization expenses and foreign exchange losses, asdiscussed above.

 

The increase in net loss from continuing operations from 2007 to 2008 islargely attributable to a combination of lower license fee revenues, anincrease in R&D costs related to the advancement of our Phase 3 programwith cetrorelix in BPH, lower manufacturing margins, higher depreciation andamortization and higher income tax expense in 2008, partly offset by lowerSG&A expenses and higher net foreign exchange gains.

 

**Netloss from discontinued operations** represents theresults of operations related to Echelon Biosciences, Inc. (“Echelon”),which we disposed of in November 2007 and whose results were included inour consolidated statements of operations for the year ended December 31,2007.

 

**Netloss**was $24.7 million, or $0.43 per basic and dilutedshare for the year ended December 31, 2009, compared to$59.8 million, or $1.12 per basic and diluted share and$32.3 million, or $0.61 per basic and diluted share, for each of the yearsended December 31, 2008 and 2007, respectively.

 

The significant decrease in net loss is due to the significantyear-over-year increase in license fee revenues, associated mainly withagreements for cetrorelix and ozarelix, combined with lower comparativeR&D, SG&A and income tax expenses, partly offset by lower comparativesales and royalties and increased depreciation and amortization expenses andforeign exchange losses, as discussed above.

 

The increase in net loss in 2008 as comparedto 2007 is attributable to a combination of lower license fee revenues, lowermanufacturing margins, higher depreciation and amortization, higher income taxexpense and higher R&D costs, partly offset by lower SG&A expenses and highernet foreign exchange gains.

 

We expect that the net loss for the year 2010 will increase, togetherwith our expected loss from operations, as discussed above.

 

The weighted average number of shares outstanding used to calculatebasic net loss per share for the years ended December 31, 2009, 2008 and2007 was 56.9 million shares, 53.2 million shares and 53.2 millionshares, respectively.

 

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**Consolidated Balance SheetInformation**

*(Unaudited)*

 
| ** **                                           | ** ** | **As at  December 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|
| **(in thousands)**                                   | ** ** | **2009**                     | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                           | ** ** | **$**                        | ** ** | **$** | ** ** | **$** | ** ** |
| ** **                                           | ** ** | ** **                   |       |   |   |   |   |
| Cash and cash equivalents                            | ** ** | **38,100**                   |       | 49,226 |   | 10,272 |   |
| Short-term investments                               | ** ** | **—**                   |       | 493 |   | 31,115 |   |
| Accounts receivable and other current assets         | ** ** | **10,913**                   |       | 12,005 |   | 18,193 |   |
| Restricted cash                                      | ** ** | **878**                      |       | — |   | — |   |
| Property, plant and equipment, net                   | ** ** | **4,358**                    |       | 6,682 |   | 7,460 |   |
| Other long-term assets                               | ** ** | **32,013**                   |       | 39,936 |   | 56,323 |   |
| **Total  assets**                                    | ** ** | **86,262**                   |       | 108,342 |   | 123,363 |   |
| ** **                                           | ** ** | ** **                   |       |   |   |   |   |
| Accounts payable  and other current liabilities      | ** ** | **19,211**                   |       | 22,121 |   | 21,480 |   |
| Current portion of long-term debt and payable        | ** ** | **57**                       |       | 49 |   | 775 |   |
| Long-term payable                                    | ** ** | **143**                      |       | 172 |   | — |   |
| Non-financial long-term liabilities*                 | ** ** | **57,625**                   |       | 64,525 |   | 12,517 |   |
| **Total  liabilities**                               | ** ** | **77,036**                   |       | 86,867 |   | 34,772 |   |
| **Shareholders’  equity**                       | ** ** | **9,226**                    |       | 21,475 |   | 88,591 |   |
| **Total  liabilities and shareholders’ equity** | ** ** | **86,262**                   |       | 108,342 |   | 123,363 |   |

 

----

* Comprised mainly of deferred revenues and employee future benefits.

 

***2009 compared to 2008***

 

The decrease in cash and cash equivalents as at December 31, 2009,compared to December 31, 2008 is due primarily to recurring cash flowsused in operating activities and by the reduction of currently available cashdue to a transfer of funds to a restricted account, as discussed below, largelyoffset by the receipt of proceeds from sanofi and to the receipt of netproceeds in connection with the two registered direct offerings, as discussedabove.

 

The decrease in property, plant and equipment as at December 31,2009, compared to December 31, 2008 is due largely to the impairmentcharge that was takenagainst certain items utilized exclusively in the development activitiesrelated to cetrorelix, as discussed above.

 

The decrease in other long-term assets primarily includes the reductionto intangible assets, which in turn was attributable to the impairment chargestaken on cetrorelix and ozarelix, as discussed above. Additionally, thereduction is attributable to deferred charges amounting to approximately $0.7million, which were deferred in 2007 and 2008, but which were included as areduction to share capital in connection with the First Offering, as discussedabove.

 

The reduction in non-financial long-term liabilities mainly isattributable to deferred revenues, which in 2009 were lower following both theongoing amortization of the proceeds received from Cowen and the fullrecognition of previously deferred amounts associated with license anddevelopment agreements related to the use of ozarelix, as discussed above.

 

The decrease in shareholders’ equity from 2008 to 2009 is attributableto the increase in consolidated deficit due to the current year’s net loss andto the decrease in accumulated other comprehensive income, offset in largeproportion by the increase in share capital and warrants following the tworegistered direct offerings discussed above.

 

***2008 compared to 2007***

 

The increase in cash and cash equivalents andthe decrease in short-term investments from 2007 to 2008 are discussed in moredetail below. The decrease in accounts receivable and other current assets from2007 to 2008 is largely attributable to lower customer billings in December 2008compared to the same period in 2007, lower grants receivable at the end of 2008and the write-down to net realizable value of certain components of inventoryin December 2008, as discussed above.

 

The decrease in other long-term assets isprimarily due to the disposal, in 2008, of the long-lived assets which had beenreported as held for sale as at December 31, 2007, as discussed above andthe impairment charge that was taken relative to teverelix in the fourthquarter of 2008, partially offset by a net increase in deferred charges, duemainly to the capitalization of financial advisory, legal and other costsincurred in connection with the sale of our rights to future royalties toCowen. The 

 

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increase in non-financial long-termliabilities is primarily attributable to the increase in deferred revenuesfollowing the receipt of proceeds from Cowen, as well as an increase inemployee future benefits related mainly to employees in our German subsidiary.

 

The decrease in shareholders’ equity from 2007to 2008 is almost entirely attributable to the increase in consolidated deficitdue to the 2008 net loss and the decrease in accumulated other comprehensiveincome, which in turn is largely made up of cumulative translation adjustments.

 

**Financial Liabilities, Obligations and Commitments**

 

We have certain contractual obligations and commercial commitments.Commercial commitments mainly include R&D services and manufacturingagreements related to the production of Cetrotide® and to other R&D programs. The followingtable summarizes future cash requirements with respect to these obligations.

 
| ** **                 | ** ** | **Payments  due by period** | ** ** |
|----------------------------|------------|-----------------------------|------------|
| **(in thousands)**         | ** ** | **Carrying  amount**        | ** ** | **Less  than********1 year** | ** ** | **1  to 3  years** | ** ** | **4  to 5  years** | ** ** | **After  5 years** | ** ** |
| ** **                 | ** ** | **$**                       | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** |
| **Long-term payable**      |       | 200                         |       | 57 |   | 114 |   | 29 |   | — |   |
| **Operating leases**       |       | 12,721                      |       | 2,008 |   | 4,038 |   | 3,894 |   | 2,781 |   |
| **Commercial commitments** |       | 6,801                       |       | 5,256 |   | 1,545 |   | — |   | — |   |
| **Total**                  |       | 19,722                      |       | 7,321 |   | 5,697 |   | 3,923 |   | 2,781 |   |

 

**Outstanding Share Data**

 

As at March 23, 2010, there were 63,089,954 common shares issuedand outstanding and there were 6,213,922 stock options outstanding. Warrantsoutstanding as at March 23, 2010 represent a total of 4,110,603 equivalentcommon shares.

 

**Capital disclosures**

 

Our objective in managing capital is to ensuresufficient liquidity to fund our R&D activities, SG&A expenses, workingcapital and capital expenditures.

 

We endeavour to manage our liquidity to minimize dilution to ourshareholders. Non-dilutive activities have included the sale of non-core assetsand rights to future royalties, collection of investment tax credits andgrants, interest income, licensing fees, service and royalties. More recently,however, we raised additional capital via the registered direct offeringsdiscussed above.

 

During 2008, we fulfilled our obligation on the loanfrom the federal and provincial governments with a nominal value ofCAN$800,000.

 

In connection with the sale of the Quebec City buildingand land discussed above, we entered into a long-term lease agreement with theprincipal tenant of the building. As part of the agreement, we agreed to paythe principal tenant CAN$300,000 (approximately $285,000) as an incentive andservice fee. The resulting payable is non-interest bearing and is due inbi-annual installments of CAN$30,000 (approximately $28,500) over the next fiveyears.

 

Our capital management objective remains the same asthat of previous years. The policy on dividends is to retain cash to keep fundsavailable to finance the activities required to advance our product developmentpipeline.

 

We are not subject to any capital requirements imposedby any regulators or any other external source.

 

It is important to note that historical patterns ofexpenditures cannot be taken as an indication of future expenditures. Theamount and timing of expenditures and availability of capital resources varysubstantially from period to period, depending on the level of research anddevelopment activity being undertaken at any one time and on the availabilityof funding from investors and prospective commercial partners.

 

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**Liquidity, Cash Flows and Capital Resources**

 

Our operations and capital expenditures have been financed mainlythrough cash flows from operating activities, the selling of non-core assetsand other non-dilutive activities, except for the two registered directofferings completed during the year ended December 31, 2009, as discussedabove.

 

Our cash, cash equivalents and short-term investments amounted to$38.1 million as at December 31, 2009, compared to $49.7 millionas at December 31, 2008. Possible additional operating losses and/orpossible investments in the acquisition of complementary businesses or productsmay require additional financing. As at December 31, 2009, cash, cashequivalents and short-term investments of the Company includedCAN$2.6 million and €6.3million.

 

Based on our assessment, which took into account the cash received inconnection with the 2008 sale of rights to future royalties to Cowen, the upfrontpayment received from sanofi and the net proceeds received in connection withthe two registered direct offerings discussed above, as well as our strategicplan and corresponding budgets for 2010 and projections for 2011 and 2012, anddespite the announcement of negative results associated with our Phase 3studies with cetrorelix in BPH, we believe that the Company has sufficientfinancial resources to fund planned expenditures and other working capitalneeds for at least, but not limited to, the next 12-month period from thebalance sheet date.

 

We may endeavour to secure additional financing, as required, throughstrategic alliance arrangements or through other non-dilutive activities, aswell as via the issuance of new share capital.

 

The variation of our liquidity by activity is explained below, notconsidering any cash flows used in or provided by discontinued operations.

 

**Operating Activities**

 

Cash flows used in our continuing operatingactivities amounted to $24.1 million for the year ended December 31,2009, compared to $1.3 million and $25.7 million for each of theyears ended December 31, 2008 and 2007, respectively.

 

The significant increase in cash used in our continuing operatingactivities from 2008 to 2009 is attributable to the receipt of cash proceeds of$52.5 million in 2008 from Cowen, as discussed below, compared to thelower cash proceeds of $30.0 million from sanofi in 2009, as discussedabove. Also, operating cash payments for prepaid expenses and accounts payablewere higher during 2009 as compared to 2008.

 

The significant decrease in cash used inoperating activities from 2007 to 2008 relates in large proportion to the netcash proceeds received from Cowen, as discussed above, in addition to higherupfront payments received from certain customers and higher cash collections oftrade accounts receivable. These cash inflows were partially offset byincreased cash expenditures that contributed to the increase in our net loss,as well as by payments made, which were mainly related to financial advisory,legal and other costs incurred in connection with the transaction with Cowen,as well as to a higher volume of trade accounts payable settlements.

 

We expect net cash used in continuing operating activities to increasesignificantly in 2010, as compared to 2009, largely given the comparativeabsence of net proceeds associated with our agreement with sanofi, which hasbeen terminated, as discussed above.

 

**Financing Activities**

 

Net cash providedby (used in) continuing financing activities was $14.2 million for theyear ended December 31, 2009, compared to ($1.2 million) and($1.1 million) for each of the years ended December 31, 2008 and2007, respectively. The significant increase in net cash provided by financingactivities in 2009 is attributable to the registered direct offerings discussedabove, while the funds in 2008 and 2007 were used mainly for the repayments ofour long-term debt and payable, as well as in connection with the filing of ashelf prospectus.

 

**Investing Activities**

 

Cash (used in) provided by continuing investing activities (excludingthe changes in short-term investments) amounted to ($1.7 million) for the yearended December 31, 2009, compared to $13.6 million and ($3.0 million) foreach of the years ended December 31, 2008 and 2007, respectively. Thesefluctuations relate in large proportion to the disposals of the 

 

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building and land in Quebec City and of Impavido®, bothof which had been reported as long-lived assets held for sale as at December 31,2007 and sold in 2008.

 

Also, as discussed above, during 2009, we transferred approximately$0.9 million to a restricted cash account. Changes to restricted cashbalances, including any interest earned thereon, are reported in the statementof cash flows as investing activities.

 

**Critical Accounting Policies and Estimates**

 

Our consolidated financial statements are prepared inaccordance with Canadian GAAP. A summary of significant and pertinentmeasurement and disclosure differences between Canadian and US GAAP is providedin note 26 to our 2009 consolidated financial statements. The preparationof financial statements in accordance with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and the disclosures ofcontingent assets and liabilities at the date of the financial statements, aswell as the reported amounts of revenues and expenses during the reportingyears. Significant estimates are generally made in connection with thecalculation of revenues, research and development expenses, stock-basedcompensation costs, as well as in determining the allowance for doubtfulaccounts, future income tax assets and liabilities, the useful lives ofproperty, plant and equipment and intangible assets with finite lives, thevaluation of intangible assets and goodwill, the fair value of stock optionsand warrants granted, employee future benefits and certain accrued liabilities.We base our estimates on historical experience, where relevant, and on variousother assumptions that we believe to be reasonable under the circumstances.Actual results could differ from those estimates.

 

The following summarizes our critical accountingpolicies and other policies that require the most significant judgment andestimates in the preparation of our consolidated financial statements.

 

**Revenue Recognition and Deferred Revenues**

 

We are currently in a phase in which potentialproducts are being further developed or marketed jointly with strategicpartners. Existing licensing agreements usually foresee one-time payments(upfront payments), payments for research and development services in the formof cost reimbursements, milestone payments and royalty receipts for licensingand marketing product candidates. Revenues associated with thosemultiple-element arrangements are allocated to the various elements based ontheir relative fair value.

 

Agreements containing multiple elements are dividedinto separate units of accounting if certain criteria are met, includingwhether the delivered element has stand-alone value to the customer and whetherthere is objective and reliable evidence of the fair value of the undeliveredobligation(s). The consideration received is allocated among the separate unitsbased on each unit’s fair value and the applicable revenue recognition criteriaare applied to each of the separate units.

 

License fees representing non-refundable paymentsreceived upon the execution of license agreements are recognized as revenueupon execution of the license agreements when we have no significant futureperformance obligations and when collectibility of the fees is assured. Upfrontpayments received at the beginning of licensing agreements are not recorded asrevenue when received but are amortized based on the progress to the relatedresearch and development work. This progress is based on estimates of totalexpected time or duration to complete the work, which is compared to the periodof time incurred to date in order to arrive at an estimate of the percentage ofrevenue earned to date.

 

Milestone payments, which are generally based ondevelopmental or regulatory events, are recognized as revenue when themilestones are achieved, collectibility is assured, and when there are nosignificant future performance obligations in connection with the milestones.

 

Royalty revenue, based on a percentage of sales ofcertain declared products sold by third parties, is recorded when we havefulfilled the terms in accordance with the contractual agreement and have nofuture obligations, the amount of the royalty fee is determinable andcollection is reasonably assured.

 

Proceeds received in connection with the sale ofrights to future royalties are deferred and recognized over the life of thelicense agreement pursuant to the “units-of-revenue” method, as discussedabove.

 

Revenues from sales of products are recognized, netof estimated sales allowances and rebates, when title passes to customers,which is at the time goods are shipped, when there are no future performanceobligations, when the purchase price is fixed and determinable, and collectionis reasonably assured.

 

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**Impairment of Long-Lived Assets and Goodwill**

 

Property,plant and equipment and intangible assets with finite lives are reviewed forimpairment when events or circumstances indicate that carrying values may notbe recoverable. Impairment exists when the carrying value of the asset isgreater than the undiscounted future cash flows expected to be provided by theasset. The amount of impairment loss, if any, is the excess of its carryingvalue over its fair value, which in turn is determined based upon discountedcash flows or appraised values, depending of the nature of assets.

 

Goodwill, which representsthe excess of the purchase price over the fair values of the net assets ofentities acquired at the respective dates of acquisition, is tested forimpairment annually, or more frequently if events or changes in circumstancesindicate that the carrying value of the reporting unit to which the goodwill isassigned may exceed the fair value of the reporting unit.

 

In the event that thecarrying amount of a reporting unit, including goodwill, exceeds its fairvalue, an impairment loss is recognized in an amount equal to the excess. Fairvalue of goodwill is estimated in the same way as goodwill is determined at thedate of the acquisition in a business combination, that is, the excess of thefair value of the reporting unit over the fair value of the identifiable netassets of the reporting unit.

 

**Income Taxes**

 

We operate in multiplejurisdictions, and our earnings are taxed pursuant to the tax laws of thesejurisdictions. Our effective tax rate may be affected by changes in, orinterpretations of, tax laws in any given jurisdiction, utilization of netoperating losses and tax credit carry-forwards, changes in geographical mix ofincome and expense, and changes in management’s assessment of matters, such asthe ability to realize future tax assets. As a result of these considerations,we must estimate our income taxes in each of the jurisdictions in which weoperate. This process involves estimating our actual current tax exposure,together with assessing temporary differences resulting from differingtreatment of items for tax and accounting purposes. These differences result infuture tax assets and liabilities, which are included in our consolidatedbalance sheet. We must then assess the likelihood that our future tax assetswill be recovered from future taxable income and establish a valuationallowance if, based on available information, it is more likely than not thatsome or all of the future income tax assets will not be realized.

 

Significant managementjudgment is required in determining our provision for income taxes, our incometax assets and liabilities, and any valuation allowance recorded against ournet income tax assets. The valuation allowance is based on our estimates oftaxable income by jurisdiction in which we operate and the period over whichour income tax assets will be recoverable. In the event that actual resultsdiffer from these estimates or we adjust these estimates in future periods, wemay need to amend our valuation allowance, which could materially impact ourfinancial position and results of operations.

 

**Stock-Based CompensationCosts**

 

We account for all forms of employee stock-basedcompensation using the fair value-based method. This method requires that wemake estimates about the risk-free interest rate, the expected volatility ofour shares and the expected life of the awards.

 

**New Accounting Standards**

 

***Impact of accounting standardsadopted in 2009***

 

In February 2008, the Canadian Institute of Chartered Accountants(“CICA”) issued Handbook Section 3064, *Goodwilland Intangible Assets*. This standard provides guidance on therecognition of intangible assets and the criteria for asset recognition,clarifying the applications of the concept of matching revenues and expenses,whether these assets are separately acquired or are developed internally. Thestandard applies to our interim and annual financial statements for periodsbeginning on January 1, 2009. Adoption of this standard has not had anyimpact on our consolidated financial statements.

 

In January 2009, the CICA issued Handbook Section 1582, *Business Combinations*, which replaces the existingstandards. This section establishes the standards for accounting for businesscombinations and states that all assets and liabilities of an acquired businesswill be recorded at fair value. Obligations for contingent considerations andcontingencies will also be recorded at fair value at the acquisition date. Thestandard also states that acquisition-related costs will be expensed asincurred and that restructuring charges will be expensed in the periods afterthe acquisition date. We have early adopted this standard effective January 1,2009 and will apply the provisions thereof prospectively to future businesscombinations.

 

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In January 2009, the CICA issued Handbook Section 1601, *Consolidated Financial Statements*, which replaces theexisting standards and establishes the standards for preparing consolidatedfinancial statements and is effective for 2011. We have early adopted thisstandard effective January 1, 2009 and will apply the provisions thereofprospectively, where applicable.

 

In January 2009, the CICA issued Handbook Section 1602, *Non-controlling Interests*, which establishes standards foraccounting for non-controlling interests of a subsidiary in the preparation ofconsolidated financial statements subsequent to a business combination. We haveearly adopted this standard effective January 1, 2009 and have applied theprovisions thereof retrospectively, without any impact on our consolidatedfinancial statements.

 

In January 2009, the CICA’s Emerging IssueCommittee (“EIC”) issued Abstract EIC-173, “Credit Risk and the Fair Value of Financial Assets andLiabilities”, which requires entities to take both counterparty creditrisk and their own credit risk into account when measuring the fair value offinancial assets and liabilities, including derivatives. We adopted EIC-173 on January 1,2009, and such adoption did not have a material impact on our consolidatedfinancial statements.

 

In July 2009, the CICA amended Handbook Section 1506,*Accounting Changes*, to exclude from itsscope changes in accounting policies upon the complete replacement of an entity’sprimary basis of accounting. The amendments apply to interim and annualfinancial statements relating to years beginning on or after July 1, 2009.We early adopted these amendments on July 1, 2009, and such adoption didnot have any impact on our consolidated financial statements.

 

In June 2009, the CICA amended Handbook Section 3862,*Financial Instruments—Disclosures*, toinclude additional disclosure requirements about fair value measurements offinancial instruments and to enhance liquidity risk disclosure requirements forpublicly accountable enterprises. The amendments apply to annual financialstatements for years ending after September 30, 2009. We have adoptedthese amendments, and there has been no significant impact on our consolidatedfinancial statements. Additional required disclosures have been made whereapplicable.

 

**Accounting standards not yet adopted**

 

In December 2009, the EIC issued abstract EIC-175, “MultipleDeliverable Revenue Arrangements” (“EIC-175”), which requires a vendor to allocatearrangement consideration at the inception of an arrangement to alldeliverables using the relative selling price method.  EIC-175 alsochanges the level of evidence of the standalone selling price required toseparate deliverables when more objective evidence of the selling price is notavailable. Given the requirement to use the relative selling price method ofallocating arrangement consideration, EIC-175 prohibits the use of the residualmethod.  EIC-175 may be appliedprospectively and is applicable to revenue arrangements with multipledeliverables entered into or materially modified in the first annual fiscalperiod beginning on or after January 1, 2011, with early adoptionpermitted. We are currently evaluating the impact that this guidance may haveon our consolidated financial statements.

 

**International FinancialReporting Standards (“IFRS”)**

 

We are currently evaluatingthe potential impact that could result from preparing our consolidatedfinancial statements in accordance with IFRS, given that the CanadianAccounting Standards Board confirmed that IFRS will replace current Canadianstandards and interpretations as Canadian GAAP for publicly accountableenterprises. The adoption of IFRS will have an impact on our consolidatedfinancial statements, as well as on certain operational and performancemeasures, beginning on January 1, 2011.

 

As previously disclosed, we have developed a formal plan for IFRSconversion and the related transition from current standards. To date, we havecompleted a full diagnostic, in which all existing international standards wereexamined in comparison with corresponding Canadian guidance, and significantdifferences between IFRS and Canadian GAAP were documented in order to plan formore detailed analysis, which is the focus of our conversion project’ssolutions development phase, currently underway.

 

Solutions development activities include, but are not limited to, thefollowing key activities:

 

·                  Performanceof a more detailed review of relevant IFRS standards in order to identifydifferences as compared to our current accounting policies;

·                  Performanceof quantitative and qualitative impact analyses pursuant to the application ofcurrent international guidance to financial information;

·                  Preparationof “mock” financial statements and notes in accordance with IFRS in order toestablish a model for required presentation, format and disclosures;

 

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·                  Selectionor modification of accounting policies, where required or appropriate,including those available under IFRS 1, *First-time Adoption ofInternational Financial Reporting Standards*(“IFRS 1”), as discussedbelow;

·                  Identificationof any necessary changes relative to information-gathering activities andprocesses, including systems;

·                  Identificationof impact on other internal and external stakeholders; and

·                  Providingtraining to selected personnel.

 

Our solutions development activities completed to date have allowed usto conclude that the adoption of certain international standards likely willresult in a significant change to current accounting policies, reportedfinancial statement amounts or disclosures. With the exception of IFRS 1,selected areas of international guidance examined to date that are relevant toour business, and the corresponding expected impact that likely will resultfrom the application thereof, are presented below.

 
| **Accounting topic**                                          | ** ** | **Accounting difference and  expected impact**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|---------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Financial instruments — contingent settlement provisions |       | IAS 32, *Financial Instruments:  Disclosure and Presentation***(“IAS 32”),  provides more precise guidance than Canadian GAAP with respect to the  classification of financial instruments, including share purchase warrants,  with contingent settlement provisions. Under Canadian GAAP, we have  classified all outstanding share purchase warrants as shareholders’ equity,  where the instruments are reported at their grant-date fair value. Under the  provisions of IAS 32, these warrants would be classified as liabilities and  marked to market at each reported balance sheet date, and any changes to fair  value would be recognized in the consolidated statement of operations. This  treatment is similar to current US GAAP requirements, which are discussed in  note 26 to our 2009 consolidated financial statements. |

 

It should be noted that the differences shown above are not a completelist of topics that are or could become pertinent to our business. As such, aswe advance our solutions development activities, we may identify other areasthat could result in significant quantitative or qualitative impacts upon IFRSadoption or thereafter in comparison to currently applied Canadian GAAP.

 

As we continue to analyze any potential quantitative adjustments andpolicy decisions that need to be made upon full conversion to IFRS, we havereached some key preliminary conclusions related to the application ofIFRS 1.

 

IFRS 1 provides authoritative guidance for use in the conversion of aset of financial statements (and interim financial reports for part of thatperiod) from another basis of accounting to IFRS. The basic concept ofIFRS 1 is that the adoption of IFRS should be applied retrospectively,meaning that an entity should present its first financial statements using IFRSas if IFRS had been applied and effective from the date of the entity’sinception. However, due to the fact that full retrospective application isunlikely to be achievable in a cost-effective manner, IFRS 1 offers certainoptional exemptions to first-time preparers of IFRS financial statements. Any,all or none of these exemptions may be taken.

 

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Presented below are our preliminary conclusions with respect to some keyIFRS 1 optional exemptions, as applicable to our business.

 
| **Accounting topic**                       | ** ** | **IFRS 1 exemption  explained**                                                                                                                                                                                                      | ** ** | **Preliminary conclusion**                                                                                                                                                                      |
|--------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Business combinations                      |       | IFRS 1 allows first-time adopters to elect not to restate business  combinations that have occurred prior to the date of transition  (January 1, 2010) in accordance with IFRS 3, *Business  Combinations*(“IFRS 3”). |       | We will elect to apply this exemption and apply IFRS 3 only to  any business combinations that may occur after the date of transition,  without restating any prior business combinations. |
| Valuation of property, plant and equipment |       | IFRS 1 permits first-time adopters to measure selected assets at fair  value and use that fair value as deemed cost of those assets in the  transition date balance sheet.                                                           |       | We will not utilize this optional exemption and continue to use the  cost model for property, plant and equipment as of the date of transition to  IFRS.                                        |
| Foreign currency translation adjustments   |       | IFRS 1 permits first-time adopters to eliminate the cumulative  translation adjustment (“CTA”) balance (a component of accumulated other  comprehensive income) at the date of transition.                                 |       | We will eliminate our date of transition CTA balance by adjusting our  opening accumulated deficit.                                                                                             |

 

Other IFRS 1 exemptions will be considered as we continue to makeprogress in our conversion activities.

 

We will continue, on a quarterly basis, to provide information regardingthe timing, status and impact of the aforementioned activities and of other keyelements inherent in our IFRS conversion plan.

 

**Outlook for 2010**

 

**Perifosine**

 

We expect to continue the development of perifosine in North America(US, Canada and Mexico) in collaboration with our partner, Keryx, and benefitfrom this development in order to ultimately achieve registration in otherterritories. The primary focus will be to advance the Phase 3 registrationstudies in conformity with the SPA that Keryx recently received from the FDA inmultiple myeloma and refractory metastatic colon cancer. Keryx is responsible,in accordance with the terms of our license agreement, for the North Americandevelopment and registration of perifosine. We have access to all correspondingdata at no additional cost. In parallel with the North American developmentactivities, we expect to seek scientific advice with the European MedicinesAgency (“EMA”) relative to a development and regulatory pathway so as to extendthe reach of perifosine to European territories. We also expect to establish astrategy that will enable us to benefit from the Asian markets and from otherattractive territories. In the event that EMA requires additional trials or anyadditional development work prior to confirming compliance with Europeanregulations, we will support the corresponding R&D investments as we seekadditional partnerships for the corresponding territories.

 

**AEZS-108**

 

We expect to perform, together with cooperative groups and clinicalinvestigators, additional studies in endometrial or ovarian cancer, as well asin new indications such as prostate cancer and bladder cancer. Based on ouravailable financial resources and on the level of sponsorships that wesuccessfully obtain from different organizations, we will decide on our nextstudies.

 

**AEZS-130 (Solorel****TM****)**

 

Upon satisfactory discussions and agreement with the FDA, we expect tocomplete the Phase 3 program for AEZS-130 (SolorelTM) as adiagnostic test for adult growth hormone deficiency and to submit acorresponding NDA to the FDA.

 

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**Revenueexpectations**

 

License fee revenues are expected to decrease substantially in 2010, dueto the known absence of future amortization of deferred revenues related toupfront payments already received. Additionally, excluding the impact of foreign exchange ratefluctuations, sales and royalties are expected to decrease slightly in 2010.

 

**Cost reduction anddevelopment focus**

 

During 2010, we expect to focus on R&D efforts vis-à-vis ourlater-stage compounds, including perifosine, AEZS-108 and SolorelTM.Earlier-stage projects will be associated with grants, R&D credits orcollaboration agreements. We do not expect to pursue any development relatingto cetrorelix or ozarelix. With this focused strategy, we can expect areduction of our R&D expenses by nearly $20.0 million in 2010, ascompared to 2009.

 

With regard to our SG&A expenses, in light of the absence of futureamortization of the royalty paid to Tulane of $3.0 million related to ouragreement with sanofi and given additional cost-saving measures, we expect toreduce our costs in 2010 by approximately $5.0 million, as compared to2009.

 

We expect that our cash burn should therefore be in the range of$32.0 million to $35.0 million, excluding any non-dilutive activitiesrelating to the licensing out of our advanced products.

 

On March 12, 2010, we filed a Canadian short-form base shelfprospectus, as well as a registration statement on Form F-3 with the UnitedStates Securities and Exchange Commission (“SEC”), which were declaredeffective by both the Canadian authorities and the SEC, and which would permitus to issue up to $60.0 million of freely tradeable common shares andwarrants to purchase common shares.

 

We continue to endeavour to become a specialty pharmaceutical focused ononcology and endocrinology with our own marketing activities in selectedterritories and seek commercial partners, in order to carry out our strategicobjectives.

 

**Financial and Other Instruments**

 

**Foreign Currency Risk**

 

Since we operate on an international scale, we areexposed to currency risks as a result of potential exchange rate fluctuations.For the year ended December 31, 2009, we were not a party to anyforward-exchange contracts, and no forward-exchange contracts were outstandingas at March 23, 2010.

 

**Credit Risk**

 

Financial instruments that potentially subject theCompany to concentrations of credit risk consist primarily of cash and cashequivalents, restricted cash, short-term investments and accounts receivable.Cash and cash equivalents and restricted cash balances are maintained withhigh-credit quality financial institutions. Short-term investments haveconsisted of notes issued by high-credit quality corporations and institutions.Also, any accounts receivable balances due as at December 31, 2009 areinsignificant, both individually and in the aggregate. Consequently, managementconsiders the risk of non-performance related to cash and cash equivalents,restricted cash, short-term investments and accounts receivable to be minimal.

 

Generally, we do not require collateral or othersecurity from customers for trade accounts receivable; however, credit isextended following an evaluation of creditworthiness. In addition, we performongoing credit reviews of all our customers and establish an allowance fordoubtful accounts when accounts are determined to be uncollectible.

 

**RelatedParty Transactions and Off-Balance Sheet Arrangements**

 

We did not enter into transactions with any related parties during theyear ended December 31, 2009.

 

As at December 31,2009, we did not have any interests in variable interest entities or any otheroff-balance sheet arrangements.

 

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## **Item 6.            Directors, Senior Management and Employees**

## ** **

### ***A.            Directors and senior management***

### *** ***

The following table setsforth information about our directors and corporate officers as of March 22,2010.

 
| **Name  and Place of Residence** | ** ** | **Position with Aeterna Zentaris**                               |
|----------------------------------|------------|------------------------------------------------------------------|
|                             |       |                                                             |
| Aubut, Marcel                    |       | Director                                                         |
| Quebec, Canada                   |       |                                                             |
|                             |       |                                                             |
| Blake, Paul                      |       | Senior Vice President  and Chief Medical Officer                 |
| Pennsylvania, United  States     |       |                                                             |
|                             |       |                                                             |
| Byorum, Martha                   |       | Director                                                         |
| New York, United States          |       |                                                             |
|                             |       |                                                             |
| Dorais, José P.             |       | Director                                                         |
| Quebec, Canada                   |       |                                                             |
|                             |       |                                                             |
| Engel Juergen                    |       | President and Chief  Executive Officer and Director              |
| Alzenau, Germany                 |       |                                                             |
|                             |       |                                                             |
| Ernst, Juergen                   |       | Executive Chairman of  the Board and Director                    |
| Brussels, Belgium                |       |                                                             |
|                             |       |                                                             |
| Lapalme, Pierre                  |       | Director                                                         |
| Quebec, Canada                   |       |                                                             |
|                             |       |                                                             |
| Laurin, Pierre                   |       | Director                                                         |
| Quebec, Canada                   |       |                                                             |
|                             |       |                                                             |
| Limoges, Gérard             |       | Director                                                         |
| Quebec, Canada                   |       |                                                             |
|                             |       |                                                             |
| MacDonald, Pierre                |       | Director                                                         |
| Quebec, Canada                   |       |                                                             |
|                             |       |                                                             |
| Martin, Gerald J.                |       | Director                                                         |
| California, United States        |       |                                                             |
|                             |       |                                                             |
| Métivier,  Amélie      |       | Assistant  Secretary                                             |
| Quebec,  Canada                  |       |                                                             |
|                             |       |                                                             |
| Pelliccione, Nicholas            |       | Senior Vice President,  Regulatory Affairs and Quality Assurance |
| New York, United States          |       |                                                             |
|                             |       |                                                             |
| Seeber, Matthias                 |       | Senior  Vice President, Administration and Legal Affairs         |
| Frankfurt, Germany               |       |                                                             |
|                             |       |                                                             |
| Shapiro, Elliot                  |       | Corporate  Secretary                                             |
| Quebec, Canada                   |       |                                                             |
|                             |       |                                                             |
| Turpin, Dennis                   |       | Senior Vice President  and Chief Financial Officer               |
| Quebec, Canada                   |       |                                                             |

 

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The following is a brief biography of each of ourdirectors and senior officers.

 

*MarcelAubut*has served as a director on our Board since 1996. A key figure inCanadian business and an icon in the world of sports, Marcel Aubut, O.C., O.Q.,Q.C. Ad. E., has been a corporate and litigation lawyer for more than thirtyyears. A partner with Heenan Blaikie Aubut LLP, he is a member of the firm’sNational Management Committee and its Executive Committee. In 1983, Mr. Aubutfounded the firm of Aubut Chabot. He was President and Chief Executive Officerof *Le Club de Hockey Les Nordiques de Québec*,as well as founding president and chief executive officer of *Parc technologique du Québec métropolitain*.Many companies have called on Mr. Aubut to be a director, including suchhigh-profile ones as Boralex Power Income Fund, Boralex Inc., Atomic EnergyCanada, Cinar, Hydro-Québec, The Laurentian Group, Investors Group of MutualFunds, Sodic Québec Inc., International Continental Insurers Ltd, the NationalHockey League Pension Society, Olybro Inc. (previously known as Olymel),TransForce Inc., La Fondation Nordiques and Purolator.

 

*Paul Blake*was appointed our SeniorVice President and Chief Medical Officer in August 2007. Prior to joiningus, Dr. Blake was Chief Medical Officer of Avigenics, Inc. since January 2007.In 2005, he was Senior Vice President, Clinical Research and Regulatory Affairsat Cephalon, Inc. before being promoted to Executive Vice President,Worldwide Medical & Regulatory Operations. From 1992 to 1998, he heldthe position of Senior Vice President and Medical Director, Clinical Researchand Development at SmithKline Beecham Pharmaceuticals (now GSK). Dr. Blakeearned a medical degree from the London University, Royal Free Hospital. He waselected Fellow of the American College of Clinical Pharmacology, Fellow of theFaculty of Pharmaceutical Medicine, Royal College of Physicians in the UK, andhe is a Fellow of the Royal College of Physicians in the UK.

 

*Martha Byorum* has served as a directoron our Board since 2001. Ms. Byorum is currently Senior Managing Directorof Stephens Cori Capital Advisors, a division of Stephens, Inc., a privateinvestment banking firm. From 2003 to 2004, Ms. Byorum served as ChiefExecutive Officer of Cori Investment Advisors, LLC, which was spun off fromVioly, Byorum & Partners (“VB&P”) in 2003. VB&P was anindependent strategic advisory and investment banking firm specializing inLatin America. Prior to co-founding VB&P in 1996, Ms. Byorum had a24-year career at Citibank, where, among other things, she served as Chief ofStaff and Chief Financial Officer for Citibank’s Latin American Banking Groupfrom 1986-1990, overseeing $15 billion of loans and coordinating activities in22 countries. She later was appointed the head of Citibank’s U.S. CorporateBanking Business, and a member of the bank’s Operating Committee and CustomerGroup with global responsibilities. Ms. Byorum is a director of thefollowing companies which file reports pursuant to the Exchange Act: ÆternaZentaris Inc., Northwest Natural Gas Company, and M&F Worldwide Corp.

 

*José P. Dorais*has served as a director onour Board since 2006. Mr. Dorais is a partner of Miller Thomson PouliotLLP where he mainly practices administrative, corporate, business andinternational trade law. Over his 35-year career, he has worked in both theprivate and public sectors; in the latter he acted as Secretary to the Ministerof Justice and as Secretary of the consulting committee on the Free TradeAgreement for the Quebec Provincial Government. Mr. Dorais has been amember of numerous boards of directors, including the Société des Alcools duQuébec, Biochem Pharma and St-Luc Hospital in Montreal. He is now a member ofthe Board of Alliance Films, the Société Générale de Financement and Chairmanof the Board of Recyc-Québec. He holds a law degree from the University ofOttawa and is a member of the Quebec Bar.

 

*Juergen Engel* was appointed Presidentand Chief Executive Officer, effective September 1, 2008, after having upto such time served as our Executive Vice President and Chief ScientificOfficer. He became a director on our Board in 2003.  Dr. Engel hasbeen Managing Director of AEZS Germany, the Company’s principal subsidiary,since the beginning of 2001. Before that, he was in charge of all research anddevelopment activities of ASTA Medica AG. He is member of the Board ofDirectors of Isotechnika Pharma Inc., and member of the Advisory Board of GIG,Berlin and ElexoPharm, Saarbrücken.

 

*Juergen Ernst*was appointed ExecutiveChairman of the Board, effective September 1, 2008, after having served asChairman of the Board from August 13, 2007 until April 10, 2008 andas Interim President and Chief Executive Officer from April 11, 2008 untilAugust 31, 2008. He has served as a director on our Board since 2005. Aseasoned executive with more than 20 years of pharmaceutical industry expertisemainly in the field of corporate development and pharmaceutical product marketing,Mr. Ernst was worldwide General Manager, Pharmaceutical Sector of SolvayS.A., before retiring in 2004. He is now a member of the Board of Directors ofSolvay Pharmaceuticals B.V. since January 1,2005 and a director of Pharming Group N.V., Leiden, Netherlands since April 15,2009.

 

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*Pierre Lapalme* has served as a director on our Board since December 2009.Mr. Lapalme has over the course of his career held numerous seniormanagement positions in various global life sciences companies. He is formerSenior Vice-President, Sales and Marketing for Ciba-Geigy (which subsequentlybecame Novartis) and former Chief Executive Officer and Chairman of the Boardof Rhone-Poulenc Pharmaceuticals Inc. in Canada and in North America, as wellas Executive Vice-President and Chief Executive Officer of Rhone-Poulenc-RorerInc. North America (now sanofi-aventis), where he supervised the development,manufacturing and sales of prescription products in North and Central America. Mr. Lapalmeserved on the Board of the National Pharmaceutical Council USA and was a Boardmember of the Pharmaceutical Manufacturers Association of Canada, where heplayed a leading role in reinstituting patent protection for pharmaceuticals.Until recently, he was Board member and Chairman of the Board of Sciele PharmaInc. which was acquired by Shionogi and Co. Ltd. Mr. Lapalme is currentlyChairman of the Board of Biomarin Inc. Chairman of the Board of Pediapharm Inc. Board member of Algorithme Pharma Inc. and Board member of Confab Inc.He studied at the University of Western Ontario and at INSEAD, France.

 

*Pierre Laurin*has served as a director onour Board since 1998. Mr. Laurin has been Director of the Hautes ÉtudesCommerciales Business School in Montreal (HEC Montréal) since January 1999. Hewas elected Chairman of the Board of Directors of our former subsidiary,Atrium, in February 2001. From 1969 to 1982, Mr. Laurin heldsuccessively the positions of teacher and Dean with the Hautes ÉtudesCommerciales. Since then, he has acted as Vice President, General Manager,Planning and Administration for Alcan. He was also the founding President andCEO of Soccrent, a venture capital firm in Saguenay-Lac-St-Jean.  He hasalso spent 13 years as Vice Chairman of the Board and President for Quebec ofMerrill Lynch. Mr. Laurin is a member of several boards of directorsof corporations including Quebecor Inc., Microcell Telecommunications Inc.,Æterna Zentaris and the Fondation J.-Armand Bombardier. Mr. Laurinholds a Ph.D. degree in business from Harvard University, a Licence ès SciencesCommerciales from the Hautes Études Commerciales Business School, and Bachelor’sdegree ès Art from the Séminaire de Philosophie de Montréal.  He alsoholds a Doctorate Honoris Causa from Concordia University. He is an officer ofthe Order of Canada, and holds “L’ordre du Mérite” of the Republic of France.

 

*Gérard Limoges* has served as a directoron our Board since 2004. Mr. Limoges served as the Deputy Chairman ofErnst & Young LLP Canada until his retirement in September 1999.After a career of 37 years with Ernst & Young, Mr. Limoges hasbeen devoting his time as a director of a number of companies. Mr. Limogesbegan his career with Ernst & Young in Montreal in 1962. Aftergraduating from the Management Faculty of Université de Montréal (HEC Montréal)in 1966, he wrote the CICA exams the same year(Honors: Governor General’s Gold Medal for the highest marks in Canada and GoldMedal of the Ordre des Comptables Agréés du Québec). He became achartered accountant in 1967 and partner ofErnst & Young in 1971. Afterpracticing as auditor since 1962 and partner since 1971, he was appointedManaging Partner of the Montreal Office in 1979 and Chairman for Quebec in 1984when he also joined the National Executive Committee. In 1992, he was appointedVice-chairman of Ernst & Young Canada and the following year, DeputyChairman of the Canadian firm. After retirement from public practice at the endof September 1999, he was appointed Trustee of the School board of GreaterMontreal (1999), member of the Quebec Commission on Health Care and SocialServices (2000-2001) and special advisor to the Rector of the University deMontreal and affiliate schools (2000-2003). Mr. Limoges is a boardmember and chairman of the audit committees of the following public companies:Æterna Zentaris Inc., Atrium Innovations Inc. (TSX), Hartco Inc. (TSX), Hart Stores Inc. (TSX) and a board memberand chairman of the governance committee of Noranda Income Fund (TSX). He isalso a board member of various privatecompanies and charities. M. Limogesreceived the Order of Canada in 2002.

 

*Pierre MacDonald*has served as a director onour Board since November 2000. Mr. MacDonald is President and CEO ofMacD Consult Inc., a management consulting firm in international finance andmarketing, based in Montreal. He served as the Senior Vice President forEastern Canada for Bank of Montreal, a position which involved the review andevaluation of the financial statements and creditworthiness of borrowers in awide variety of industries. In December 1995, he was elected to theNational Assembly of Quebec and became Minister of International Trade andTechnology. He was also named Vice Chairman of the Treasury Board of theGovernment of Quebec. He also served as the Chairman of the Audit Committee ofTeleglobe Inc. for six years. Mr. MacDonald received Bachelor of Arts,Bachelor of Commerce and Master of Commerce degrees from Laval University inQuébec.

 

*Gerald J. Martin*has served as a director onour Board since 2006. Former Vice President, Corporate Licensing and TechnologyAlliances at Abbott Laboratories, Mr. Martin is currently Board Member ofLife Sciences Information Technology Global Institute, a not-for-profit publicbenefit corporation chartered to identify and develop Good InformaticsPractices (GIP) with a focus on the establishment of GIP in drug development.He was former Chairman of the Board of Milkahaus Laboratory based inProvidence, Rhode Island, a biotechnology company specialized mainly in malehealth. During his career in the biopharmaceutical and pharmaceutical sectors, Mr. Martin,in addition to his general management functions, developed a strong expertisein sales and marketing, business development, as well as in clinicaldevelopment.

 

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*AmélieMétivier*,Assistant Secretary. Ms. Métivier has servedas our Assistant Secretary since April 2009. In addition, Ms. Métivieris currently a lawyer at the law firm of Ogilvy Renault LLP with a business lawand transaction-oriented practice, where she has worked since 2003. She is amember of the *Barreau du Québec*since 2006, and holds an LL.B. (2004) degree from Université de Montréal.

 

*Nicholas J. Pelliccione*was appointed our SeniorVice President, Regulatory Affairs and Quality Assurance in May 2007. Inprevious roles, Dr. Pelliccione has been responsible for theclinical/preclinical and CMC regulatory aspects of new drugs in the oncology,anti-infectives, cytokines and cardiovascular therapy areas, leading to severalapprovals. He served as Senior Vice President, Regulatory and PharmaceuticalSciences at Chugai Pharma USA from May 2005 until March 2007. Priorto his experience at Chugai, Dr. Pelliccione spent more than 15 years atSchering Plough Corporation holding positions with increasing responsibilityfrom Manager of Regulatory Affairs, Oncology to, prior to his departure, VicePresident, Global Regulatory Affairs, Chemistry, Manufacturing and Controls. Dr. Pelliccioneholds a Ph.D. in Biochemistry from Mount Sinai School of Medicine, New York anda BS in Chemistry from Polytechnic University.

 

*Matthias Seeber* was appointed our SeniorVice President, Administration and Legal Affairs in December 2008. Mr. Seeberserved as Managing Director of AEZS Germany since July 2003 up to his mostrecent appointment. Prior to that, he had assumed the position of InvestorRelations Manager of Altana AG, following several years in the banking industrywith Deka Investment Management and Dresdner Bank AG. Mr. Seeber is amember of the Deutsche Vereinigung für Finanzanalyse und Asset Management(DVFA/CEFA). He obtained his M.B.A. from George Mason University GraduateSchool of Business Administration in the United States.

 

*ElliotShapiro* wasappointed our Corporate Secretary in April 2009. In addition, Mr. Shapirois currently a partner and a lawyer at the law firm of Ogilvy Renault LLP witha business law and transaction-oriented practice, where he has worked since1999. He has been a member of the *Barreau duQuébec* since 2000. Mr. Shapiro holds B.C.L. (1999), LL.B.(1999) and B.A. (1993) degrees from McGill University.

 

*Dennis Turpin*was appointed our SeniorVice President and Chief Financial Officer in August 2007. Prior to that,he served as our Vice President and Chief Financial Officer since June 1999.Mr. Turpin joined Æterna Zentaris in August 1996 as Director ofFinance. Prior to that, he was Director in the tax department at CoopersLybrand, now PricewaterhouseCoopers, from 1988 to 1996 and worked as an auditorfrom 1985 to 1988. Mr. Turpin earned his Bachelor’s degree in Accountingfrom Laval University in Québec. He obtained his license in accounting in 1985and became a chartered accountant in 1987.

 

### ***B.***                                    Compensation

### *** ***

A.            Compensation of Outside Directors

 

The compensation paid to theCompany’s directors is designed to (i) attract and retain the mostqualified people to serve on the Board and its committees, (ii) align theinterests of the Company’s directors with those of its shareholders, and (iii) provideappropriate compensation for the risks and responsibilities related to being aneffective director. This compensation is recommended to the Board by theCorporate Governance, Nominating and Human Resources Committee (the “GovernanceCommittee”). During the most recently completed financial year, the GovernanceCommittee was composed of four (4) directors, each of whom is independent,namely Messrs. Pierre MacDonald, José P. Dorais, Juergen Ernst and PierreLaurin. One of the members of the Governance Committee, namely Juergen Ernst,is an executive officer of the Company.

 

The Board has adopted a formal mandate for theGovernance Committee, which is available on our website at www.aezsinc.com. Themandate of the Governance Committee provides that it is responsible for (i) assistingthe Board in developing our approach to corporate governance issues, (ii) proposingnew Board nominees, (iii) assessing the effectiveness of the Board and itscommittees, their respective chairs and individual directors and (iv) makingrecommendations to the Board with respect to directors’ compensation.

 

In light of prevailingeconomic and market conditions, as well as the cost-saving measures implementedby the Company, the Governance Committee recommended and the Board approved twosets of reductions to directors’ and committee members’ retainers andattendance fees, such reductions having taken effect as of July 1, 2009and January 1, 2010, respectively.

 

Wedid not retain the services of any external compensation consultant in or withrespect to the financial year ended December 31, 2009.

 

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**Annual Retainers and Attendance Fees**

 

Annual retainers and attendance fees are paid on aquarterly basis to the members of the Board who are not employees of theCompany or its subsidiaries (“Outside Directors”) as described in the tablebelow.

 
| **Type of Compensation**                     | ** ** | **Annualized  Compensation  between Jan. 1 and  June 30, 2009  (in units of home  country currency)** | ** ** | **Annualized  Compensation between  July 1 and Dec. 31, 2009  (in units of home country  currency)** | ** ** | **Average  Annualized  Total Compensation  in 2009  (in units of home  country currency)** | ** ** | **Annual  Compensation  as of Jan. 1, 2010  (in units of home  country currency)** |
|----------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|
| Executive Chairman’s Retainer           |       | 75,000                                                                                                          |       | 60,000                                                                                                         |       | 67,500                                                                                     |       | 45,000                                                                                  |
| Vice Chairman’s Retainer                |       | 25,000                                                                                                          |       | 20,000                                                                                                         |       | 22,500                                                                                     |       | 15,000                                                                                  |
| Board Retainer                               |       | 25,000                                                                                                          |       | 20,000                                                                                                         |       | 22,500                                                                                     |       | 15,000                                                                                  |
| Board Meeting Attendance Fees                |       | 2,000 per meeting                                                                                               |       | 1,500 per meeting                                                                                              |       | 1,750 per meeting                                                                          |       | 1,000 per meeting                                                                       |
| Audit Committee Chair Retainer               |       | 20,000                                                                                                          |       | 15,000                                                                                                         |       | 17,500                                                                                     |       | 15,000                                                                                  |
| Audit Committee Member Retainer              |       | 5,000                                                                                                           |       | 4,000                                                                                                          |       | 4,500                                                                                      |       | 4,000                                                                                   |
| Audit Committee Meeting Attendance Fees      |       | 2,000 per meeting                                                                                               |       | 1,500 per meeting                                                                                              |       | 1,750 per meeting                                                                          |       | 1,000 per meeting                                                                       |
| Governance Committee Chair Retainer          |       | 15,000                                                                                                          |       | 12,000                                                                                                         |       | 13,500                                                                                     |       | 12,000                                                                                  |
| Governance Committee Member Retainer         |       | 2,500                                                                                                           |       | 2,000                                                                                                          |       | 2,250                                                                                      |       | 2,000                                                                                   |
| Governance Committee Meeting Attendance Fees |       | 2,000 per meeting                                                                                               |       | 1,500 per meeting                                                                                              |       | 1,750 per meeting                                                                          |       | 1,000 per meeting                                                                       |

 

All amounts in the above table are paid to Board and committee membersin their home country currency.

 

ThePresident and Chief Executive Officer is the only member of the Board who isnot an Outside Director. Therefore, he is not compensated in his capacity as adirector. The Executive Chairman is an Outside Director and is compensated assuch. Outside Directors are reimbursed for travel and other out-of-pocketexpenses incurred in attending Board or committee meetings.

 

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**OutstandingOption-Based Awards and Share-Based Awards**

 

The following table showsall awards outstanding to each Outside Director up to the end of the financialyear ending December 31, 2009:

 
| ** **          | ** ** | **Option-based  Awards**                 | ** ** | **Share-based  Awards**                                                                | ** ** |
|---------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| **Name**            | ** ** | **Issuance  Date********(mm-dd-  yyyy)** | ** ** | **Number  of  Securities********Underlying********Unexercised  Options(1)********(#)** | ** ** | **Option********Exercise  Price********(CAN$)** | ** ** | **Option********Expiration  Date********(mm-dd-  yyyy)** | ** ** | **Value  of********Unexercised  In-the-  money********Options(2)********(CAN$)** | ** ** | **Issuance  Date********(mm-dd-  yyyy)** | ** ** | **Number  of********Shares or********Units of  Shares********that have Not********Vested********(#)** | ** ** | **Market  or Payout********Value of Share-  based********Awards that have  Not Vested********($)** | ** ** |
|                |       | 12-04-2001                               |       | 5,000                                                                                  |       | 6.18 |   | 12-31-2011 |   | — |   | — |   | — |   | — |   |
|                |       | 12-16-2002                               |       | 15,000                                                                                 |       | 3.68 |   | 12-15-2012 |   | — |   | — |   | — |   | — |   |
|                |       | 12-11-2003                               |       | 30,000                                                                                 |       | 1.74 |   | 12-10-2013 |   | — |   | — |   | — |   | — |   |
|                |       | 12-14-2004                               |       | 15,000                                                                                 |       | 5.83 |   | 12-13-2014 |   | — |   | — |   | — |   | — |   |
| Marcel Aubut        |       | 12-13-2005                               |       | 15,000                                                                                 |       | 3.53 |   | 12-12-2015 |   | — |   | — |   | — |   | — |   |
|                |       | 01-04-2007                               |       | 5,000                                                                                  |       | 4.65 |   | 01-03-2017 |   | — |   | — |   | — |   | — |   |
|                |       | 12-11-2007                               |       | 25,000                                                                                 |       | 1.82 |   | 12-10-2017 |   | — |   | — |   | — |   | — |   |
|                |       | 12-08-2008                               |       | 15,000                                                                                 |       | 0.55 |   | 12-08-2018 |   | 4,500 |   | — |   | — |   | — |   |
|                |       | 12-09-2009                               |       | 20,000                                                                                 |       | 0.95 |   | 12-08-2019 |   | — |   | — |   | — |   | — |   |
|                |       |                                     |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                |       | 12-04-2001                               |       | 5,000                                                                                  |       | 6.18 |   | 12-31-2011 |   | — |   | — |   | — |   | — |   |
|                |       | 12-16-2002                               |       | 15,000                                                                                 |       | 3.68 |   | 12-15-2012 |   | — |   | — |   | — |   | — |   |
|                |       | 12-11-2003                               |       | 30,000                                                                                 |       | 1.74 |   | 12-10-2013 |   | — |   | — |   | — |   | — |   |
|                |       | 12-14-2004                               |       | 15,000                                                                                 |       | 5.83 |   | 12-13-2014 |   | — |   | — |   | — |   | — |   |
| Martha Byorum       |       | 12-13-2005                               |       | 15,000                                                                                 |       | 3.53 |   | 12-12-2015 |   | — |   | — |   | — |   | — |   |
|                |       | 01-04-2007                               |       | 5,000                                                                                  |       | 4.65 |   | 01-03-2017 |   | — |   | — |   | — |   | — |   |
|                |       | 12-11-2007                               |       | 25,000                                                                                 |       | 1.82 |   | 12-10-2017 |   | — |   | — |   | — |   | — |   |
|                |       | 12-08-2008                               |       | 15,000                                                                                 |       | 0.55 |   | 12-08-2018 |   | 4,500 |   | — |   | — |   | — |   |
|                |       | 12-09-2009                               |       | 20,000                                                                                 |       | 0.95 |   | 12-08-2019 |   | — |   | — |   | — |   | — |   |
|                |       |                                     |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| José P. Dorais |       | —                                   |       | —                                                                                 |       | — |   | — |   | — |   | — |   | — |   | — |   |
|                |       |                                     |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                |       | 02-25-2005                               |       | 15,000                                                                                 |       | 5.09 |   | 02-24-2015 |   | — |   | — |   | — |   | — |   |
|                |       | 12-13-2005                               |       | 15,000                                                                                 |       | 3.53 |   | 12-12-2015 |   | — |   | — |   | — |   | — |   |
|                |       | 01-04-2007                               |       | 5,000                                                                                  |       | 4.65 |   | 01-03-2017 |   | — |   | — |   | — |   | — |   |
| Juergen Ernst       |       | 12-11-2007                               |       | 25,000                                                                                 |       | 1.82 |   | 12-10-2017 |   | — |   | — |   | — |   | — |   |
|                |       | 11-14-2008                               |       | 100,000                                                                                |       | 0.65 |   | 11-13-2018 |   | 20,000 |   | — |   | — |   | — |   |
|                |       | 12-08-2008                               |       | 15,000                                                                                 |       | 0.55 |   | 12-08-2018 |   | 4,500 |   | — |   | — |   | — |   |
|                |       | 12-09-2009                               |       | 20,000                                                                                 |       | 0.95 |   | 12-08-2019 |   | — |   | — |   | — |   | — |   |
|                |       |                                     |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Pierre Lapalme      |       | 12-09-2009                               |       | 20,000                                                                                 |       | 0.95 |   | 12-08-2019 |   | — |   | — |   | — |   | — |   |
|                |       |                                     |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Pierre Laurin       |       | 12-04-2001                               |       | 5,000                                                                                  |       | 6.18 |   | 12-31-2011 |   | — |   | — |   | — |   | — |   |
|                | 12-16-2002 |                                     | 24,000     |                                                                                   | 3.68       |   | 12-15-2012 |   | — |   | — |   | — |   | — |   |
|                | 12-11-2003 |                                     | 30,000     |                                                                                   | 1.74       |   | 12-10-2013 |   | — |   | — |   | — |   | — |   |
|                | 03-29-2004 |                                     | 3,000      |                                                                                   | 6.26       |   | 03-28-2014 |   | — |   | — |   | — |   | — |   |
|                | 12-14-2004 |                                     | 15,000     |                                                                                   | 5.83       |   | 12-13-2014 |   | — |   | — |   | — |   | — |   |
|                | 12-13-2005 |                                     | 15,000     |                                                                                   | 3.53       |   | 12-12-2015 |   | — |   | — |   | — |   | — |   |
|                | 01-04-2007 |                                     | 5,000      |                                                                                   | 4.65       |   | 01-03-2017 |   | — |   | — |   | — |   | — |   |
|                | 12-11-2007 |                                     | 25,000     |                                                                                   | 1.82       |   | 12-10-2017 |   | — |   | — |   | — |   | — |   |
|                | 12-08-2008 |                                     | 15,000     |                                                                                   | 0.55       |   | 12-08-2018 |   | 4,500 |   | — |   | — |   | — |   |
|                | 12-09-2009 |                                     | 20,000     |                                                                                   | 0.95       |   | 12-08-2019 |   | — |   | — |   | — |   | — |   |
|                |       |                                     |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gérard Limoges |       | 12-14-2004                               |       | 15,000                                                                                 |       | 5.83 |   | 12-13-2014 |   | — |   | — |   | — |   | — |   |
|                | 12-13-2005 |                                     | 15,000     |                                                                                   | 3.53       |   | 12-12-2015 |   | — |   | — |   | — |   | — |   |
|                | 01-04-2007 |                                     | 5,000      |                                                                                   | 4.65       |   | 01-03-2017 |   | — |   | — |   | — |   | — |   |
|                | 12-11-2007 |                                     | 25,000     |                                                                                   | 1.82       |   | 12-10-2017 |   | — |   | — |   | — |   | — |   |
|                | 12-08-2008 |                                     | 15,000     |                                                                                   | 0.55       |   | 12-08-2018 |   | 4,500 |   | — |   | — |   | — |   |
|                | 12-09-2009 |                                     | 20,000     |                                                                                   | 0.95       |   | 12-08-2019 |   | — |   | — |   | — |   | — |   |

 

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| ** **            | ** ** | **Option-based  Awards**                 | ** ** | **Share-based  Awards**                                                                | ** ** |
|-----------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| **Name**              | ** ** | **Issuance  Date********(mm-dd-  yyyy)** | ** ** | **Number  of  Securities********Underlying********Unexercised  Options(1)********(#)** | ** ** | **Option********Exercise  Price********(CAN$)** | ** ** | **Option********Expiration  Date********(mm-dd-  yyyy)** | ** ** | **Value  of********Unexercised  In-the-  money********Options(2)********(CAN$)** | ** ** | **Issuance  Date********(mm-dd-  yyyy)** | ** ** | **Number  of********Shares or********Units of  Shares********that have Not********Vested********(#)** | ** ** | **Market  or Payout********Value of Share-  based********Awards that have  Not Vested********($)** | ** ** |
|                  |       | 12-04-2001                               |       | 5,000                                                                                  |       | 6.18 |   | 12-31-2011 |   | — |   | — |   | — |   | — |   |
|                  |       | 12-16-2002                               |       | 24,000                                                                                 |       | 3.68 |   | 12-15-2012 |   | — |   | — |   | — |   | — |   |
|                  |       | 12-11-2003                               |       | 30,000                                                                                 |       | 1.74 |   | 12-10-2013 |   | — |   | — |   | — |   | — |   |
|                  |       | 12-14-2004                               |       | 15,000                                                                                 |       | 5.83 |   | 12-13-2014 |   | — |   | — |   | — |   | — |   |
| Pierre MacDonald      |       | 12-13-2005                               |       | 15,000                                                                                 |       | 3.53 |   | 12-12-2015 |   | — |   | — |   | — |   | — |   |
|                  |       | 01-04-2007                               |       | 5,000                                                                                  |       | 4.65 |   | 01-03-2017 |   | — |   | — |   | — |   | — |   |
|                  |       | 12-11-2007                               |       | 25,000                                                                                 |       | 1.82 |   | 12-10-2017 |   | — |   | — |   | — |   | — |   |
|                  |       | 12-08-2008                               |       | 15,000                                                                                 |       | 0.55 |   | 12-08-2018 |   | 4,500 |   | — |   | — |   | — |   |
|                  |       | 12-09-2009                               |       | 20,000                                                                                 |       | 0.95 |   | 12-08-2019 |   | — |   | — |   | — |   | — |   |
|                  |       |                                     |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                  |       | 01-25-2006                               |       | 15,000                                                                                 |       | 5.04 |   | 12-12-2015 |   | — |   | — |   | — |   | — |   |
|                  |       | 01-04-2007                               |       | 5,000                                                                                  |       | 4.65 |   | 01-03-2017 |   | — |   | — |   | — |   | — |   |
| Gérald J. Martin |       | 12-11-2007                               |       | 25,000                                                                                 |       | 1.82 |   | 12-10-2017 |   | — |   | — |   | — |   | — |   |
|                  |       | 12-08-2008                               |       | 15,000                                                                                 |       | 0.55 |   | 12-08-2018 |   | 4,500 |   | — |   | — |   | — |   |
|                  |       | 12-09-2009                               |       | 20,000                                                                                 |       | 0.95 |   | 12-08-2019 |   | — |   | — |   | — |   | — |   |

 

----

(1)          The number of securitiesunderlying unexercised options represent all awards outstanding as at December 31,2009.

 

(2)          “Value of unexercisedin-the-money options” at financial year-end is calculated based on thedifference between the closing price of the common shares on the TSX on thelast trading day of the fiscal year (December 31, 2009) of CAN$0.85 andthe exercise price of the options, multiplied by the number of unexercisedoptions.

 

See “Summary of the Stock Option Plan” below formore details on the Stock Option Plan (as defined below).

 

**Total Compensation of Outside Directors**

 

The table below summarizesthe total compensation earned by the Outside Directors during the financialyear ended December 31, 2009 (all amounts are in US dollars):

 
| ** **          | ** ** | **Fees  earned********($)** | ** ** | **Share-  based********Awards** | ** ** | **Option-based********Awards(2)** | ** ** | **Non-Equity********Incentive Plan  Compensation** | ** ** | **Pension********Value** | ** ** | **All  Other********Compensation(3)** | ** ** | **Total** | ** ** |
|---------------------|------------|-----------------------------|------------|---------------------------------|------------|-----------------------------------|------------|----------------------------------------------------|------------|--------------------------|------------|---------------------------------------|------------|-----------|------------|
| **Name**            | ** ** | **Retainer(1)**             | ** ** | **Attendance(1)**               | ** ** | **($)**                           | ** ** | **($)**                                            | ** ** | **($)**                  | ** ** | **($)**                               | ** ** | **($)**   | ** ** | **($)** | ** ** |
| Marcel Aubut        |       | 19,710                      |       | 11,169                          |       | —                            |       | 9,636                                              |       | —                   |       | —                                |       | —    |       | 40,515 |   |
| Martha Byorum       |       | 27,000                      |       | 17,500                          |       | —                            |       | 9,636                                              |       | —                   |       | —                                |       | 1,500     |       | 55,636 |   |
| José P. Dorais |       | 21,681                      |       | 17,739                          |       | —                            |       | —                                             |       | —                   |       | —                                |       | —    |       | 39,420 |   |
| Juergen Ernst       |       | 128,043                     |       | 31,924                          |       | —                            |       | 9,636                                              |       | —                   |       | —                                |       | 27,760    | (4)        | 197,363 |   |
| Pierre Lapalme(5)   |       | —                      |       | 1,314                           |       | —                            |       | 9,636                                              |       | —                   |       | —                                |       | —    |       | 10,950 |   |
| Pierre Laurin       |       | 21,681                      |       | 18,615                          |       | —                            |       | 9,636                                              |       | —                   |       | —                                |       | —    |       | 49,932 |   |
| Gérard Limoges |       | 35,040                      |       | 20,586                          |       | —                            |       | 9,636                                              |       | —                   |       | —                                |       | 3,942     |       | 69,204 |   |
| Pierre MacDonald    |       | 55,188                      |       | 21,681                          |       | —                            |       | 9,636                                              |       | —                   |       | —                                |       | 2,628     |       | 89,133 |   |
| Gerald J. Martin    |       | 22,500                      |       | 14,750                          |       | —                            |       | 9,636                                              |       | —                   |       | —                                |       | —    |       | 46,886 |   |

 

----

(1)   These amounts represent the portion paid in cash to the OutsideDirectors and are paid in each director’s home country currency.

(2)          Thevalue of option-based awards represents the closing price of the common shareson the TSX at the date of grant (CAN$0.95, equivalent to US$0.83) for optionsgranted on December 9, 2009 multiplied by the Black-Scholes factor as atsuch date (57.895% for options granted on December 9, 2009) and the numberof stock options granted in 2009.

(3)          These amountsrepresent fees paid in cash for special tasks or overseas travelling and arealso paid in each director’s home country currency.

(4)          Excludes a bonusof €125,000 paid to Mr. Ernst in 2009 in his prior capacity as InterimPresident and CEO in connection with the entering into of the commercialagreement for cetrorelix with sanofi-aventis in March 2009.

(5)          Pierre Lapalmewas appointed to the Board on December 8, 2009.

 

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Duringthe financial year ended December 31, 2009, the Company paid an aggregateamount of $521,951 to all of its Outside Directors for services rendered intheir capacity as directors, excluding reimbursement of out-of-pocket expensesand the value of option-based awards granted in 2009. Outside Directors arepaid in their home country currency and are reimbursed for travel and otherout-of-pocket expenses incurred while attending Board or committee meetings.

 

B.            Compensation of Executive Officers

 

Themandate of the Governance Committee provides that it is responsible for takingall reasonable measures to ensure that appropriate human resources systems andprocedures, such as hiring policies, competency profiles, training policies andcompensation structures are in place so that we can attract, motivate andretain the quality of personnel required to meet our business objectives.

 

TheGovernance Committee also assists the Board in discharging its responsibilitiesrelating to executive and other human resources hiring, assessment,compensation and succession planning matters.

 

Thus,the Governance Committee recommends the appointment of senior officers,including the terms and conditions of their appointment and termination, andreviews the evaluation of the performance of our senior officers, includingrecommending their compensation. The Board, which includes the members of theGovernance Committee, reviews the Chief Executive Officer’s corporate goals andobjectives and evaluates his performance and compensation in light of suchgoals and objectives.

 

**Compensation Discussion & Analysis**

 

***Compensation Philosophy and Objectives***

 

TheCompany’s executive compensation program is designed to attract, motivate andretain high performing senior executives, encourage and reward superiorperformance and align the executives’ interests with those of our shareholdersby:

 

·                  providing the opportunityfor an executive to earn compensation that is competitive with the compensationreceived by executives employed by a group of comparable North Americancompanies;

 

·                  providing executives withan equity-based incentive plan, namely a stock option plan;

 

·                  aligning employeecompensation with company corporate objectives; and

 

·                  attracting and retaininghighly qualified individuals in key positions.

 

***Benchmarking***

 

Inorder to attain our objectives of providing market competitive compensationopportunities, our executive compensation plan, based on a study provided byAON Corporation (and updated annually), is benchmarked against marketcompensation data gathered from organizations of comparable size and othercompanies with which we compete for executive talent (the “Reference Group”).An overview of the characteristics of the Reference Group is provided in thefollowing table:

 

*(Inmillions of US$)*

 
| ** **                                              | ** ** | **Æterna Zentaris**  |   | **Survey Reference Group** |   |
|---------------------------------------------------------|------------|---------------------------|--------|----------------------------|--------|
| **Location**                                            |       | North America and  Europe |   | North America              |   |
| **Industries**                                          |       | Biopharmaceutical         |   | Biopharmaceutical          |   |
| **Revenues**

Last  fiscal year                         |       | 38.48                     | (1)    | 37.6                       | (2)    |
| **Market Capitalization**

As  at October 30, 2009 |       | 64.35                     |   | 148.69                     |   |
| **Net Loss**

Last  fiscal year                         |       | 59.82                     | (1)    | 53.13                      | (2)    |

 

----

(1)          For the year ended December 31,2008.

(2)          The Reference Group for thefinancial year ended December 31, 2009 was selected in October 2009and these data are based on their most recently completed fiscal year at suchtime.

 

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The Reference Group used inrespect of the financial year ended December 31, 2009 was composed of thefollowing companies: Acadia Pharmaceuticals Inc.; AcordaTherapeutics Inc.; Array Biopharma Inc.; Caraco Pharmaceutical Labs;BioSanté Pharmaceuticals, Inc.; Cell Therapeutics Inc.; EnzonPharmaceuticals Inc.; Genomic Health Inc.; IstaPharmaceuticals Inc.; Ligand Pharmaceuticals; MDRNA, Inc.; NeurocrineBiosciences Inc.; Nps Pharmaceuticals Inc.; SalixPharmaceuticals Ltd; Savient Pharmaceuticals Inc.; and Xoma Ltd.

 

*Positioning*

 

TheCompany’s compensation policy is for executive compensation to be generallyaligned with the 50th percentile of the Reference Group. The GovernanceCommittee uses discretion and judgment when determining compensation levels asthey apply to a specific executive officer. Individual compensation may bepositioned above or below median, based on individual experience andperformance or other criteria deemed important by the Governance Committee. Thetotal cash target payment for our executive officers generally falls within themarket 50th percentilecompetitive range.

 

*Compensation Elements*

 

Anexecutive compensation policy has been established to acknowledge and rewardthe contributions of the executive officers to our success and to ensurecompetitive compensation, in order that we may benefit from the expertiserequired to pursue our objectives.

 

Ourexecutive compensation policy is comprised of both fixed and variablecomponents. The variable components include equity and non-equity incentiveplans. Each compensation component is intended to serve a different function,but all elements are intended to work in concert to maximize company andindividual performance by establishing specific, competitive operational andcorporate goals and by providing financial incentives to employees based ontheir level of attainment of these goals.

 

Ourcurrent executive compensation program is comprised of the following four basiccomponents:

 

(i)                         base salary;

 

(ii)                      non-equityincentives —****consisting of a cashbonus linked to both individual and corporate performance;

 

(iii)                   long-termcompensation — consisting of our stock option plan established for the benefitof our directors, executive officers and employees (the “Stock Option Plan”);and

 

(iv)                  other elementsof compensation —****consisting ofbenefits, perquisites and retirement benefits.

 

*Base Salary*

 

Salariesof our executive officers are established based on a comparison withcompetitive benchmark positions. The starting point to determine executive basesalaries is the median of executive salaries in the Reference Group.

 

Indetermining individual base salaries, the Governance Committee takes intoconsideration individual circumstances that may include the scope of anexecutive’s position, the executive’s relevant competencies or experience andretention risk. The Governance Committee also takes into consideration thefulfillment of our corporate objectives as well as the individual performanceof the executive.

 

*Short-Term Non-Equity Incentive Compensation*

 

Theshort-term non-equity incentive compensation plan sets out the allocation ofincentive awards based on the financial results and the advancement of ourproduct development and strategic objectives. These objectives are set at thebeginning of each financial year as part of the annual review of corporatestrategies.

 

Inthe case of executive officers, a program is designed to maximize bothcorporate and individual performance by establishing specific operational andfinancial goals and to provide financial incentives to executive officers basedon their level of attainment of these goals. The granting of cash incentivesrequires the approval of both the Governance Committee and the Board and isbased upon an assessment of each individual’s performance, as well as theperformance of the Company.

 

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For the financial year ended December 31, 2009,the Governance Committee recommended, and the Board approved, in light ofprevailing economic and market conditions, as well as the cost-saving measures implemented by the Company, thatno cash bonuses be paid in respect of the 2009 year, and that there be noincrease in 2010 from the 2009 annual base salaries and potential bonus amountsfor all executive officers. Instead, in partial replacement of their 2009annual cash bonuses, the Governance Committee approved the granting ofadditional stock options to executives according to the following formula: $1(CAN or US) or €1 = 1 stock option, as adjusted based on each seniorexecutive’s individual performance. Stock options granted in December 2009to the Company’s senior executives were granted with an accelerated vestingschedule (18 months instead of three years, with the first one-third of theoptions vesting six months after the date of grant), in order to allow thesegrants to serve their purpose as partial compensation for the non-payment ofcash bonuses. See “Summary of the Stock Option Plan” below for more details onthe Stock Option Plan.

 

The stock options grantedto our executive officers represented 95% of the target payout established bythe Governance Committee.

 

*Long-termEquity Compensation Plan of Executive Officers*

 

The long-term componentof the compensation of the Company’s executive officers is based exclusively onthe Stock Option Plan, which permits the award of a number of options thatvaries in accordance with the contribution of the officers and theirresponsibilities. To encourage retention and focus management on developing andsuccessfully implementing the continuing growth strategy of the Company, stockoptions generally vest over a period of three years, however, as mentioned inthe section above, the vesting schedule for the options granted to seniorexecutives in December 2009 was accelerated from three years to 18 months.Stock options are usually granted to executive officers in December ofeach year.

 

***Summary of the Stock Option Plan***

 

Weestablished the Stock Option Plan in order to attract and retain directors,executive officers and employees, who will be motivated to work towardsensuring the success of the Company. The Board has full and complete authorityto interpret the Stock Option Plan, to establish applicable rules andregulations applying to it and to make all other determinations it deemsnecessary or useful for the administration of the Stock Option Plan, providedthat such interpretations, rules, regulations and determinations are consistentwith the rules of all stock exchanges and quotation systems on which oursecurities are then traded and with all relevant securities legislation.

 

Individualseligible to participate under the Stock Option Plan will be determined byeither the Board or the Governance Committee.

 

Optionsgranted under the Stock Option Plan may be exercised at any time within amaximum period of ten years following the date of their grant (the “OutsideExpiry Date”). The Board or the Governance Committee, as the case may be,designates, at its discretion, the individuals to whom stock options aregranted under the Stock Option Plan and determines the number of common sharescovered by each of such options grants, the grant date, the exercise price ofeach option, the expiry date, the vesting schedule and any other matterrelating thereto, in each case in accordance with the applicable rules andregulations of the regulatory authorities. The price at which the common sharesmay be purchased may not be lower than the greater of the closing prices of thecommon shares on the TSX and the NASDAQ on the last trading day preceding thedate of grant of the option. Options granted under the Stock Option Plangenerally vest in equal tranches over a three-year period (one-third each year,starting on the first anniversary of the grant date) or as otherwise determinedby the Board or the Governance Committee, as the case may be.

 

Unlessthe Board or the Governance Committee decides otherwise, option holders ceaseto be entitled to exercise their options under the Stock Option Plan: (i) immediately,in the event an option holder who is an officer or employee resigns orvoluntarily leaves his or her employment with the Company or one of itssubsidiaries or the employment with the Company or one of its subsidiaries isterminated with cause and, in the case of an optionee who is a non-employeedirector of the Company or one of its subsidiaries, the date on which suchoptionee ceases to be a member of the relevant board of directors; (ii) sixmonths following the date on which employment is terminated as a result of thedeath of an option holder who is an officer or employee and, in the case of anoptionee who is a non-employee director of the Company or one of itssubsidiaries, six months following the date on which such optionee ceases to bea member of the relevant board of directors by reason of death; (iii) 30days following the date on which an option holder’s employment with the Companyor any of its subsidiaries is terminated for a reason other than thosementioned in (i) or (ii) above including, without limitation, uponthe disability, long-term illness, retirement or early retirement of the optionholder; and (iv) where the option holder is a service supplier, 30 daysfollowing the date on which such option holder ceases to act as such, for anycause or reason (each, an “Early Expiry Date”).

 

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TheStock Option Plan also provides that, if the expiry date of an option(s) (whetheran Early Expiry Date or an Outside Expiry Date) occurs during a “blackoutperiod” or within the seven business days immediately after a blackout periodimposed by the Company, the expiry date will be automatically extended to thedate that is seven business days after the last day of the blackout period. Forthe purposes of the foregoing, “blackout period” means the period during whichtrading in the Company’s securities is restricted in accordance with itscorporate policies.

 

Optionholders may not assign their options (nor any interest therein) other than bywill or in accordance with the applicable laws of estates and succession.

 

Inthe event that, at any time, an offer to purchase is made to holders of all ourcommon shares, notice of such offer shall be given by the Company to eachoptionee and all unexercised options will become exercisable immediately attheir respective exercise prices, but only to the extent necessary to enableoptionees to tender their common shares in response to such offer.

 

The Stock Option Plancurrently provides that the following amendments may be made to the StockOption Plan upon approval of each of the Board and our shareholders as well asreceipt of all required regulatory approvals:

 

·                  any amendment to Section 3.2of the Stock Option Plan (which sets forth the limit on the number of optionsthat may be granted to insiders) that would have the effect of permitting,without having to obtain shareholder approval on a “disinterested vote” at aduly convened shareholders’ meeting, the grant of any option(s) under theStock Option Plan otherwise prohibited by Section 3.2;

 

·                  any amendment to the numberof securities issuable under the Stock Option Plan (except for certainpermitted adjustments, such as in the case of stock splits, consolidations orreclassifications);

 

·                  any amendment which wouldpermit any option granted under the Stock Option Plan to be transferable orassignable other than by will or in accordance with the applicable laws ofestates and succession;

 

·                  the addition of a cashlessexercise feature, payable in cash or securities, which does not provide for a fulldeduction of the number of underlying securities from the Stock Option Planreserve;

 

·                  the addition of a deferredor restricted share unit component or any other provision which results inemployees receiving securities while no cash consideration is received by theCompany;

 

·                  with respect to any optionholder whether or not such option holder is an “insider” and except in respectof certain permitted adjustments, such as in the case of stock splits,consolidations or reclassifications:

 

·                  any reduction in theexercise price of any option after the option has been granted, or

 

·                  any cancellation of anoption and the re-grant of that option under different terms;

 

·                  any extension to the termof an option beyond its Outside Expiry Date to an option holder who is an“insider” (except for extensions made in the context of a “blackout period”);

 

·                  any amendment to the methodof determining the exercise price of an option granted pursuant to the StockOption Plan;

 

·                  the addition of any form offinancial assistance or any amendment to a financial assistance provision whichis more favourable to employees; and

 

·                  any amendment to theforegoing amending provisions requiring Board, shareholder and regulatoryapprovals.

 

TheStock Option Plan further currently provides that the following amendments maybe made to the Stock Option Plan upon approval of the Board and upon receipt ofall required regulatory approvals, but without shareholder approval:

 

·                  amendments of a“housekeeping” or clerical nature or to clarify the provisions of the StockOption Plan;

 

·                  amendments regarding anyvesting period of an option;

 

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·                  amendments regarding theextension of an option beyond an Early Expiry Date in respect of any optionholder, or the extension of an option beyond the Outside Expiry Date in respectof any option holder who is a “non-insider” of the Company;

 

·                  adjustments to the numberof issuable common shares underlying, or the exercise price of, outstandingoptions resulting from a split or a consolidation of the common shares, areclassification, the payment of a stock dividend, the payment of a specialcash or non-cash distribution to our shareholders on a pro rata basis providedsuch distribution is approved by our shareholders in accordance with applicablelaw, a recapitalization, a reorganization or any other event which necessitatesan equitable adjustment to the outstanding options in proportion withcorresponding adjustments made to all outstanding common shares;

 

·                  discontinuing orterminating the Stock Option Plan; and

 

·                  any other amendment whichdoes not require shareholder approval under the terms of the Stock Option Plan.

 

Themaximum number of common shares issuable under the Stock Option Plan is fixedat 11.4% of the issued and outstanding common shares at any given time, which,as at March 22, 2010, represented 7,192,255 common shares. There arecurrently 6,213,922 options outstanding under the Stock Option Planrepresenting 9.8% of all issued and outstanding common shares. Under the StockOption Plan, (i) the number of securities issued to insiders, at any time,or issuable within any one-year period, under all of the Company’ssecurity-based compensation arrangements, cannot exceed 10% of the Company’sissued and outstanding securities and (ii) no single option holder mayhold options to purchase, from time to time, more than 5% of the Company’sissued and outstanding common shares.

 

***Outstanding Option-Based Awards andShare-Based Awards***

 

The following table showsall awards outstanding to each of our Company’s President and Chief Executive Officer,the Chief Financial Officer and our three (3) other most highly compensatedexecutive officers of the Company during the most recently completed financial year(collectively, the “Named Executive Officers”) as of December 31, 2009:

 
| ** **     | ** ** | **Option-based  Awards**                 | ** ** | **Share-based  Awards**                                                                            |
|----------------|------------|------------------------------------------|------------|----------------------------------------------------------------------------------------------------|
| **Name**       | ** ** | **Issuance  Date********(mm-dd-  yyyy)** | ** ** | **Number  of********Securities********Underlying********Unexercised********Options(1)********(#)** | ** ** | **Option********Exercise  Price********(CAN$)** | ** ** | **Option********Expiration  Date********(mm-dd-  yyyy)** | ** ** | **Value  of********Unexercised In-the-money********Options(2)********(CAN$)** | ** ** | **Issuance  Date** | ** ** | **Number  of********Shares or********Units of shares********that have Not********Vested********(#)** | ** ** | **Market  or  Payout********Value of  Share-based********Awards that  have Not  Vested********($)** |
| Engel, Juergen |       | 02-20-2003                               |       | 60,000                                                                                             |   | 2.43 |   | 12-31-2012 |   | — |   | — |   | — |   | — |
|           |       | 12-11-2003                               |       | 60,000                                                                                             |   | 1.74 |   | 12-10-2013 |   | — |   | — |   | — |   | — |
|           |       | 12-14-2004                               |       | 100,000                                                                                            |   | 5.83 |   | 12-13-2014 |   | — |   | — |   | — |   | — |
|           |       | 12-13-2005                               |       | 50,000                                                                                             |   | 3.53 |   | 12-12-2015 |   | — |   | — |   | — |   | — |
|           |       | 01-04-2007                               |       | 50,000                                                                                             |   | 4.65 |   | 01-03-2017 |   | — |   | — |   | — |   | — |
|           |       | 12-11-2007                               |       | 50,000                                                                                             |   | 1.82 |   | 12-10-2017 |   | — |   | — |   | — |   | — |
|           |       | 11-14-2008                               |       | 200,000                                                                                            |   | 0.65 |   | 11-13-2018 |   | 40,000 |   | — |   | — |   | — |
|           |       | 12-08-2008                               |       | 75,000                                                                                             |   | 0.55 |   | 12-08-2018 |   | 22,500 |   | — |   | — |   | — |
|           |       | 12-09-2009                               |       | 165,000                                                                                            |   | 0.95 |   | 12-08-2010 |   | — |   | — |   | — |   | — |
| Turpin, Dennis |       | 12-04-2001                               |       | 30,000                                                                                             |   | 6.18 |   | 12-04-2011 |   | — |   | — |   | — |   | — |
|           |       | 11-01-2002                               |       | 90,000                                                                                             |   | 3.94 |   | 10-31-2012 |   | — |   | — |   | — |   | — |
|           |       | 12-16-2002                               |       | 50,000                                                                                             |   | 3.68 |   | 12-15-2012 |   | — |   | — |   | — |   | — |
|           |       | 12-11-2003                               |       | 60,000                                                                                             |   | 1.74 |   | 12-10-2013 |   | — |   | — |   | — |   | — |
|           |       | 12-14-2004                               |       | 90,000                                                                                             |   | 5.83 |   | 12-13-2014 |   | — |   | — |   | — |   | — |
|           |       | 12-13-2005                               |       | 50,000                                                                                             |   | 3.53 |   | 12-12-2015 |   | — |   | — |   | — |   | — |
|           |       | 01-04-2007                               |       | 50,000                                                                                             |   | 4.65 |   | 01-03-2017 |   | — |   | — |   | — |   | — |
|           |       | 12-11-2007                               |       | 50,000                                                                                             |   | 1.82 |   | 12-10-2017 |   | — |   | — |   | — |   | — |
|           |       | 12-09-2009                               |       | 115,000                                                                                            |   | 0.95 |   | 12-08-2010 |   | — |   | — |   | — |   | — |
| Blake, Paul    |       | 07-27-2007                               |       | 45,000                                                                                             |   | 3.05 | (3) | 07-26-2017 |   | — |   | — |   | — |   | — |
|           |       | 12-11-2007                               |       | 50,000                                                                                             |   | 1.82 | (3) | 12-10-2017 |   | — |   | — |   | — |   | — |
|           |       | 12-08-2008                               |       | 50,000                                                                                             |   | 0.55 |   | 12-08-2018 |   | 15,000 |   | — |   | — |   | — |

 

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| ** **               | ** ** | **Option-based  Awards**                 | ** ** | **Share-based  Awards**                                                                            |
|--------------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------------------------------------|
| **Name**                 | ** ** | **Issuance  Date********(mm-dd-  yyyy)** | ** ** | **Number  of********Securities********Underlying********Unexercised********Options(1)********(#)** | ** ** | **Option********Exercise  Price********(CAN$)** | ** ** | **Option********Expiration  Date********(mm-dd-  yyyy)** | ** ** | **Value  of********Unexercised In-the-money********Options(2)********(CAN$)** | ** ** | **Issuance  Date** | ** ** | **Number  of********Shares or********Units of shares********that have Not********Vested********(#)** | ** ** | **Market  or  Payout********Value of  Share-based********Awards that  have Not  Vested********($)** |
|                     |       | 12-09-2009                               |       | 110,000                                                                                            |   | 0.95 |   | 12-08-2010 |   | — |   | — |   | — |   | — |
| Seeber, Matthias         |       | 02-20-203                                |       | 15,000                                                                                             |   | 2.43 |   | 12-31-2012 |   | — |   | — |   | — |   | — |
|                     |       | 12-11-2003                               |       | 45,000                                                                                             |   | 1.74 |   | 12-10-2013 |   | — |   | — |   | — |   | — |
|                     |       | 12-14-2004                               |       | 50,000                                                                                             |   | 5.83 |   | 12-13-2014 |   | — |   | — |   | — |   | — |
|                     |       | 12-13-2005                               |       | 40,000                                                                                             |   | 3.53 |   | 12-12-2015 |   | — |   | — |   | — |   | — |
|                     |       | 01-04-2007                               |       | 30,000                                                                                             |   | 4.65 |   | 01-03-2017 |   | — |   | — |   | — |   | — |
|                     |       | 12-11-2007                               |       | 25,000                                                                                             |   | 1.82 |   | 12-10-2017 |   | — |   | — |   | — |   | — |
|                     |       | 12-08-2008                               |       | 30,000                                                                                             |   | 0.55 |   | 12-08-2018 |   | 9,000 |   | — |   | — |   | — |
|                     |       | 12-09-2009                               |       | 115,000                                                                                            |   | 0.95 |   | 12-08-2010 |   | — |   | — |   | — |   | — |
| Pelliccione, Nicholas J. |       | 05-07-2007                               |       | 25,000                                                                                             |   | 3.96 | (3) | 05-06-2017 |   | — |   | — |   | — |   | — |
|                     |       | 12-11-2007                               |       | 50,000                                                                                             |   | 1.82 | (3) | 12-10-2017 |   | — |   | — |   | — |   | — |
|                     |       | 12-08-2008                               |       | 20,000                                                                                             |   | 0.55 |   | 12-08-2018 |   | 6,000 |   | — |   | — |   | — |
|                     |       | 12-09-2009                               |       | 60,000                                                                                             |   | 0.95 |   | 12-08-2010 |   | — |   | — |   | — |   | — |

 

----

(1)          The number of securities underlying unexercised options represents allawards outstanding at December 31, 2009.

(2)          “Value of unexercised in-the-money options” at financial year-end iscalculated based on the difference between the closing price of the commonshares on the TSX on the last trading day of the year (December 31, 2009)of CAN$0.85 and the exercise price of the options, multiplied by the number ofunexercised options.

(3)          These amounts are expressed in US dollars.

 

**Incentiveplan awards - Value vested or earned during the year**

 

The following table showsthe incentive plan awards value vested or earned for each Named ExecutiveOfficer for the financial year ending December 31, 2009.

* *
| **Name**                 | ** ** | **Option-based awards - Value********vested during the year(1)********(CAN$)** | ** ** | **Share-based awards - Value********vested during the year********(CAN$)** | ** ** | **Non-equity incentive plan********compensation - Value earned********during the year********(CAN$)** | ** ** |
|--------------------------|------------|--------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|
| Engel, Juergen           |       | 40,000                                                                         |       | —                                                                     |       | —                                                                                                |       |
| Turpin, Dennis           |       | —                                                                         |       | —                                                                     |       | —                                                                                                |       |
| Blake, Paul              |       | 6,667                                                                          |       | —                                                                     |       | —                                                                                                |       |
| Seeber, Matthias         |       | 4,000                                                                          |       | —                                                                     |       | —                                                                                                |       |
| Pelliccione, Nicholas J. |       | 2,667                                                                          |       | —                                                                     |       | —                                                                                                |       |

 

----

(1)          The amount represents the aggregate dollar value that would have beenrealized if the options had been exercised on the vesting date, based on thedifference between the closing price of the common shares on the TSX and theexercise price on such vesting date.

 

**Other Forms of Compensation**

 

*Benefits and Perquisites*

 

Ourexecutive employee benefits program also includes life, medical, dental anddisability insurance. Perquisites consist of a car allowance and humanresources counselling. These benefits and perquisites are designed to becompetitive overall with equivalent positions in comparable North Americanorganizations in the life sciences industry.

 

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*Pension Plan*

 

Oneof our Named Executive Officers, namely Dr. Juergen Engel, the Presidentand Chief Executive Officer, participates in a non-contributory defined benefitpension plan. Benefits payable under this plan correspond to 40% of theexecutive officer’s average salary of the last twelve months during the firstfive working years after initial participation in this plan and increase by0.4% for each additional year of employment.

 

The normal retirement ageis 65 years, but early retirement in accordance with Germany’s social pensioninsurance is possible without reduction (or “clawback”) of the benefit. Thefollowing table shows total annual pension benefits payable to Dr. Engelpursuant to this plan. Upon the death of a participant, the surviving spouseand/or children of the participant will be entitled to a benefit equal to 60%of the benefits to which such participant was entitled. All benefits payableunder this plan are in addition to German governmental social securitybenefits. Only base salary is taken into consideration in calculating pensionbenefits.

 

Asat December 31, 2009, Dr. Engel had 33 years and 4 months of creditedservice in the aforementioned non-contributory defined benefit pension plan.

 

**Defined Benefit Plans Table**

** **
| ** **    | ** ** | **Number of  years of  credited** | ** ** | **Annual benefits  payable**  | ** ** | **Accrued  obligation at**  | ** ** | **Compensatory**                | ** ** | **Non-  compensatory**   | ** ** | **Accrued  obligation at** | ** ** |
|---------------|------------|-----------------------------------|------------|-------------------------------|------------|-----------------------------|------------|---------------------------------|------------|--------------------------|------------|----------------------------|------------|
| **Name**      | ** ** | **service********(#)**            | ** ** | **At year end********($)(1)** | ** ** | **At age 65********($)(1)** | ** ** | **start of year********($)(1)** | ** ** | **change********($)(1)** | ** ** | **change********($)(1)**   | ** ** | **year end********($)(1)** | ** ** |
| Juergen Engel |       | 33.33                             |       | 218,217                       |       | 218,501                     |       | 2,998,772                       |       | 431,110                  |       | 113,769                    |       | 3,543,651 |   |

 

----

(1)          All amounts inthe above table have been converted from euros to US$ based on the exchangerate on December 31, 2009, which was €1.000 = US$1.4272.

 

*Employer Contribution to Employees’ Retirement Plan*

 

In2008, the Board approved a plan whereby we would contribute to our employees’retirement plans both in Canada (RRSP) and the United States (401(k)) to theextent of 50% of the employee’s contribution up to a maximum of $7,750 annuallyfor employees under 50 years old and $10,250 for those over 50 years old. Thisplan was implemented in 2008. Employees based in Frankfurt, Germany alreadybenefit from certain employer contributions into the employees’ pension funds(DUPK/RUK). Our executive officers, including the Named Executive Officers, areeligible to participate in the aforementioned employer-contribution plans tothe same extent and in the same manner as all of our other employees.

 

*Summary Compensation Table*

 

TheSummary Compensation Table set forth below shows compensation information forthe Named Executive Officers for services rendered in all capacities during thefinancial year ended December 31, 2009 and 2008. Our executive officersare generally paid in their home country’s currency. All amounts in the SummaryCompensation Table below are in US dollars and have been converted from theNamed Executive Officers’ home country currency to US dollars based on thefollowing average exchange rates for the financial year ended December 31,2009: €1.00 = US$1.388; and CAN$1.00 = US$0.876; and for the financial yearended December 31, 2008: €1.00 = US$1.464; and CAN$1.00 = US$0.937.

 

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**SUMMARYCOMPENSATION TABLE**

** **
| ** **                                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                     | ** ** | ** **                         | ** ** | **Non-equity  incentive********plan compensation** | ** ** | ** **                                  | ** ** | ** **               | ** ** | ** **                            | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|--------------------------------|------------|------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------|------------|--------------------------|------------|---------------------------------------|------------|
| **Name and  principal**                                                                 | ** ** | ** ** | ** ** | **Salary** | ** ** | **Share  based********awards** | ** ** | **Option  based********awards(1)** | ** ** | **Annual********incentive********plan**            | ** ** | **Long-term********incentive********plans** | ** ** | **Pension********value** | ** ** | **All  other********compensation(2)** | ** ** | **Total  compensation** | ** ** |
| **position**                                                                            | ** ** | **Years**  | ** ** | **($)**    | ** ** | **($)**                        | ** ** | **($)**                            | ** ** | **($)**                                            | ** ** | **($)**                                     | ** ** | **($)**                  | ** ** | **($)**                               | ** ** | **($)** | ** ** |
| Juergen Engel  President and CEO                                                        |       | 2009       |       | 458,040    |       | —                         |       | 79,497                             |       | —                                             |       | —                                      |       | 431,110                  |       | 3,209                                 | (3)        | 971,856 |   |
|                                                                                    | 2008       |       | 405,925    | (4)        | —     |                           | 67,777     |                               | 248,093    | (5)(6)                                             | —     |                                        | 473,277    |                     | 3,366      | (3)                                   | 1,198,438  |   |
| Dennis Turpin  Senior Vice President and CFO                                            |       | 2009       |       | 284,700    |       | —                         |       | 55,407                             |       | —                                             |       | —                                      |       | —                   |       | —                                |       | 340,107 |   |
|                                                                                    | 2008       |       | 317,352    |       | —     |                           | —     |                               | 30,000     | (6)                                                | —     |                                        | —     |                     | 95,780     | (7)                                   | 443,132    |   |
|                                                                                    |       |       |       |       |       |                           |       |                               |       |                                               |       |                                        |       |                     |       |                                  |       |   |
| Paul Blake  Senior Vice President and Chief Medical Officer                             |       | 2009       |       | 366,000    |       | —                         |       | 52,998                             |       | —                                             |       | —                                      |       | —                   |       | 10,250                                | (7)        | 429,248 |   |
|                                                                                    | 2008       |       | 355,250    |       | —     |                           | 10,788     |                               | 135,000    | (6)                                                | —     |                                        | —     |                     | 10,250     | (8)                                   | 511,288    |   |
|                                                                                    |       |       |       |       |       |                           |       |                               |       |                                               |       |                                        |       |                     |       |                                  |       |   |
|                                                                                    |       |       |       |       |       |                           |       |                               |       |                                               |       |                                        |       |                     |       |                                  |       |   |
| Matthias Seeber  Senior Vice President, Administration and Legal Affairs                |       | 2009       |       | 306,748    |       | —                         |       | 55,407                             |       | —                                             |       | —                                      |       | —                   |       | 54,300                                | (3)        | 416,455 |   |
|                                                                                    | 2008       |       | 307,372    |       | —     |                           | 6,473      |                               | 120,755    | (5)                                                | —     |                                        | —     |                     | 61,881     | (3)                                   | 496,481    |   |
|                                                                                    |       |       |       |       |       |                           |       |                               |       |                                               |       |                                        |       |                     |       |                                  |       |   |
|                                                                                    |       |       |       |       |       |                           |       |                               |       |                                               |       |                                        |       |                     |       |                                  |       |   |
| Nicholas J. Pelliccione  Senior Vice President Regulatory Affairs and Quality Assurance |       | 2009       |       | 317,300    |       | —                         |       | 28,908                             |       | —                                             |       | —                                      |       | —                   |       | 8,250                                 | (7)        | 354,458 |   |
|                                                                                    | 2008       |       | 317,300    |       | —     |                           | 4,315      |                               | 70,000     | (6)                                                | —     |                                        | —     |                     | 10,250     | (8)                                   | 401,865    |   |
|                                                                                    |       |       |       |       |       |                           |       |                               |       |                                               |       |                                        |       |                     |       |                                  |       |   |
|                                                                                    |       |       |       |       |       |                           |       |                               |       |                                               |       |                                        |       |                     |       |                                  |       |   |

 

----

(1)          The value of the option-based awards represents the closing price of thecommon shares on the TSX at the date of grant (CAN$0.95 equivalent to US$0.83)for options granted on December 9, 2009 multiplied by the Black-Scholesfactor as at such date (57.895% for options granted on December 9, 2009)and the number of stock options granted in 2009.

(2)          “All Other Compensation” represents perquisites and other personalbenefits which, in the aggregate, amount to $50,000 or more, or are equivalentto 10% or more of a Named Executive Officer’s total salary for the financialyear ended December 31, 2009. The type and amount of each perquisite, thevalue of which exceeds 25% of the total value of perquisites, is separatelydisclosed for each Named Executive Officer, if applicable.

(3)          Represents DUPK/RUK (Germany) employer contributionsto Dr. Engel’s and Mr. Seeber’s retirementsavings plans. Although the Company does not generally view employercontributions to employees’ and executives retirement savings plans asperquisites or benefits since such contributions are available to allemployees, it has decided to voluntarily disclose the amounts of such employercontributions to the Named Executive Officers in the above table in order toprovide fulsome disclosure.

(4)          Represents Dr. Engel’sannual base salary as Executive Vice President and Chief Scientific Officerthat was paid to him up until September 1, 2008 plus an adjusted annualbase salary following his appointment as President and CEO between September 1and December 31, 2008.

(5)          Includes specialbonuses paid to Dr. Engel and Mr. Seeber in connection with thenegotiation, management and successful completion of two important transactionsin 2008, namely the monetization of Cetrotide® and the saleof all rights related to Impavido®.

(6)          Includes a one time cash payment of $10,000 that was awarded in March 2008to the Named Executive Officers with the exception of Mr. Seeber. Thisaward, to have been used solely to purchase the Company’s common shares on the NASDAQ, was granted by the Board in order toencourage share ownership of the Company’s common shares by senior management.

(7)          Represents$91,765 of relocation costs and $4,015 in employer’s contribution to Mr. Turpin’s401(k) retirement savings plan. Although the Company does not generallyview employer contributions to employees’ and executives retirement savingsplans as perquisites or benefits since such contributions are available to allemployees, it has decided to voluntarily disclose the amounts of such employercontributions to the Named Executive Officers in the above table in order toprovide fulsome disclosure.

(8)          Represents 401(k) employer contributions to Messrs. Blake’sand Pelliccione’s retirement savings plans. Although the Company does notgenerally view employer contributions to employees’ and executives retirementsavings plans as perquisites or benefits since such contributions are availableto all employees, it has decided to voluntarily disclose the amounts of suchemployer contributions to the Named Executive Officers in the above table inorder to provide fulsome disclosure.

 

*Compensation of the Chief Executive Officer*

 

Thecompensation of the President and Chief Executive Officer is governed by theCompany’s executive compensation policy described in section entitled,“Compensation of Executive Officers”, under Item 6 and the President and ChiefExecutive Officer participates together with the other Named Executive Officersin all of our incentive plans.

 

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Dr. Engel’s total earned salary for 2009 was$458,040, which places him approximately 5.1% below the 50th percentile in relation to the companies in theReference Group.

 

The Governance Committee recommended, and the Boardapproved, in light of prevailing economic and marketconditions, as well as the cost-saving measures implemented by the Company, that no annual cashbonus be paid in respect of the 2009 year. Instead, in partial replacement ofthe 2009 annual cash bonus, the Governance Committee approved the granting ofadditional stock options to the CEO based on his individual performance. Theterms of such grant provide for accelerated vesting conditions, in order toallow these grants to serve their purpose as a partial replacement for annualbonuses. See “Summary of the Stock Option Plan” on page 87 for moredetails on the Stock Option Plan.

 

The President and Chief Executive Officer was awardeda grant of 165,000 stock options on December 9, 2009 (at an exerciseprice of CAN$0.95) for his performance in the context of the Company’sobjectives in 2009.

 

### ***C.            Boardpractices***

### *** ***

OurArticles provide that our Board shall be composed of a minimum of five and amaximum of fifteen directors. Directors are elected annually by ourshareholders, but the directors may from time to time appoint one or moredirectors, provided that the total number of directors so appointed does notexceed one-third of the number of directors elected at the last annual meetingof shareholders. Each elected director will remain in office until terminationof the next annual meeting of the shareholders or until his or her successor isduly elected or appointed, unless his or her post is vacated earlier.

 

Under the terms of contractual agreements among theCompany, SGF Santé Inc. and Dr. Éric Dupont concerning, among othermatters, the election of directors, provided that SGF Santé Inc. holds atleast 5% of the Company’s issued and outstanding voting shares, (a) theCompanywill propose for election as a director of the Company, at each annualmeeting of the shareholders (i) one candidate designated by SGFSanté Inc., provided that the candidate receives a favourablerecommendation from the Governance Committee, and (ii) one candidatejointly designated by SGF Santé Inc. and Dr. Éric Dupont, (b) theCompanywill solicit proxies from its shareholders for the election of suchcandidates as directors of the Company, and (c) Dr. Éric Dupont willexercise the voting rights attached to his common shares, on anyresolution relating to the election of directors to be submitted to thebeneficial holders of any participating shares of the Company, in favour of theelection of the candidates so designated. Similarly, under the terms of anagreement among the Company, SGF Santé Inc. and Fonds de solidarité destravailleurs du Québec (F.T.Q.). (“F.T.Q.”) concerning the election ofdirectors, provided that SGF Santé Inc. and F.T.Q. together hold at least5% of the Company’s issued and outstanding voting shares, (a) theCompanywill propose for election as a director of the Company, at each annualmeeting of the shareholders, one candidate jointly designated by SGFSanté Inc. and F.T.Q., provided that the candidate receives a favourablerecommendation from the Governance Committee and (b) the Companywillsolicit proxies from its shareholders for the election of such candidate as adirector of the Company.

 

**Committeesof the Board of Directors**

 

AuditCommittee

 

OurBoard has established an Audit Committee and the Governance Committee.

 

TheAudit Committee assists the Board in fulfilling its oversight responsibilities.The Audit Committee reviews the financial reporting process, the system ofinternal control, the audit process, and the Company’s process for monitoringcompliance with laws and regulations and with our Code of Ethical Conduct. Inperforming its duties, the Audit Committee will maintain effective workingrelationships with the Board, management, and the external auditors. Toeffectively perform his or her role, each committee member will obtain anunderstanding of the detailed responsibilities of committee membership as wellas the Company’s business, operations and risks.

 

Thefunction of the Audit Committee is oversight and while it has theresponsibilities and powers set forth in its charter (filed as Exhibit 11.2to this annual report), it is neither the duty of the committee to plan or toconduct audits or to determine that the Company’s financial statements arecomplete, accurate and in accordance with generally accepted accountingprinciples, nor to maintain internal controls and procedures.

 

Thecurrent members of the Audit Committee are Martha Byorum, Gérard Limoges andPierre MacDonald.

 

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GovernanceCommittee

 

Themandate of the Governance Committee provides that it is responsible for takingall reasonable measures to ensure that appropriate human resources systems andprocedures, such as hiring policies, competency profiles, training policies andcompensation structures are in place so that the Company can attract, motivateand retain the quality of personnel required to meet its business objectives.

 

TheGovernance Committee also assists the Board in discharging its responsibilitiesrelating to executive and other human resources hiring, assessment,compensation and succession planning matters.

 

Thus,the Governance Committee recommends the appointment of senior officers,including the terms and conditions of their appointment and termination, andreviews the evaluation of the performance of our senior officers, includingrecommending their compensation. The Board, which includes the members of theGovernance Committee, reviews the Chief Executive Officer’s corporate goals andobjectives and evaluates his or her performance and compensation in light ofsuch goals and objectives.

 

Thecurrent members of the Governance Committee are Juergen Ernst, José P. Dorais,Pierre Laurin and Pierre MacDonald.

 

### ***D.            Employees***

### *** ***

As of March 1, 2010,we had a total of 99 Full Time Equivalents (“FTE”) (as compared to 109 at March 1,2009 and 131 at March 1, 2008), of which 82 are based in Frankfurt,Germany  (excluding the effects of “shorthours” as explained below), 6 in New Jersey, United States, and 11 in QuebecCity, Canada. Of these, 61 are involved in discovery, preclinical, clinical andpharmaceutical development, 11 are involved in regulatory affairs, qualityassurance and intellectual property, and 27 are involved in businessoperations, communications, finance, information technology, human resources,project management and legal affairs. Following the negative results of ourPhase 3 efficacy studies for Cetrorelix in BPH in 2009, we applied for and weregranted approval by the German Ministry of Labor to implement the so-called“Kurzarbeit” (“short hours”) regime for a one-year term.  “Short hours” is a system offered by theGerman Ministry of Labor for companies undergoing economic distress as a resultof an unexpected event which causes temporary overcapacity in the work force.Under the system, we are allowed to selectively reduce the working hours of ouremployees thereby reducing the labor costs for the company accordingly. Theemployees affected by “short hours” are compensated for the salary shortfall bythe German Government.  As of March 1,2010, and including the effects of “short hours”, the equivalent number of FTEis further reduced to 68 FTE for Frankfurt, Germany and to 85 for the Companyas a whole. The initial approval by the German Ministry of Labor is valid untilAugust 2010 allowing for a follow-up application of up to a maximum of oneadditional year.

 

We have agreements withall of our employees covering confidentiality and loyalty, non-competition, andassignment to the Company of all intellectual property rights developed duringthe employment period. Some of our employees based in Frankfurt, Germany are representedby the Chemical Union of Germany. As such, their compensation is largely drivenby the outcome of the negotiations between the Chemical Union and theAssociation of Employers for the chemical industry which is then binding forall German companies in the industry. The current collective bargainingagreement (*Tarifvertrag*) thatapplies to all tariff-employees of AEZS Germany expires on March 31, 2010.We have never experienced a work stoppage and we believe that relationswith our employees as well as with the works council representing our Germanemployees are generally good.

 

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### ***E.            Share ownership***

### *** ***

The information in the table below is provided as of March 22,2010:

 
| **Name**                                             | ** ** | **No. of common shares  owned or held** | ** ** | **Percent(1)** | ** ** | **No. of stock options  Held(2)** | ** ** | **No. of currently  exercisable options** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------|------------|----------------|------------|----------------------------------------|------------|------------------------------------------------|------------|
|                                                 |       |                                         |       |           |       |                                   |       |                                           |       |
| Marcel Aubut                                         |       | 112,500                                      |       | *              |       | 145,000                                |       | 110,000                                        |       |
| Paul Blake                                           |       | 60,720                                       |       | *              |       | 255,000                                |       | 80,001                                         |       |
| Martha Byorum                                        |       | 12,000                                       |       | *              |       | 145,000                                |       | 110,000                                        |       |
| José P. Dorais                                  |       | —                                       |       | *              |       |                                   |       |                                           |       |
| Juergen Engel                                        |       | 79,779                                       |       | *              |       | 810,000                                |       | 445,001                                        |       |
| Juergen Ernst                                        |       | 58,850                                       |       | *              |       | 195,000                                |       | 93,334                                         |       |
| Pierre Lapalme                                       |       | —                                       |       |           |       | 20,000                                 |       | —                                         |       |
| Pierre Laurin                                        |       | 50,200                                       |       | *              |       | 157,000                                |       | 122,000                                        |       |
| Gérard Limoges                                  |       | 9,000                                        |       | *              |       | 95,000                                 |       | 60,000                                         |       |
| Pierre MacDonald                                     |       | 26,500                                       |       | *              |       | 154,000                                |       | 119,000                                        |       |
| Gerald J. Martin                                     |       | 14,000                                       |       | *              |       | 80,000                                 |       | 45,000                                         |       |
| Nicholas J.  Pelliccione                             |       | 25,000                                       |       | *              |       | 155,000                                |       | 56,668                                         |       |
| Matthias Seeber                                      |       | —                                       |       | *              |       | 350,000                                |       | 206,667                                        |       |
| Dennis Turpin                                        |       | 13,250                                       |       | *              |       | 585,000                                |       | 453,334                                        |       |
|                                                 |       |                                         |       |           |       |                                   |       |                                           |       |
| All of our  directors and senior officers as a group |       | 461,799                                      |       | 0.73           |       | 3,146,000                              |       | 1,901,005                                      |       |

 

----

*      Less than 1%

 

(1)         Based on 63,089,954 commonshares outstanding as of March 22, 2010.

(2)         For information regarding optionexpiration dates and exercise price refer to the tables included under item6.B.

 

## **Item 7.           Major Shareholders and Related Party Transactions**

## ** **

### ***A.            Major shareholders***

### *** ***

Weare not directly or indirectly owned or controlled by another corporation or byany foreign government.

 

Basedon filings with the Securities and Exchange Commission and the Canadiansecurities regulatory authorities, as of March 22, 2010, set out below arethe only persons/entities who beneficially owned, directly or indirectly, orexercised control or direction over our common shares carrying more than 5% ofthe voting rights attached to all our common shares.  As used in the tablebelow, “beneficial ownership” means sole or shared power to vote or direct thevoting of the security, or the sole or shared investment power with respect toa security (i.e., the power to dispose, or direct a disposition, of asecurity). A person is deemed at any date to have “beneficial ownership” of anysecurity that the person has a right to acquire within 60 days. More than oneperson may be deemed to have beneficial ownership of the same group ofsecurities.

 
| **Name of shareholder**                                            | ** ** | **Common Shares** | ** ** | **Total Percentage********of Voting Rights** | ** ** |
|--------------------------------------------------------------------|------------|-------------------|------------|----------------------------------------------|------------|
| ** **                                                         | ** ** | **(#)**           | ** ** | **(%)**                                      | ** ** |
| Fonds de solidarité  des travailleurs du Québec (F.T.Q.) |       | 8,161,569         |       | 12.94                                        |       |
|                                                               |       |              |       |                                         |       |
| SGF Santé Inc.                                                |       | 8,810,878         |       | 13.97                                        |       |

 

None of the shareholders set out above has differentvoting rights from the other shareholders, although F.T.Q. and SGF do havecertain Board nomination rights as described under Item 6.C above, “Directors,Senior Management and Employees — Board Practices”.

 

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**UnitedStates Shareholders**

 

Asof December 31, 2009, there were a total of 236 holders of record of ourcommon shares, of which 7 were registered with addresses in the United Statesholding in the aggregate approximately 17.45% of our outstanding common shares.We believe that the number of beneficial owners of our common shares issubstantially greater than the number of record holders, because a largeportion of our common shares are held in broker “street names.”

 

### ***B.            Related party transactions***

### *** ***

None

 

### ***C.            Interests of experts and counsel***

### *** ***

Not applicable.

 

## **Item 8.           Financial Information**

## ** **

### ***A.            Consolidated statements and otherfinancial information***

### *** ***

The financial statements filed as part of thisannual report are presented under “Item 18. — Financial Statements.”

 

**Valuation and qualifying accounts are as follows (in thousands of USdollars):**

 

*Valuation allowance on future income tax assets*

 
| ** **                               | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------|------------|-----------------------------------|------------|
| ** **                               | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                               | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance  - Beginning of year             |       | $                                 | 36,581     |   | $ | 23,289 |   | $ | 13,337 |   |
| Change  in valuation allowance           |       | 9,959                             |       | 17,554 |   | 6,963 |   |
| Impact  of foreign exchange rate changes |       | 3,810                             |       | (4,262 | ) | 2,989 |   |
|                                     |       |                              |       |   |   |   |   |
| Balance  - End of year                   |       | $                                 | 50,350     |   | $ | 36,581 |   | $ | 23,289 |   |

 

**Export Sales**

 

Export and domestic sales in thousands of USdollars and as percentage of total sales as follows:

 
| ** **      | ** ** | **Years ended December 31,** | ** ** |
|-----------------|------------|---------------------------------------------|------------|
| ** **      | ** ** | **2009**                                    | ** ** | **2008** | ** ** | **2007** | ** ** |
|            |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Export  Sales   |       | $                                           | 63,237     |   | 100.00 | % | $ | 38,145 |   | 99.13 | % | $ | 41,668 |   | 99.05 | % |
| Domestic  Sales |       | —                                      |       | 0.00 | % | 333 |   | 0.87 | % | 400 |   | 0.95 | % |
|            |       | $                                           | 63,237     |   | 100.00 | % | $ | 38,478 |   | 100.00 | % | $ | 42,068 |   | 100.00 | % |

 

**Dividend Policy**

 

Since our incorporation, we have not paid anydividends, and we do not anticipate paying any dividends in the foreseeablefuture.

 

### ***B.            Significant changes***

### *** ***

No significant changes occurred since the date ofour annual consolidated financial statements included elsewhere in this annualreport.

 

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## **Item 9.           The Offering and Listing**

## ** **

### ***A.            Offer and listing details***

### *** ***

Not Applicable, except for Item 9A(4).

 

Our common shares are listed and posted for tradingon NASDAQ under the symbol “AEZS” and on the TSX under the symbol “AEZ”. Thefollowing table indicates, for the relevant periods, the high and low closingprices of our common shares on NASDAQ and on the TSX:

 
| ** **          | ** ** | **NASDAQ (US$)** | ** ** | **TSX (CAN$)** | ** ** |
|---------------------|------------|------------------|------------|----------------|------------|
| ** **          | ** ** | **High**         | ** ** | **Low**        | ** ** | **High** | ** ** | **Low** | ** ** |
| 2009                |       | 2.83             |       | 0.46           |       | 3.11 |   | 0.57 |   |
| 2008                |       | 1.80             |       | 0.40           |       | 1.85 |   | 0.44 |   |
| 2007                |       | 4.36             |       | 1.46           |       | 5.10 |   | 1.47 |   |
| 2006                |       | 7.46             |       | 4.05           |       | 8.60 |   | 4.68 |   |
| 2005                |       | 6.36             |       | 4.18           |       | 7.65 |   | 4.92 |   |
|                |       |             |       |           |       |   |   |   |   |
| **2008**            |       |             |       |           |       |   |   |   |   |
| Fourth  quarter     |       | 0.60             |       | 0.40           |       | 0.72 |   | 0.44 |   |
| Third  quarter      |       | 1.36             |       | 0.59           |       | 1.42 |   | 0.61 |   |
| Second  quarter     |       | 1.80             |       | 1.00           |       | 1.85 |   | 1.01 |   |
| First  quarter      |       | 1.73             |       | 0.77           |       | 1.78 |   | 0.75 |   |
|                |       |             |       |           |       |   |   |   |   |
| **2009**            |       |             |       |           |       |   |   |   |   |
| Fourth  quarter     |       | 1.25             |       | 0.80           |       | 1.40 |   | 0.83 |   |
| Third  quarter      |       | 2.83             |       | 0.89           |       | 3.11 |   | 0.97 |   |
| Second  quarter     |       | 2.35             |       | 0.89           |       | 2.63 |   | 1.06 |   |
| First  quarter      |       | 0.97             |       | 0.46           |       | 1.25 |   | 0.57 |   |
|                |       |             |       |           |       |   |   |   |   |
| **Last six months** |       |             |       |           |       |   |   |   |   |
| Feb-10              |       | 0.87             |       | 0.81           |       | 0.91 |   | 0.86 |   |
| Jan-10              |       | 0.93             |       | 0.80           |       | 0.99 |   | 0.83 |   |
| Dec-09              |       | 1.12             |       | 0.80           |       | 1.17 |   | 0.83 |   |
| Nov-09              |       | 1.10             |       | 0.98           |       | 1.17 |   | 1.05 |   |
| Oct-09              |       | 1.25             |       | 0.99           |       | 1.40 |   | 1.07 |   |
| Sept-09             |       | 1.38             |       | 0.89           |       | 1.46 |   | 0.98 |   |

### *** ***

### ***B.            Plan of distribution***

### *** ***

Not applicable.

 

### ***C.            Markets***

### *** ***

Our common shares arelisted and posted for trading on the TSX under the symbol “AEZ” and are quotedon the NASDAQ under the symbol “AEZS.” On January 21, 2010, we announcedthat we had received a letter from the Listing Qualifications Department of theNasdaq Stock Market regarding the failure by the Company to comply withNASDAQ’s minimum closing bid price requirements. In accordance with NASDAQListing Rule 5810(c)(3)(a), we are provided a grace period of 180 calendardays, or until July 20, 2010, to regain compliance with this requirement.If we fail to meet any of NASDAQ’s continued listing requirements and NASDAQattempts to enforce compliance with its rules, our common shares may bedelisted from NASDAQ. If our shares were delisted from TSX or NASDAQ, investorsmay have difficulty in disposing of our common shares held by them.

 

### ***D.            Selling shareholders***

### *** ***

Not applicable.

 

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### ***E.            Dilution***

### *** ***

Not applicable.

 

### ***F.            Expenses of the issuer***

### *** ***

Not applicable.

 

## **Item 10.         Additional Information**

## ** **

### ***A.            Share capital***

### *** ***

Not applicable.

 

### ***B.            Memorandum and articles ofassociation***

### *** ***

TheCompany is governed by its restated articles of incorporation (the “RestatedArticles of Incorporation”) under the *CanadaBusiness Corporations Act*(the “CBCA”) and by its bylaws (the“bylaws”). The Company’s Restated Articles of Incorporation are on file withthe Corporations Directorate of Industry Canada under Corporation Number264271-9. The Restated Articles of Incorporation do not include a statedpurpose and do not place any restrictions on the business that the Company maycarry on.

 

**Inspection Rights of Shareholders**

 

Underthe CBCA, shareholders are entitled to be provided with a copy of the list ofregistered shareholders of the Company. In order to obtain the shareholderlist, the Company must be provided with an affidavit including, among otherthings, a statement that the list will only be used for the purposes permittedby the CBCA. These permitted purposes include an effort to influence the votingof shareholders of the Company, an offer to acquire securities of the Companyand any other matter relating to the affairs of the Company. The Company isentitled to charge a reasonable fee for the provision of the shareholder listand must deliver that list no more than ten days after receipt of the affidavitdescribed above.

 

Underthe CBCA, shareholders of the Company have the right to inspect certaincorporate records, including its Restated Articles of Incorporation and bylawsand minutes of meetings and resolutions of the shareholders. Shareholders haveno statutory right to inspect minutes of meetings and resolutions of directorsof the Company. Shareholders of the Company have the right to certain financialinformation respecting the Company. In addition to the annual and quarterlyfinancial statements required to be filed under applicable securities laws,under the CBCA the Company is required to place before every annual meeting ofshareholders its audited comparative annual financial statements. In addition,shareholders have the right to examine the financial statements of each of oursubsidiaries and any other corporate entity whose accounts are consolidated inthe financial statements of the Company.

 

**Directors**

 

Theminimum number of directors of the Company is five and the maximum number isfifteen. In accordance with the Company’s bylaws and the CBCA, a majority ofits directors must be residents of Canada. In order to serve as a director, aperson must be a natural person at least 18 years of age, of sound mind, notbankrupt, and must not be prohibited by any court from holding the office ofdirector. For as long as the Company is a company that publicly distributes itssecurities, at least two-thirds of its directors must not be officers oremployees of the Company or its subsidiaries. None of the Restated Articles ofIncorporation, the bylaws and the CBCA impose any mandatory retirementrequirements for directors.

 

Thedirectors are elected by a majority of the votes cast at the annual meeting atwhich an election of directors is required, to hold office until the electionof their successors except in the case of resignations or if their officesbecome vacant by death or otherwise. Subject to the provisions of the Company’sbylaws, all directors may, if still qualified to serve as directors, stand forre-election. The Board is not replaced at staggered intervals but is electedannually.

 

Underthe Company’s bylaws and the Restated Articles of Incorporation, a director ofthe Company need not be a shareholder.

 

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The directors are entitledto remuneration as shall from time to time be determined by the Board or by acommittee to which the Board may delegate the power to do so. Under the mandateof the Company’s Governance Committee, such committee, comprised of a majorityof independent directors, is tasked with making recommendations to the Boardconcerning director remuneration.

 

TheCompany’s bylaws provide that a director shall promptly disclose to the Companyany interest he or she has in any undertaking or association that is likely toplace him or her in a situation of conflict of interest, as well as the rightshe or she may assert against the Company, indicating, should such be the case,the nature and value thereof. Likewise, the CBCA and the Company’s bylawsprovide that a director who is a party to, or who is a director or officer of,or has a material interest in, any person who is a party to a material contractor transaction or proposed material contract or transaction with the Companymust disclose to the Company the nature and extent of his or her interest atthe time and in the manner provided by the CBCA, or request that same beentered in the minutes of the meetings of the Board, even if such contract, inconnection with the normal business activity of the Company, does not requirethe approval of either the directors or the shareholders. At the request of thepresident or any director, the director placed in a situation of conflict ofinterest must leave the meeting while the Board discusses the matter. The CBCAand the Company’s bylaws prohibit such a director from voting on any resolutionto approve the contract or transaction unless the contract or transaction:

 

·                  relates primarily to his orher remuneration as a director, officer, employee or agent of the Company or anaffiliate;

 

·                  is for indemnity orinsurance for director’s liability as permitted by the CBCA; or

 

·                  is with an affiliate of theCompany.

 

TheCBCA provides that the Board may, on behalf of the Company and withoutauthorization of its shareholders:

 

·                  borrow money upon thecredit of the Company;

 

·                  issue, reissue, sell orpledge debt obligations of the Company;

 

·                  give a guarantee on behalfof the Company to secure performance of an obligation of any person; and

 

·                  mortgage, hypothecate,pledge or otherwise create a security interest in all or any property of theCompany, owned or subsequently acquired, to secure any obligation of theCompany.

 

Theshareholders have the ability to restrict such powers through the Company’sRestated Articles of Incorporation or bylaws (or through a unanimousshareholder agreement), but no such restrictions are in place.

 

Inaddition, the Company’s bylaws provide that the Board may:

 

·                  subject to the provisionsof the Company’s Restated Articles of Incorporation, accept subscriptions,allot, issue all or part of the unissued shares of the Company, grant optionsin respect of such shares or otherwise dispose thereof to such persons, on suchterms and conditions and for such consideration and in such manner not contraryto the CBCA or the Restated Articles of Incorporation of the Company as thedirectors think fit; and

 

·                  from time to time as it maydeem advisable and to the extent permitted by the CBCA, declare and pay to theshareholders, according to their rights, dividends in money or property or inthe form of shares of the Company.

 

TheCBCA prohibits the giving of a guarantee to any shareholder, director, officeror employee of the Company or of an affiliated corporation or to an associateof any such person for any purpose or to any person for the purpose of or inconnection with a purchase of a share issued or to be issued by the Company orits affiliates, where there are reasonable grounds for believing that theCompany is or, after giving the guarantee, would be unable to pay itsliabilities as they become due, or the realizable value of the Company’s assetsin the form of assets pledged or encumbered to secure a guarantee, after givingthe guarantee, would be less than the aggregate of the Company’s liabilitiesand stated capital of all classes. These borrowing powers may be varied by theCompany’s bylaws or its Restated Articles of Incorporation. However, theCompany’s bylaws and Restated Articles of Incorporation do not contain anyrestrictions on or variations of these borrowing powers.

 

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Pursuant to the Company’sbylaws, the directors of the Company manage and administer the business andaffairs of the Company and exercise all such powers and authority as theCompany is authorized to exercise pursuant to the CBCA, the Restated Articles ofIncorporation and the bylaws. The general duties of a director or officer ofthe Company under the CBCA are to act honestly and in good faith with a view tothe best interests of the Company and to exercise the care, diligence and skillthat a reasonably prudent person would exercise in comparable circumstances.Any breach of these duties may lead to liability to the Company and itsshareholders for breach of fiduciary duty. In addition, a breach of certainprovisions of the CBCA, including the improper payment of dividends or theimproper purchase or redemption of shares, will render the directors whoauthorized such action liable to account to the Company for any amountsimproperly paid or distributed.

 

TheCompany’s bylaws provide that the Board may, from time to time, appoint fromamongst their number committees of the Board, and delegate to any suchcommittee any of the powers of the Board except those which pursuant to theCBCA a committee of the Board has no authority to exercise. As such, the Board hastwo standing committees: the Audit Committee and the Governance Committee.

 

Subjectto the limitations provided by the CBCA, the Company must indemnify a directoror an officer of the Company, a former director or officer of the Company or aperson who acts or acted at the Company’s request as a director or officer of abody corporate of which the Company is or was a shareholder or creditor, andhis or her heirs and legal representatives, against all costs, losses, chargesand expenses, including an amount paid to settle an action or satisfy ajudgment, reasonably incurred by him or her in respect of any civil, criminalor administrative action or proceeding to which he or she is made a party byreason of having been a director or officer of the Company or such bodycorporate, provided:

 

(a)         he or sheacted in good faith in the best interests of the Company; and

 

(b)         in the case ofa criminal or an administrative action or proceeding that is enforced by amonetary penalty, he or she had reasonable grounds to believe that his or herconduct was lawful.

 

Thedirectors of the Company are authorized to indemnify from time to time anydirector or other person who has assumed or is about to assume in the normalcourse of business any liability for the Company or for any corporationcontrolled by the Company, and to secure such director or other person againstany loss by the pledge of all or part of the movable or immovable property ofthe Company through the creation of a hypothec or any other real right in all orpart of such property or in any other manner.

 

**Share Capitalization**

 

Our authorized sharecapital structure consists of an unlimited number of shares of the followingclasses (all classes are without nominal or par value): common shares; andfirst preferred shares (the “First Preferred Shares”) and second preferredshares (the “Second Preferred Shares” and, together with the First PreferredShares, the “Preferred Shares”), both issuable in series. As of March 22,2010, there were 63,089,954 common shares outstanding. No Preferred Shares ofthe Company have been issued to date.

 

**CommonShares**

 

The holders of the commonshares are entitled to one vote for each common share held by them at allmeetings of shareholders, except meetings at which only shareholders of aspecified class of shares are entitled to vote. In addition, the holders areentitled to receive dividends if, as and when declared by the Company’s Boardof Directors on the common shares. Finally, the holders of the common sharesare entitled to receive the remaining property of the Company upon anyliquidation, dissolution or winding-up of the affairs of the Company, whethervoluntary or involuntary. Shareholders have no liability to further capitalcalls as all shares issued and outstanding are fully paid and non-assessable.

 

**PreferredShares**

 

The First and SecondPreferred Shares are issuable in series with rights and privileges specific toeach class. The holders of Preferred Shares are generally not entitled toreceive notice of or to attend or vote at meetings of shareholders. The holdersof First Preferred Shares are entitled to preference and priority to anyparticipation of holders of Second Preferred Shares, common shares or shares ofany other class of shares of the share capital of the Company ranking junior tothe First Preferred Shares with respect to dividends and, in the event of theliquidation of the Company, the distribution of its property upon itsdissolution or winding-up, or the distribution of all or part of its assetsamong the shareholders, to an amount equal to the value of the considerationpaid in respect of such shares outstanding, as credited to the issued andpaid-up share capital of the 

 

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Company, on an equalbasis, in proportion to the amount of their respective claims in regard to suchshares held by them. The holders of Second Preferred Shares are entitled topreference and priority to any participation of holders of common shares orshares of any other class of shares of the share capital of the Company rankingjunior to the Second Preferred Shares with respect to dividends and, in theevent of the liquidation of the Company, the distribution of its property uponits dissolution or winding-up, or the distribution of all or part of its assetsamong the shareholders, to an amount equal to the value of the considerationpaid in respect of such shares outstanding, as credited to the issued andpaid-up share capital of the Company, on an equal basis, in proportion to theamount of their respective claims in regard to such shares held by them.

 

Our Board of Directorsmay, from time to time, provide for additional series of Preferred Shares to becreated and issued, but the issuance of any Preferred Shares is subject to thegeneral duties of the directors under the CBCA**to acthonestly and in good faith with a view to the best interests of the Company andto exercise the care, diligence and skill that a reasonably prudent personwould exercise in comparable circumstances.

 

**Shareholder Actions**

 

TheCBCA provides that shareholders of the Company may, with leave of a court,bring an action in the name of and on behalf of the Company for the purpose ofprosecuting, defending or discontinuing an action on behalf of the Company. Inorder to grant leave to permit such an action, the CBCA provides that the courtmust be satisfied that the directors of the Company were given adequate notice ofthe application, the shareholder is acting in good faith and that it appears tobe in the Company’s best interests that the action be brought.

 

**Shareholder Rights Plan**

 

*Objectivesand Background of the Shareholder Rights Plan*

 

The fundamental objectives of the Company’sShareholder Rights Plan (the “Rights Plan”) are to provide adequate time forour Board and shareholders to assess an unsolicited take-over bid for theCompany, to provide the Board with sufficient time to explore and developalternatives for maximizing shareholder value if a take-over bid is made, andto provide shareholders with an equal opportunity to participate in a take-overbid.

 

The Rights Plan encourages a potential acquiror whomakes a take-over bid to proceed either by way of a “Permitted Bid”, asdescribed below, which requires a take-over bid to satisfy certain minimumstandards designed to promote fairness, or with the concurrence of our Board.If a take-over bid fails to meet these minimum standards and the Rights Plan isnot waived by the Board, the Rights Plan provides that holders of commonshares, other than the acquiror, will be able to purchase additional commonshares at a significant discount to market, thus exposing the person acquiringcommon shares to substantial dilution of its holdings.

 

*Summaryof the Rights Plan*

 

The following is a summary of the principal terms ofthe Rights Plan, which summary is qualified in its entirety by reference to theterms thereof. Capitalized terms not otherwise defined in this summary shallhave the meaning ascribed to such terms in the Shareholder Rights PlanAgreement which sets forth the Rights Plan. The Rights Plan is filed as anexhibit to this annual report on Form 20-F.

 

*Operationof the Rights Plan*

 

Pursuant to the terms of the Rights Plan, one rightwas issued in respect of each common share outstanding at 5:01 p.m. on March 29,2010 (the “Effective Date”). In addition, one right will be issued for eachadditional common share issued after the Record Time and prior to the earlier ofthe Separation Time (as defined below) and the Expiration Time (as definedbelow). The rights have an initial exercise price equal to the Market Price (asdefined below) of the common shares as determined at the Separation Time,multiplied by five, subject to certain anti-dilution adjustments (the “ExercisePrice”), and they are not exercisable until the Separation Time. Upon theoccurrence of a Flip-in Event, each right will entitle the holder thereof,other than an Acquiring Person or any other person whose rights are or becomevoid pursuant to the provisions of the Rights Plan, to purchase from theCompany, effective at the close of business on the eighth trading day after theStock Acquisition Date, upon payment to the Company of the Exercise Price, commonshares having an aggregate Market Price equal to twice the Exercise Price onthe date of consummation or occurrence of such Flip-in Event, subject tocertain anti-dilution adjustments.

 

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*Definitionof Market Price*

 

Market Price is generally defined in the Rights Plan,on any given day on which a determination must be made, as the volume weightedaverage trading price of the common shares for the five consecutive tradingdays (i.e. days on which the TSX is open for the transaction of business,subject to certain exceptions), through and including the trading dayimmediately preceding such date of determination, subject to certainexceptions.

 

*Trading ofRights*

 

Until the Separation Time (or the earlier terminationor expiration of the rights), the rights trade together with the common sharesand are represented by the same share certificates as the common shares or anentry in the Company’s securities register in respect of any outstanding commonshares. From and after the Separation Time and prior to the Expiration Time,the rights are evidenced by rights certificates and trade separately from thecommon shares. The rights do not carry any of the rights attaching to thecommon shares such as voting or dividend rights.

 

*SeparationTime*

 

The rights will separate from the common shares towhich they are attached and become exercisable at the time (the “Separation Time”)of the close of business on the eighth business day after the earliest to occurof:

 

1.              the first date (the “Stock Acquisition Date”) of apublic announcement of facts indicating that a person has become an AcquiringPerson; and

 

2.              the date of the commencement of, or first publicannouncement of the intention of any person (other than the Company or any ofits subsidiaries) to commence a take-over bid or a share exchange bid for morethan 20% of the outstanding common shares of the Company other than a PermittedBid or a Competing Permitted Bid (as defined below), so long as such take-overbid continues to satisfy the requirements of a Permitted Bid or a CompetingPermitted Bid), as the case may be.

 

The Separation Time can also be such later time as mayfrom time to time be determined by the Board, provided that if any suchtake-over bid expires, or is cancelled, terminated or otherwise withdrawn priorto the Separation Time, without securities deposited thereunder being taken upand paid for, it shall be deemed never to have been made and if the Boarddetermines to waive the application of the Rights Plan to a Flip-in Event, theSeparation Time in respect of such Flip-in Event shall be deemed never to haveoccurred.

 

From and after the Separation Time and prior to theExpiration Time, each right entitles the holder thereof to purchase one commonshare upon payment to the Company of the Exercise Price.

 

*Flip-inEvent*

 

The acquisition by a person (an “Acquiring Person”),including others acting jointly or in concert with such person, of more than20% of the outstanding common shares, other than by way of a Permitted Bid, aCompeting Permitted Bid or in certain other limited circumstances described inthe Rights Plan, is referred to as a “Flip-in Event”.

 

In the event that, prior to the Expiration Time, aFlip-in Event which has not been waived occurs (see “Waiver and Redemption”below), each right (other than those held by or deemed to be held by theAcquiring Person) will thereafter entitle the holder thereof, effective as ofthe close of business on the eighth trading day after the Stock AcquisitionDate, to purchase from the Company, upon payment of the Exercise Price andotherwise exercising such right in accordance with the terms of the RightsPlan, that number of common shares having an aggregate Market Price on the dateof consummation or occurrence of the Flip-in Event equal to twice the ExercisePrice, for an amount in cash equal to the Exercise Price (subject to certainanti-dilution adjustments described in the Rights Plan).

 

A bidder may enter into Lock-up Agreements with theCompany’s shareholders (“Locked-up Persons”) who are not affiliates orassociates of the bidder and who are not, other than by virtue of entering intosuch agreement, acting jointly or in concert with the bidder, whereby suchshareholders agree to tender their common shares to the take-over bid (the“Lock-up Bid”) without the bidder being deemed to beneficially own the commonshares deposited pursuant to the Lock-up Bid. Any such agreement must include aprovision that permits the Locked-up Person to withdraw the common shares totender to another take-over bid or to support another transaction that willeither provide greater consideration to the shareholder than the Lock-up Bid orprovide for a right to sell a greater number of shares than the Lock-up Bidcontemplates (provided that the Lock-up 

 

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Agreement may require that such greater number exceedthe number of shares under the Locked-up Bid by a specified percentage not toexceed 7%).

 

The Lock-up Agreement may require that theconsideration under the other transaction exceed the consideration under theLock-up Bid by a specified amount. The specified amount may not be greater than7%. For greater certainty, a Lock-up Agreement may contain a right of firstrefusal or require a period of delay (or other similar limitation) to give a bidderan opportunity to match a higher price in another transaction as long as thelimitation does not preclude the exercise by the Locked-up Person of the rightto withdraw the common shares during the period of the other take-over bid ortransaction.

 

The Rights Plan requires that any Lock-up Agreement bemade available to the Company and the public. The definition of Lock-upAgreement also provides that under a Lock-up Agreement, no “break up” fees,“topping” fees, penalties, expenses or other amounts that exceed in aggregatethe greater of (i) 21⁄2% of the price or value of the aggregateconsideration payable under the Lock-up Bid, and (ii) 50% of the amount bywhich the price or value of the consideration received by a Locked-up Personunder another take-over bid or transaction exceeds what such Locked-up Personwould have received under the Lock-up Bid, can be payable by such Locked-upPerson if the Locked-up Person fails to deposit or tender common shares to theLock-up Bid or withdraws common shares previously tendered thereto in order todeposit such common shares to another take-over bid or support anothertransaction.

 

*PermittedBid Requirements*

 

The requirements of a Permitted Bid include thefollowing:

 

1.              the take-over bid must be made by means of a take-overbid circular;

 

2.              the take-over bid must be made to all holders ofcommon shares wherever resident, on identical terms and conditions, other thanthe bidder;

 

3.              the take-over bid must not permit common sharestendered pursuant to the bid to be taken up or paid for

 

(a)         prior to the close of business on a date which is notless than 60 days following the date of the bid, and

 

(b)         then only if at such date more than 50% of the thenoutstanding common shares held by shareholders other than any other AcquiringPerson, the bidder, the bidder’s affiliates or associates, persons actingjointly or in concert with the bidder and any employee benefit plan, deferredprofit-sharing plan, stock participation plan or trust for the benefit ofemployees of the Company or any of its subsidiaries, unless the beneficiariesof such plan or trust direct the manner in which the common shares are to bevoted or direct whether the common shares are to be tendered to a take-over bid(the “Independent Shareholders”), have been deposited or tendered to thetake-over bid and not withdrawn;

 

4.              the take-over bid must allow common shares to bedeposited, unless the take-over bid is withdrawn, at any time up to the closeof business on the date that the common shares are to be first taken up andpaid for;

 

5.              the take-over bid must allow common shares to bewithdrawn until taken up and paid for; and

 

6.              if more than 50% of the then outstanding common sharesheld by Independent Shareholders are deposited or tendered to the take-over bidwithin the 60-day period and not withdrawn, the bidder must make a publicannouncement of that fact and the take-over bid must remain open for depositsand tenders of common shares for not less than ten days from the date of suchpublic announcement.

 

A Permitted Bid need not be a bid for all outstandingcommon shares not held by the bidder, i.e., a Permitted Bid may be a partialbid. The Rights Plan also allows a competing Permitted Bid (a “CompetingPermitted Bid”) to be made while a Permitted Bid is in existence. A CompetingPermitted Bid must satisfy all the requirements of a Permitted Bid other thanthe requirement set out in clause 3(a) above and must not permit commonshares tendered or deposited pursuant to the bid to be taken up or paid for priorto the close of business on a date which is earlier than 35 days (or suchlonger minimum period of days that the bid must be open for acceptance afterthe date of the bid under applicable Canadian provincial securities legislationand the 60th day after the earliest date on which any other Permitted Bid orCompeting Permitted Bid that is then in existence was made.

 

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* *

*Waiver andRedemption*

 

The Board may, prior to the occurrence of a Flip-inEvent, waive the dilutive effects of the Rights Plan in respect of, among otherthings, a particular Flip-in Event resulting from a take-over bid made by wayof a take-over bid circular to all holders of common shares of the Company. Insuch an event, such waiver shall also be deemed to be a waiver in respect ofany other Flip-in Event occurring under a take-over bid made by way of atake-over bid circular to all holders of common shares prior to the expiry ofthe first mentioned take-over bid.

 

The Board may, with the approval of a majority ofIndependent Shareholders (or, after the Separation Time has occurred, holdersof rights, other than rights which are void pursuant to the provisions of theRights Plan or which, prior to the Separation Time, are held otherwise than byIndependent Shareholders), at any time prior to the occurrence of a Flip-inEvent which has not been waived, elect to redeem all, but not less than all, ofthe then outstanding rights at a price of $0.00001 each, appropriately adjustedas provided in the Rights Plan (the “Redemption Price”).

 

Where a take-over bid that is not a Permitted Bid orCompeting Permitted Bid is withdrawn or otherwise terminated after theSeparation Time has occurred and prior to the occurrence of a Flip-in Event,the Board may elect to redeem all the outstanding rights at the RedemptionPrice without the consent of the holders of the common shares or the rights andreissue rights under the Rights Plan to holders of record of common sharesimmediately following such redemption. Upon the rights being so redeemed andreissued, all the provisions of the Rights Plan will continue to apply as ifthe Separation Time had not occurred, and the Separation Time will be deemednot to have occurred and the Company shall be deemed to have issued replacementrights to the holders of its then outstanding common shares.

 

*Amendment to the Rights Plan*

 

The Rights Plan may be amended to correct any clericalor typographical error or to make such changes as are required to maintain thevalidity of the Rights Plan as a result of any change in any applicablelegislation, regulations or rules thereunder, without the approval of theholders of the common shares or rights. Prior to the Separation Time, theCompany may, with the prior consent of the holders of common shares, amend,vary or delete any of the provisions of the Rights Plan in order to effect anychanges which the Board, acting in good faith, considers necessary ordesirable. The Company may, with the prior consent of the holders of rights, atany time after the Separation Time and before the Expiration Time, amend, varyor delete any of the provisions of the Rights Plan.

 

*Protection Against Dilution*

 

The Exercise Price, the number and nature ofsecurities which may be purchased upon the exercise of rights and the number ofrights outstanding are subject to adjustment from time to time to preventdilution in the event of stock dividends, subdivisions, consolidations,reclassifications or other changes in the outstanding common shares, *pro rata*distributions to holders of common shares and othercircumstances where adjustments are required to appropriately protect theinterests of the holders of rights.

 

*FiduciaryDuty of Board*

 

The Rights Plan will not detract from or lessen theduty of the Board to act honestly and in good faith with a view to the bestinterests of the Company and its shareholders. The Board will continue to havethe duty and power to take such actions and make such recommendations to theCompany’s shareholders as are considered appropriate.

 

*Exemptions for Investment Advisors*

 

Fund managers, investment advisors (for fully-managedaccounts), trust companies (acting in their capacities as trustees andadministrators), statutory bodies whose business includes the management offunds, and administrators of registered pension plans are exempt from triggeringa Flip-in Event, provided that they are not making, or are not part of a groupmaking, a take-over bid.

 

*Term*

 

The Rights Plan willexpire (the “Expiration Time”) on the earlier of the firstannual meeting of shareholders of the Company  followingMarch 29, 2016, being thesixth anniversary of the Effective Date (subject to the approval of the resolution by theshareholders at the Meeting and reconfirmation at the firstannual meeting of shareholders of the Company  following March 29,2013 (being the third anniversary of the Effective Date)) and the time at which the right toexercise rights shall terminate 

 

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pursuant to theprovisions of the Rights Plan pertaining to the redemption of rights and thewaiver of the application of the Rights Plan, after which time it willautomatically terminate.

 

**Action Necessary to Change Rights of Shareholders**

 

Inorder to change the rights of its shareholders, the Company would need to amendits Restated Articles of Incorporation to effect the change. Such an amendmentwould require the approval of holders of two-thirds of the issued andoutstanding shares cast at a duly called special meeting. For certainamendments such as those creating a class of Preferred Shares, a shareholder isentitled under the CBCA to dissent in respect of such a resolution amending theRestated Articles of Incorporation and, if the resolution is adopted and theCompany implements such changes, demand payment of the fair value of itsshares.

 

**Disclosure of Share Ownership**

 

Ingeneral, under applicable securities regulation in Canada, a person or companywho beneficially owns, or who exercises control or direction over directly orindirectly, voting securities of a reporting issuer voting securities of anissuer or a combination of both, carrying more than ten percent of the votingrights attached to all the issuer’s outstanding voting securities is an insiderand must, within ten days of becoming an insider, file a report in the requiredform effective the date on which the person became an insider, disclosing anydirect or indirect beneficial ownership of, or control or direction over,securities of the reporting issuer.

 

Additionally,securities regulation in Canada provides for the filing of a report by aninsider of a reporting issuer whose holdings change, which report must be filedwithin ten days from the day on which the change takes place.

 

Section 13of the *United States Securities Exchange Actof 1934*(the “Exchange Act”) imposes reporting requirements onpersons who acquire beneficial ownership (as such term is defined in the Rule 13d-3under the Exchange Act) of more than five percent of a class of an equitysecurity registered under Section 12 of the Exchange Act. The Company’scommon shares are so registered. In general, such persons must file, within tendays after such acquisition, a report of beneficial ownership with the SECcontaining the information prescribed by the regulations under Section 13of the Exchange Act. This information is also required to be sent to the issuerof the securities and to each exchange where the securities are traded.

 

**Meeting of Shareholders**

 

Anannual meeting of shareholders is held each year for the purpose of consideringthe financial statements and reports, electing directors, appointing auditorsand fixing or authorizing the Board to fix their remuneration and for thetransaction of other business as may properly come before a meeting ofshareholders. Any annual meeting may also constitute a special meeting to takecognizance and dispose of any matter of which a special meeting may takecognizance and dispose. Under the bylaws, the president of the Company has thepower to call a meeting of shareholders.

 

Whilethe bylaws provide that one or more shareholders who hold at least 20% of theoutstanding voting shares of the Company may requisition the directors of theCompany to call a meeting of shareholders for the purpose stated in therequisition, the CBCA provides that the holders of not less than 5% of theoutstanding voting shares of the Company may so requisition the directors ofthe Company. Except in limited circumstances, including where a meeting of shareholdershas already been called and a notice of meeting already given or where it isclear that the primary purpose of the requisition is to redress a personalgrievance against the Company or its directors, officers or shareholders, thedirectors of the Company, on receipt of such requisition, must call a meetingof shareholders. If the directors fail to call a meeting of shareholders withintwenty-one days after receiving the requisition, any shareholder who signed therequisition may call the meeting of shareholders and, unless the shareholdersresolve otherwise at the meeting, the Company shall reimburse the shareholdersfor the expenses reasonably incurred by them in requisitioning, calling andholding the meeting of shareholders.

 

TheCBCA also provides that, except in limited circumstances, a resolution inwriting signed by all of the shareholders entitled to vote on that resolutionat a meeting of shareholders is as valid as if it had been passed at a meetingof shareholders.

 

A quorum of shareholders ispresent at an annual or special meeting of shareholders, regardless of thenumber of persons present in person at the meeting, if the holder or holders ofshares representing at least 20% of the outstanding voting shares at suchmeeting are present in person or represented in accordance with the Company’sbylaws. In the case where the CBCA, the Restated Articles of Incorporation orthe bylaws of the Company require or permit the vote by class of holders of agiven class of shares of the share capital of the Company, the quorum at anymeeting will be one or more persons representing 20% of the outstanding sharesof such class.

 

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Noticeof the time and place of each annual or special meeting of shareholders must begiven not less than 21 days, nor more than 50 days, before the date of eachmeeting to each director, to the auditor and to each shareholder entitled tovote thereat. If the address of any shareholder, director or auditor does notappear in the books of the Company, the notice may be sent to such address asthe person sending the notice may consider to be most likely to reach suchshareholder, director or auditor promptly. Every person who, by operation ofthe CBCA, transfers or by any other means whatsoever, becomes entitled to anyshare, shall be bound by every notice given in respect of such share which,prior to the entry of his or her name and address on the register of theCompany, is given to the person whose name appears on the register at the timesuch notice is sent. Notice of meeting of shareholders called for any otherpurpose other than consideration of the financial statements and auditor’sreport, election of directors and reappointment of the incumbent auditor, muststate the nature of the business in sufficient detail to permit the shareholderto form a reasoned judgment on and must state the text of any specialresolution or bylaw to be submitted to the meeting.

 

**Limitations on Right to Own Securities**

 

NeitherCanadian law nor the Company’s Restated Articles of Incorporation or bylawslimit the right of a non-resident to hold or vote common shares, other than asprovided in the *Investment Canada Act*(the “Investment Act”). The Investment Act prohibits implementation ofcertain direct reviewable investments by an individual, government or agencythereof, corporation, partnership, trust or joint venture that is not a“Canadian,” as defined in the Investment Act (a “non-Canadian”), unless,after review, the minister responsible for the Investment Act is satisfied oris deemed to be satisfied that the investment is likely to be of net benefit toCanada. An investment in the common shares of the Company by a non-Canadian(other than a “WTO Investor,” as defined below) would be reviewable under theInvestment Act if it were an investment to acquire direct control of theCompany, and the book value of the assets of the Company were CAN$5 millionor more (provided that immediately prior to the implementation of theinvestment the Company was not controlled by WTO Investors). Subject to theAmendments (as defined below), an investment in common shares of the Company bya WTO Investor would be reviewable under the Investment Act if it were aninvestment to acquire direct control of the Company and the value of the assetsof the Company equalled or exceeded CAN$299 million (for 2010). Anon-Canadian, whether a WTO Investor or otherwise, would be deemed to acquirecontrol of the Company for purposes of the Investment Act if he or she acquireda majority of the common shares of the Company. The acquisition of less than amajority, but at least one-third of the shares, would be presumed to be anacquisition of control of the Company, unless it could be established that theCompany was not controlled in fact by the acquirer through the ownership of theshares. In general, an individual is a WTO Investor if he or she is a“national” of a country (other than Canada) that is a member of the World TradeOrganization (“WTO Member”) or has a right of permanent residence in a WTOMember. A corporation or other entity will be a “WTO Investor” if it is a “WTOInvestor-controlled entity,” pursuant to detailed rules set out in theInvestment Act. The United States is a WTO Member. Certain transactionsinvolving the common shares would be exempt from the Investment Act, including:(a) an acquisition of the shares if the acquisition were made in theordinary course of that person’s business as a trader or dealer in securities; (b) anacquisition of control of the Company in connection with the realization of asecurity interest granted for a loan or other financial assistance and not forany purpose related to the provisions of the Investment Act; and (c) anacquisition of control of the Company by reason of an amalgamation, merger,consolidation or corporate reorganization, following which the ultimate director indirect control in fact of the Company, through the ownership of votinginterests, remains unchanged.

 

TheCanadian Federal Government adopted certain amendments (the “Amendments”)to the Investment Act in 2009. Some of the Amendments, which came into force onFebruary 6, 2009, introduce a national security test and review process,authorizing the Canadian Minister of Industry to review investments that “couldbe injurious to national security,” regardless of the size of the transaction.Some of the other Amendments will come into force on a day to be fixed by orderof the Canadian Governor in Council, including the increase to the thresholdsthat trigger governmental review for WTO Investors. Therefore, the thresholdsfor the review of direct acquisitions of control by WTO Investors wouldincrease from the current CAN$299 million (based on book value) toCAN$600 million (to be based on the “enterprise value” of theCanadian business) for the two years after such Amendments come into force, toCAN$800 million in the following two years and then to CAN$1 billionfor the next two years. Thereafter, the thresholds are to be adjusted toaccount for inflation. A number of the Amendments still require additionaldefinition and details, which will be set forth in regulations promulgatedunder the Investment Act.

 

There are no limits on the rights of non-Canadians toexercise voting rights on their common shares of the Company.

 

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### ***C.            Material contracts***

### *** ***

Otherthan as disclosed herein under “Shareholder Rights Plan” and below, and exceptfor contracts entered into in the ordinary course of business, there are nomaterial contracts to which the Company or any of its subsidiaries is a party otherthan the employment agreements and change of control agreements with ourexecutive officers as described below.

 

**Employment Agreements**

 

TheCompany and/or its subsidiaries have entered into employment agreements(the “Employment Agreements”) with each of the Named Executive Officers.The Employment Agreements provide that we will pay the Named Executive Officersa base salary and an annual bonus and that such executives will be eligible toreceive grants of stock options which will be reviewed annually in accordancewith our policies. The Employment Agreements have an indefinite term. However,in addition to his Employment Agreement, Dr. Engel had previously enteredinto a service contract in his prior capacity as Managing Director with ÆternaZentaris GmbH, our principal subsidiary, which service contract expires on August 31,2010.Each of the Employment Agreements provides that, if we terminate theemployment of a Named Executive Officer without cause, then the executive willbe entitled to receive, in the case of Dr. Engel, a lumpsum payment, lessstatutory deductions, of the equivalent of twelve months of his then applicablebase salary, an amount equivalent to the annual bonus received for the mostrecently completed year and an amount equivalent to twelve months of the costof the other benefits to which he is entitled (such amounts increasing to theequivalent of 24 months of his then applicable base salary and twice his annualbonus received for the last completed year, commencing in March 2010). Inthe case of Mr. Turpin, the lump sum will be equivalent to 18 monthsof his then applicable base salary, 1.5 times the annual bonus of the precedingyear and 18 months of the value of the other benefits to which he is entitled.In the case of Dr. Blake and Messrs. Pelliccione and Seeber, they areentitled to receive, upon termination of employment without cause, a lump sumequivalent to twelve months of their then applicable base salaries, an amountequivalent to the annual bonus received for the preceding year and twelvemonths of the value of the other benefits to which they are entitled.

 

Furthermore,each Named Executive Officer shall not, directly or indirectly, solicit any ofour customers for the purpose or intent of selling them any products which aresimilar or otherwise competing with our products; nor shall any Named ExecutiveOfficer induce, entice or otherwise attempt to directly or indirectly hire orengage any of our employees, for a period equal to one year following suchexecutive’s termination of employment with the Company.

 

Pursuantto the Employment Agreements, each of the Named Executive Officers is alsoentitled to certain payments (the “Change of Control Payments”) in the event (i) a“Change of Control” occurs and (ii) during the twelve-month periodfollowing the Change of Control, either the Company terminates the employmentof the executive “without Cause” or if the executive terminates his or heremployment “for Good Reason”.

 

TheChange of Control Payments are as follows:

 

·                  for Dr. Engel and Mr. Seeber,(i) the equivalent of 24 months of their then prevailing annual basesalaries, (ii) an amount equivalent to twice the annual bonus, if any,which the executive would have been entitled to receive in the year duringwhich the Change of Control occurred, and (iii) an amount equivalent to 24months of the value of the benefits which were in force at the time oftermination of the executive’s employment, calculated on a yearly basis,including car allowance, but excluding operating costs; and

 

·                  for Mr. Turpin, the Change of Control Payment would be the same asin the context of a termination of employment described above, except that the1.5 multiple of his bonus payment would be based on his potential bonus for theyear in which the Change of Control occurs as opposed to his actual bonusreceived for the preceding financial year; and

 

·                  for Dr. Blake and Mr. Pelliccione(i) the equivalent of 18 months of their then prevailing annual basesalaries, (ii) an amount equivalent to 1.5 times the annual bonus, if any,which the executive would have been entitled to receive in the year duringwhich the Change of Control occurred, and (iii) an amount equivalent to 18months of the value of the benefits which were in force at the time oftermination of the executive’s employment, calculated on a yearly basis,including car allowance, but excluding operating costs.

 

AllChange of Control Payments described above are subject to applicable statutorywithholdings. In addition, any outstanding stock options held by a NamedExecutive Officer are unaffected by the change of control provisions includedin the Employment Agreements and, in the event of a Change of Control followedby termination of employment within twelve months, such stock options will betreated in accordance with the applicable provisions of the Stock Option Plandescribed elsewhere in this annual report.

 

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Forthe purposes of the Employment Agreements (including the annexes and schedulesthereto):

 

·                  a “Change of Control” shallbe deemed to have occurred in any of the following circumstances: (i) subjectto certain exceptions, upon the acquisition by a person (or one or more personswho are affiliates of one another or who are acting jointly or in concert) of abeneficial interest in securities of the Company representing in anycircumstance 50% or more of the voting rights attaching to the then outstandingsecurities of the Company; (ii) upon a sale or other disposition of all orsubstantially all of the Company’s assets; (iii) upon a plan ofliquidation or dissolution of the Company; or (iv) if, for any reason,including an amalgamation, merger or consolidation of the Company with or intoanother company, the individuals who, as at the date of the relevant EmploymentAgreement, constituted the Board (and any new directors whose appointment bythe Board or whose nomination for election by the Company’s shareholders wasapproved by a vote of at least two-thirds of the directors then still in officewho either were directors as at the date of the relevant Employment Agreementor whose appointment or nomination for election was previously so approved)cease to constitute a majority of the members of the Board;

 

·                  termination of employmentby the Company “for Cause” includes (but is not limited to) (i) if theExecutive commits any fraud, theft, embezzlement or other criminal act of asimilar nature, and (ii) if the Executive is guilty of serious misconductor willful negligence in the performance of his duties; and

 

·                  termination of employmentby the executive officer for “Good Reason” means the occurrence, without theexecutive’s express written consent, of any of the following acts: (i) amaterial reduction of the executive’s total compensation (including annual basesalary plus annual bonus, benefits and number of stock options) as in effect onthe date of the relevant Employment Agreement or as same may be increased fromtime to time; (ii) a material reduction or change in the executive’sduties, authority, responsibilities, accountability or a change in the businessor corporate structure of the Company which materially affects his or herauthority, compensation or ability to perform duties or responsibilities (suchas shifting from a policy-making to a policy-implementation position); (iii) aforced relocation; or (iv) a material change in the terms and conditionsof the change of control provisions included in the relevant EmploymentAgreement.

 

**Other Material Contracts**

 

We are party to a license and collaborationagreement with Keryx. Under the terms of this agreement, Keryx undertakes, atits own cost, all development activities necessary to obtain regulatory andmarketing approvals of perifosine, a signal transduction inhibitor, for alluses in the United States, Canada and Mexico. The agreement provides for, amongother things, the availability of data generated by both parties free ofcharge. In September 2002, we received an upfront payment of approximately$0.5 million and are eligible to receive payments of up to an aggregate of$18.3 million upon Keryx’s successful achievement of clinical development andregulatory milestones, in addition to scale-up royalties (from high single tolow double-digit) on future net sales in the United States, Canada and Mexico.

 

InNovember 2008, we signed a definitive agreement to sell to CHRP our rightsto royalties on future sales of Cetrotide® covered by ourlicense agreement with Merck Serono. This license agreement was signed in 2000and granted Merck Serono exclusive rights to market, distribute and sellCetrotide® worldwide, with the exception of Japan, in the field of *in vitro*fertilization. On closing, wereceived $52.5 million from CHRP (less transaction costs of $1.0 million) and,contingent on 2010 net sales of Cetrotide® reaching a specifiedlevel, we would receive an additional payment of $2.5 million from CHRP. Underthe terms of the agreement, if cetrorelix is approved for sale by the Europeanregulatory authorities in an indication other than *in vitro* fertilization, we have agreed to make a one-timecash payment to CHRP in an amount ranging from $5 million up to $15 million.

 

### ***D.            Exchange controls***

### *** ***

Canada has no system of exchange controls. There areno exchange restrictions on borrowing from foreign countries or on theremittance of dividends, interest, royalties and similar payments, managementfees, loan repayments, settlement of trade debts or the repatriation ofcapital.

 

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***E.            Taxation***

 

THEFOLLOWING SUMMARY IS OF A GENERAL NATURE ONLY AND IS NOT INTENDED TO BE, NORSHOULD IT BE CONSTRUED TO BE, LEGAL OR TAX ADVICE TO ANY PARTICULARHOLDER.  CONSEQUENTLY, HOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORSFOR ADVICE AS TO THE TAX CONSEQUENCES OF AN INVESTMENT IN THE COMMON SHARESHAVING REGARD TO THEIR PARTICULAR CIRCUMSTANCES.

 

Thefollowing summary describes the principal Canadian federal income taxconsequences to a purchaser who acquires common shares (a “holder”) who, forthe purposes of the Canadian federal Income Tax Act, R.S.C. 1985, as amended(the “Tax Act”), deals at arm’s length with, and is not affiliated with, theCorporation and holds their common shares as capital property.  Commonshares will generally be considered to be capital property for purposes of theTax Act unless either the holder holds such common shares in the course ofcarrying on a business, or the holder has held or acquired such common sharesin a transaction or transactions considered to be an adventure in the nature oftrade.

 

Thissummary is not applicable to a holder an interest in which is a “tax shelterinvestment” as defined in the Tax Act, or to a holder which is a “financialinstitution” as defined in the Tax Act subject to the “mark-to-market” rules setout therein.  Such holders should consult their own tax advisors.

 

Thissummary is based upon the current provisions of the Tax Act and the regulationsthereunder (the “Regulations”) and the Company’s understanding of the currentpublished administrative practices and policies of the Canada Revenue Agency(“CRA”).  It also takes into account all proposed amendments to the TaxAct and the Regulations publicly released by the Minister of Finance (Canada)(“Tax Proposals”) prior to the date hereof, and assumes that all such TaxProposals will be enacted as currently proposed.  No assurance can begiven that the Tax Proposals will be enacted in the form proposed or atall.  This summary does not otherwise take into account or anticipate anychanges in law, whether by way of legislative, judicial or administrativeaction or interpretation, nor does it address any provincial, local,territorial or foreign tax considerations.

 

HoldersNot Resident in Canada

 

Thefollowing discussion applies to a holder of common shares who, at all relevanttimes, for purposes of the Tax Act and any applicable income tax treaty orconvention, is neither resident nor deemed to be resident in Canada and doesnot, and is not deemed to, use or hold common shares in carrying on a businessor part of a business in Canada (a “Non-Resident holder”).  In addition,this discussion does not apply to an insurer who carries on an insurancebusiness in Canada and elsewhere or to an authorized foreign bank (as definedin the Tax Act).

 

Dispositionof Common Shares

 

ANon-Resident holder will not be subject to tax under the Tax Act in respect ofany capital gain realized by such Non-Resident holder on a disposition ofcommon shares unless such shares constitute “taxable Canadian property” (asdefined in the Tax Act) of the Non-Resident holder at the time of dispositionand the holder is not entitled to relief under an applicable income tax treatyor convention.  As long as the common shares are then listed on a“designated stock exchange” (which currently includes the NASDAQ and the TSX),the common shares generally will not constitute taxable Canadian property of aNon-Resident holder, unless at any time during the 60-month period immediatelypreceding the disposition, the Non-Resident holder, persons with whom theNon-Resident holder did not deal at arm’s length, or the Non-Resident holdertogether with all such persons, owned 25% or more of the issued shares of anyclass or series of shares of the capital stock of the Company.

 

UnderTax Proposals announced by the Minister of Finance on March 4, 2010,common shares will generally not constitute taxable Canadian property to aNon-Resident holder at a particular time provided that (a) the commonshares are listed on a designated stock exchange and (b) during the60-month period that ends at the time the common shares are disposed of, both (i) 25%or more of the issued shares of any class or series of shares of the Company were not owned by and didnot belong to one or any combination of the Non-Resident holder and personswith whom the Non-Resident holder did not deal at arm’s length, and (ii) notmore than 50% of the fair market value of the common shares was deriveddirectly or indirectly from real or immovable property situated in Canada,Canadian resource properties, timber resource properties and options in respectof, interests in or rights in such properties, whether or not the propertyexists.

 

Ifthe common shares were to cease being listed on the NASDAQ, the TSX or another“recognized stock exchange”, a Non-Resident holder who disposes of commonshares that are taxable Canadian property may be required to fulfill therequirements of section 116 of the Tax Act. An exemption from such requirementsis available on the disposition of “treaty-

 

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protectedproperty”, which is property any income or gain on the disposition of which isexempt from tax under Part I of the Tax Act as a result of an applicableincome tax treaty or convention.

 

Taxationof Dividends on Common Shares

 

Dividendspaid or credited or deemed to be paid or credited on the common shares to aNon-Resident holder will be subject to Canadian withholding tax in the amountof 25%.  Such withholding tax may be reduced by virtue of the provisionsof an income tax treaty or convention between Canada and the country of whichthe Non-Resident holder is a resident.  Under the Canada-United StatesIncome Tax Convention (the “Convention”), the rate of withholding tax in respectof dividends or deemed dividends beneficially owned by a resident of the UnitedStates entitled to the benefits of the Convention is generally reduced to 15%.

 

HoldersResident in Canada

 

Thefollowing discussion applies to a holder of common shares who, at all relevanttimes, for purposes of the Tax Act and any applicable income tax treaty orconvention, is or is deemed to be resident in Canada (a “Canadianholder”).  Certain Canadian holders whose common shares might nototherwise qualify as capital property may, in certain circumstances, treat thecommon shares and every other “Canadian security” (as defined in the Tax Act)owned by the Canadian holder as capital property by making an irrevocableelection provided by subsection 39(4) of the Tax Act.

 

Taxationof Dividends on Common Shares

 

Dividendsreceived or deemed to be received on the common shares will be included in aCanadian holder’s income for purposes of the Tax Act.  Such dividendsreceived or deemed to be received by a Canadian holder that is an individual(other than certain trusts) will be subject to the gross-up and dividend taxcredit rules generally applicable under the Tax Act in respect ofdividends received on shares of taxable Canadian corporations.  Generally,a dividend will be eligible for the enhanced gross-up and dividend tax creditif the recipient receives written notice from the corporation designating thedividend as an “eligible dividend” (within the meaning of the Tax Act). There may be limitations on the ability of the Company to designate dividends aseligible dividends.  A Canadian holder that is a corporation will berequired to include such dividends in computing its income and will generallybe entitled to deduct the amount of such dividends in computing its taxable income. A Canadian holder that is a “private corporation” or a “subject corporation”(as such terms are defined in the Tax Act), may be liable under Part IV ofthe Tax Act to pay a refundable tax of 33 1/3% on dividends received or deemedto be received on the common shares to the extent such dividends are deductiblein computing the holder’s taxable income.

 

Dispositionof Common Shares

 

Adisposition, or a deemed disposition, of a common share by a Canadian holderwill generally give rise to a capital gain (or a capital loss) equal to theamount by which the proceeds of disposition of the share, net of any reasonablecosts of disposition, exceed (or are less than) the adjusted cost base of theshare to the holder.  Such capital gain (or capital loss) will be subjectto the treatment described below under “Taxation of Capital Gains and CapitalLosses”.

 

AdditionalRefundable Tax

 

ACanadian holder that is a “Canadian-controlled private corporation” (as suchterm is defined in the Tax Act) may be liable to pay an additional refundabletax of 6 2/3% on certain investment income including amounts in respect of“Taxable Capital Gains”, as defined below.

 

Taxationof Capital Gains and Capital Losses

 

Ingeneral, one half of any capital gain (a “Taxable Capital Gain”) realized by aCanadian holder in a taxation year will be included in the holder’s income inthe year.  Subject to and in accordance with the provisions of the TaxAct, one half of any capital loss (an “Allowable Capital Loss”) realized by aCanadian holder in a taxation year must be deducted from Taxable Capital Gainsrealized by the holder in the year and Allowable Capital Losses in excess ofTaxable Capital Gains may be carried back and deducted in any of the threepreceding taxation years or carried forward and deducted in any subsequenttaxation year against net Taxable Capital Gains realized in such years. The amount of any capital loss realized by a Canadian holder that is acorporation on the disposition of a common share may be reduced by the amount ofdividends received or deemed to be received by it on such common share (or on ashare for which the common share has been substituted) to the extent and underthe circumstances prescribed by the Tax Act.  Similar rules may applywhere a corporation is a member of a partnership or a beneficiary of a trustthat owns common shares, directly or indirectly, through a partnership or atrust.  A 

 

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TaxableCapital Gain realized by a Canadian holder who is an individual may give riseto liability for alternative minimum tax.

 

Certain U.S. Federal Income Tax Considerations

 

Thefollowing discussion is a summary of certain U.S. federal income taxconsequences applicable to the ownership and disposition of common shares(“Shares”) by a U.S. Holder (as defined below), but does not purport to be acomplete analysis of all potential U.S. federal income tax effects. This summaryis based on the Internal Revenue Code of 1986, as amended (the “Code”), U.S.Treasury regulations promulgated thereunder, Internal Revenue Service (“IRS”)rulings and judicial decisions in effect on the date hereof. All of these aresubject to change, possibly with retroactive effect, or differentinterpretations.

 

Thissummary does not address all aspects of U.S. federal income taxation that maybe relevant to particular U.S. Holders in light of their specific circumstances(for example, U.S. Holders subject to the alternative minimum tax provisions ofthe Code) or to holders that may be subject to special rules under U.S.federal income tax law. This summary also does not address the tax consequencesof holding, exercising or disposing of warrants in the Company. If the Companyis a “passive foreign investment company” (“PFIC”), as defined below, U.S.Holders of its warrants will be subject to adverse tax rules and will notbe able to make the mark-to-market or the QEF election described below withrespect to such warrants. U.S. Holders of warrants should consult their taxadvisors with regard to the U.S. federal income tax consequences of holding,exercising or disposing of warrants in the Company, including in the situationin which the Company is classified as a PFIC.

 

Thissummary also does not discuss any aspect of state, local or foreign law, orU.S. federal estate or gift tax law as applicable to U.S. Holders. U.S. Holdersshould consult their tax advisors about the potential application of such laws andthe application of the U.S. federal income tax rules summarized below totheir particular situation. In addition, this discussion is limited to U.S.Holders holding Shares as capital assets. For purposes of this summary, “U.S.Holder” means a beneficial holder of Shares who or that for U.S. federal incometax purposes is:

 

·                  an individual citizen orresident of the United States;

·                  a corporation or otherentity classified as a corporation for U.S. federal income tax purposes createdor organized in or under the laws of the United States, any state thereof orthe District of Columbia;

·                  an estate, the income ofwhich is subject to U.S. federal income taxation regardless of its source; or

·                  a trust, if a court withinthe United States is able to exercise primary supervision over theadministration of such trust and one or more “U.S. persons” (within the meaningof the Code) have the authority to control all substantial decisions of thetrust, or if a valid election is in effect for it to be treated as a U.S.person.

 

Ifa partnership or other entity or arrangement classified as a partnership forU.S. federal income tax purposes holds Shares, the U.S. federal income taxtreatment of a partner generally will depend on the status of the partner andthe activities of the partnership. This summary does not address the taxconsequences to any such partner. Such a partner should consult its own taxadvisor as to the tax consequences of the partnership owning and disposing ofShares.

 

***Dividends***

 

Subjectto the PFIC rules discussed below, any distributions paid by the Companyout of current or accumulated earnings and profits (as determined for U.S.federal income tax purposes), before reduction for any Canadian withholding taxpaid with respect thereto, will generally be taxable to a U.S. Holder asforeign source dividend income, and will not be eligible for the dividendsreceived deduction generally allowed to corporations. Distributions in excessof current and accumulated earnings and profits will be treated as anon-taxable return of capital to the extent of the U.S. Holder’s adjusted taxbasis in the Shares and thereafter as capital gain. U.S. Holders should consulttheir own tax advisors with respect to the appropriate U.S. federal income taxtreatment of any distribution received from the Company.

 

Fortaxable years beginning before January 1, 2011, dividends paid by theCompany should be taxable to a non-corporate U.S. Holder at the special reducedrate normally applicable to long term capital gains, provided that certainconditions are satisfied. A U.S. Holder will not be able to claim the reducedrate if the Company is treated as a PFIC for the taxable year in which adividend is paid or the preceding year. See “Passive Foreign Investment CompanyConsiderations” below.

 

Undercurrent law payments of dividends by the Company to non-Canadian investors aregenerally subject to a 25 percent Canadian withholding tax. The rate ofwithholding tax applicable to U.S. Holders that are eligible for benefits underthe Canada-United States Tax Convention (1980) (“the Treaty”) is reduced to amaximum of 15%. This reduced rate of 

 

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withholdingwill not apply if the dividends received by a U.S. Holder are effectivelyconnected with a permanent establishment of the U.S. Holder in Canada.

 

Dividends paid inCanadian dollars will be included in income in a U.S. dollar amount calculatedby reference to the exchange rate in effect on the day the dividends are receivedby the U.S. Holder, regardless of whether the Canadian dollars are convertedinto U.S. dollars at that time. Gain or loss, if any, realized on a sale orother disposition of the Canadian dollars will generally be U.S. sourceordinary income or loss to a U.S. Holder.

 

AU.S. Holder will generally be entitled, subject to certain limitations, to acredit against its U.S. federal income tax liability, or a deduction incomputing its U.S. federal taxable income, for Canadian income taxes withheldby the Company. U.S. Holders should consult their tax advisors concerning theforeign tax credit implications of the payment of Canadian taxes.

 

TheCompany generally does not pay any dividends and does not anticipate paying anydividends in the foreseeable future.

 

***Sale or Other Taxable Disposition***

 

Subjectto the PFIC rules discussed below, upon a sale or other taxabledisposition of Shares, a U.S. Holder generally will recognize capital gain orloss for U.S. federal income tax purposes equal to the difference, if any,between the amount realized on the sale or other taxable disposition and theU.S. Holder’s adjusted tax basis in the Shares.

 

Thiscapital gain or loss will be long-term capital gain or loss if the U.S.Holder’s holding period in the Shares exceeds one year. For taxable yearsbeginning before January 1, 2011, the rates of taxation for long-termcapital gains of non-corporate U.S. Holders are reduced as compared tosuch rates thereafter. The deductibility of capital losses is subject tolimitations. Any gain or loss will generally be U.S. source for U.S. foreigntax credit purposes.

 

***Passive Foreign Investment CompanyConsiderations***

 

Aforeign corporation will be classified as a PFIC for any taxable year in which,after taking into account the income and assets of the corporation and certainsubsidiaries pursuant to applicable “look-through rules,” either (i) atleast 75% of its gross income is “passive income” or (ii) at least 50% ofthe average value of its assets is attributable to assets which produce passiveincome or are held for the production of passive income.

 

TheCompany believes it was not a PFIC for the 2009 taxable year. However, sincethe fair market value of the Company’s assets may be determined in large partby the market price of the Shares, which is likely to fluctuate, and thecomposition of the Company’s income and assets will be affected by how, and howquickly, the Company spends any cash that is raised in any financingtransaction, no assurance can be provided that the Company would not beclassified as a PFIC for the 2010 taxable year and for any future taxable year.

 

Ifthe Company is classified as a PFIC for any taxable year during which a U.S.Holder owns Shares, the U.S. Holder, absent certain elections (including themark-to-market election described below), will generally be subject to adverse rules (regardlessof whether the Company continues to be classified as a PFIC) with respect to (i) any“excess distributions” (generally, any distributions received by the U.S.Holder on the Shares in a taxable year that are greater than 125% of theaverage annual distributions received by the U.S. Holder in the three precedingtaxable years or, if shorter, the U.S. Holder’s holding period for the Shares)and (ii) any gain realized on the sale or other disposition of Shares.

 

Underthese adverse rules (a) the excess distribution or gain will beallocated rateably over the U.S. Holder’s holding period, (b) the amountallocated to the current taxable year and any taxable year prior to the firsttaxable year in which the Company is classified as a PFIC will be taxed asordinary income, and (c) the amount allocated to each of the other taxableyears during which the Company was classified as a PFIC will be subject to taxat the highest rate of tax in effect for the applicable class of taxpayer forthat year and an interest charge will be imposed with respect to the resultingtax attributable to each such other taxable year.

 

U.S.Holders can avoid the interest charge described above by making a mark-to-marketelection with respect to the Shares, provided that the Shares are “marketable.”Shares will be marketable if they are regularly traded on a qualified exchangeor other market. For this purpose, Shares generally will be considered to beregularly traded during any calendar year during which they are traded, otherthan in *de minimis* quantities, on at least 15days during each calendar quarter. The Shares are currently listed andregularly traded on NASDAQ, which constitutes a qualified exchange.

 

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AU.S. Holder that makes a mark-to-market election must include in gross income,as ordinary income, for each taxable year an amount equal to the excess, ifany, of the fair market value of the Shares at the close of the taxable yearover the U.S. Holder’s adjusted tax basis in the Shares. An electing U.S.Holder may also claim an ordinary loss deduction for the excess, if any, of theU.S. Holder’s adjusted tax basis in the Shares over the fair market value ofthe Shares at the close of the taxable year, but this deduction is allowableonly to the extent of any net mark-to-market gains for prior taxable years. A U.S.Holder that makes a mark-to-market election generally will adjust such U.S.Holder’s tax basis in the Shares to reflect the amount included in gross incomeor allowed as a deduction because of such mark-to-market election. Gains fromthe actual sale or other disposition of the Shares will be treated as ordinaryincome, and any losses incurred on a sale or other disposition of Shares willbe treated as ordinary loss to the extent of any net mark-to-market gains forprior taxable years.

 

Amark-to-market election will be effective for the taxable year for which theelection is made and all subsequent taxable years. The election cannot berevoked without the consent of the IRS unless the Shares cease to bemarketable, in which case the election is automatically terminated. If theCompany is classified as a PFIC for any taxable year in which a U.S. Holderowns Shares but before a mark-to-market election is made, the interest charge rules describedabove will apply to any mark-to-market gain recognized in the year the electionis made.

 

Insome cases, a shareholder of a PFIC can avoid the interest charge and otheradverse PFIC consequences described above by making a qualified electing fund(“QEF”) election to be taxed currently on its share of the PFIC’s undistributedincome. If the Company is classified as a PFIC, it does not, however, expect toprovide to U.S. Holders the information regarding its income that would benecessary in order for a U.S. Holder to make a QEF election with respect toShares.

 

Ifthe Company is classified as a PFIC, a U.S. Holder of Shares will generally betreated as owning stock owned by the Company in any direct or indirectsubsidiaries that are also PFICs and will be subject to similar adverse rules withrespect to distributions to the Company by, and dispositions by the Company ofthe stock of such subsidiaries.  Amark-to-market election is not permitted for the shares of any subsidiary ofthe Company that is also classified as a PFIC.

 

Ifthe Company is classified as a PFIC and then ceases to be so classified, a U.S.Holder may make an election (a “deemed sale election”) to be treated for U.S.federal income tax purposes as having sold such U.S. Holder’s Shares on thelast day of the taxable year of the Company during which it was a PFIC. A U.S.Holder that made a deemed sale election would then cease to be treated asowning a stock in a PFIC by reason of ownership of Shares in the Company.However, gain recognized as a result of making the deemed sale election wouldbe subject to the adverse rules described above.

 

Under recently enacted U.S. tax legislation and subject to futureguidance, if the Company is a PFIC, U.S. Holders will be required to file, forreturns due after March 18, 2010, an annual information return with the IRSrelating to their ownership of Shares. Although expected, no guidance has yet been issued about such return,including on the information required to be reported on such return, the formof the return, or the due date for the return.

 

U.S.Holders should consult their tax advisors regarding the potential applicationof the PFIC regime and any reporting obligations to which they may be subjectunder that regime.

 

***Information Reporting and BackupWithholding***

 

The proceeds of a sale or other disposition, aswell as dividends paid with respect to Shares by a U.S. payor, generally willbe reported to the IRS and to the U.S. Holder as required under applicableregulations. Backup withholding tax may apply to these payments if the U.S.Holder fails to timely provide in the appropriate manner an accurate taxpayeridentification number or otherwise fails to comply with, or establish anexemption from, such backup withholding tax requirements. Certain U.S. Holders(including, among others, corporations) are not subject to the informationreporting or backup withholding tax requirements described herein. U.S. Holdersshould consult their tax advisors as to their qualification for exemption frombackup withholding tax and the procedure for obtaining an exemption.

 

Backup withholding is not an additional tax. U.S.Holders generally will be allowed a refund or credit against their U.S. federalincome tax liability for amounts withheld, provided the required information istimely furnished to the IRS.

 

Subject to specified exceptions and futureguidance, recently enacted U.S. tax legislation generally requires a U.S. Holder (that is an individual or, to theextent provided in future guidance, a domestic entity) to report to theIRS such U.S. Holder’s interests in stock or securities issued by a non-U.S.person (such as the Company) for taxable years beginning after March 18,2010. Although expected, no guidance on this reporting requirement has yet beenissued. U.S. Holders should consult their tax advisors regarding the information reporting obligations that may arisefrom their acquisition, ownershipor disposition of Shares.

 

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### ***F.            Dividends and paying agents***

### *** ***

Not applicable.

 

### ***G.            Statement by experts***

### *** ***

Not applicable.

 

### ***H.            Documents on display***

### *** ***

In addition to placing our audited comparativeannual financial statements before every annual meeting of shareholders asdescribed above, we are subject to the information requirements of theSecurities Exchange Act of 1934, as amended. In accordance with theserequirements, we file and furnish reports and other information with the SEC.These materials, including this annual report on Form 20-F and theexhibits thereto, may be inspected and copied at the SEC’s Public Reference Room at100 F Street, N.E., Room 1580, Washington, D.C. 20549. The public mayobtain information on the operation of the SEC’s Public Reference Room bycalling the SEC in the United States at 1-800-SEC-0330. The SEC also maintainsa website at www.sec.gov that contains reports, proxy statements and otherinformation regarding registrants that file electronically with the SEC. TheCompany’s annual reports and some of the other information submitted by theCompany to the SEC may be accessed through this website. In addition, materialfiled by the Company can be inspected on the Canadian SecuritiesAdministrators’ electronic filing system, SEDAR, accessible at the websitewww.sedar.com. This material includes the Company’s Management InformationCircular for its annual meeting to be held on May 13, 2010 to be furnishedto the SEC on Form 6-K, which provides information including directors’and officers’ remuneration and indebtedness and principal holders ofsecurities. Additional financial information is provided in our annualfinancial statements for the year ended December 31, 2009 and our MD&Arelating to these statements included elsewhere in this annual report. Thesedocuments are also accessible on SEDAR (www.sedar.com) and on EDGAR(www.sec.gov).

 

### ***I.             Subsidiary information***

### *** ***

The subsidiaries of the Company are set forth under“Item 4C. — Organizational Structure”.

 

## **Item 11.         Quantitative and Qualitative Disclosures About Market Risk**

## ** **

We have not entered into any forward currencycontracts or other financial derivatives to hedge foreign exchange risk and,therefore, we are subject to foreign currency transaction and translation gainsand losses.

 

**Fair value**

** **

The Company has establishedthe following classifications for its financial instruments:

 

·                  cash and cashequivalents and restricted cash (2009 only) are classified under “Assets Heldfor Trading”;

·                  short-terminvestments (2008 only) are classified under “Available-for-Sale Assets”;

·                  accountsreceivable are classified under “Loans and Receivables”; and

·                  accountspayable and accrued liabilities, long-term payable and other long-termliability are classified under “Other Financial Liabilities”.

 

The carrying values of allof the aforementioned financial instruments approximate their fair values dueto their short-term maturity or to the prevailing interest rates of theseinstruments, which are comparable to those of the market.

 

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** **

**Financial risk management**

 

Disclosures relating tothe nature and extent of the Company’s exposure to risks arising from financialinstruments, including credit risk, liquidity risk, foreign currency riskand interest rate risk, and how the Company manages those risks, are presentedbelow.

 

*a)**           **Creditrisk*

 

Creditrisk is the risk of an unexpected loss if a customer or counterparty to afinancial instrument fails to meet its contractual obligations. The Companyregularly monitors its credit risk exposure and takes steps to mitigate thelikelihood of these exposures from resulting in actual loss.

 

Financialinstruments that potentially subject the Company to concentrations of creditrisk consist primarily of cash and cash equivalents, restricted cash,short-term investments and accounts receivable. Cash and cash equivalents and restricted cash balances are maintainedwith high-credit quality financial institutions. Short-term investments (2008only) consist of notes issued by high-credit quality corporations andinstitutions. Also, any accounts receivable balances due to the Company thatare past due as at December 31, 2009 are insignificant, both individuallyand in the aggregate. Consequently, management considers the risk ofnon-performance related to cash and cash equivalents, restricted cash,short-term investments and accounts receivable to be minimal.

 

*b)**           **ForeignCurrency Risk*

 

Sincethe Company operates on an international scale, it is exposed to currency risksas a result of potential exchange rate fluctuations related to non-intragrouptransactions. Fluctuations in the US dollar and the EUR exchange rates couldhave a potentially significant impact on the Company’s results ofoperations.  The following variations are reasonably possible over a12-month period:

 

·                  Foreign exchange rate variation of -5%(depreciation of the EUR) and +5%(appreciation of the EUR) against the US$, from a period-end rate of EUR1.00 =US$1.4272.

 

Ifthese variations were to occur, the impact on the Company’s consolidated netloss for each category of financial instruments held at December 31, 2009would be as follows:

** **
| ** **                                                       | ** ** | **Carrying** | ** ** | **Balances denominated********in US$** | ** ** |
|------------------------------------------------------------------|------------|--------------|------------|----------------------------------------|------------|
| **(in thousands)**                                               | ** ** | **amount**   | ** ** | **-5%**                                | ** ** | **+5%** | ** ** |
| ** **                                                       | ** ** | **$**        | ** ** | **$**                                  | ** ** | **$** | ** ** |
| **Assets**                                                       |       |         |       |                                   |       |   |   |
| Cash and cash equivalents                                        |       | 27,244       | ** ** | **1,362**                              | ** ** | **(1,362** | **)** |
| **Total impact on consolidated  net loss - (increase)/decrease** | ** ** | ** **   | ** ** | **1,362**                              | ** ** | **(1,362** | **)** |

 

*c)**            **Liquidityrisk*

 

Liquidityrisk is the risk that the Company will not be able to meet its financialobligations as they become due. The Company manages liquidity risk through themanagement of its capital structure and financial leverage. The Company alsomanages liquidity risk by continuously monitoring actual and projected cashflow. The Board of Directors reviews and approves the Company’s operating andcapital budgets, and reviews any material transactions outside of the normalcourse of business.

 

TheCompany’s investment policy ensures the safety and preservation of itsprincipal, as outlined above, to ensure the Company’s liquidity needs are met.

 

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## **Item 12.         Description of Securities Other than Equity Securities**

## ** **

### ***A.            Debt securities***

### *** ***

Not applicable.

 

### ***B.            Warrants and rights***

### *** ***

Not applicable.

 

### ***C.            Other securities***

### *** ***

Not applicable.

 

### ***D.            American depositary shares***

### *** ***

Not applicable.

 

**PART II**

** **

## **Item 13.         Defaults, Dividend Arrearages and Delinquencies**

## ** **

None.

 

## **Item 14.         Material Modification to the Rights of Security Holders andUse of Proceeds**

## ** **

None.

 

## **Item 15.         Controls and Procedures**

## ** **

Underthe supervision and with the participation of the Registrant’s management,including the Chief Executive Officer and Chief Financial Officer, we haveevaluated the effectiveness of our disclosure controls and procedures as at December 31,2009. Based on that evaluation, the Chief Executive Officer and Chief FinancialOfficer have concluded that these disclosure controls and procedures wereeffective as at December 31, 2009.

 

**Management’s Annual Report on Internal Control overFinancial Reporting**

 

TheRegistrant’s management is responsible for establishing and maintainingadequate internal control over financial reporting. The Registrant’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with GAAP.

 

TheRegistrant’s internal control over financial reporting includes those policiesand procedures that: (i) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the Registrant’s assets; (ii) provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with GAAP, and that receipts and expenditures of theRegistrant are being made only in accordance with authorizations of theRegistrant’s management; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof the Registrant’s assets that could have a material effect on the financialstatements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

Managementconducted an evaluation of the effectiveness of the Registrant’s internalcontrol over financial reporting based on the criteria established in InternalControl — Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission. Based on this evaluation, managementconcluded that the Registrant’s internal control over financial reporting waseffective as at December 31, 2009.

 

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**AttestationReport of the Independent Auditors**

 

See the report of PricewaterhouseCoopers LLP includedunder Item 18, “Financial Statements”.

 

**Changes in Internal Control over Financial Reporting**

 

Therehave been no changes in our internal control over financial reporting duringthe year ended December 31, 2009 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

## **Item 16.         [Reserved]**

## ** **

## **Item 16A.      Audit Committee Financial Expert**

## ** **

TheBoard of the Registrant has determined that the Registrant has at least oneaudit committee financial expert (as defined in paragraph (b) of Item 16Ato Form 20-F). The name of the audit committee financial expert of theRegistrant is Mr. Gérard Limoges, FCA, the Audit Committee’sChairman. The Commission has indicated that the designation of Mr. Limogesas the audit committee financial expert of the Registrant does not: (i) makeMr. Limoges an “expert” for any purpose, including without limitation forpurposes of Section 11 of the Securities Act of 1933, as amended, as aresult of this designation; (ii) impose any duties, obligations orliability on Mr. Limoges that are greater than those imposed on him as amember of the Audit Committee and the Board in the absence of such designation;or (iii) affect the duties, obligations or liability of any other memberof the Audit Committee or the Board. The other members of the Audit committeeare Ms. Martha Byorum and Mr. Pierre MacDonald, each of whom, alongwith Mr. Limoges, is independent, as that term is defined in the NASDAQlisting standards. For a description of their respective education andexperience, please refer to “Item 6. — Directors, Senior Management andEmployees”.

 

## **Item 16B.      Code of Ethics**

## ** **

OnMarch 29, 2004, the Board adopted a “Code of Ethical Conduct”, which hasbeen amended by the Board on November 3, 2004, December 13, 2005, March 2,2007 and March 10, 2009. The December 13, 2005 amendment incorporateschanges to the duty to report violations consistent with applicable laws. TheRegistrant has selected an independent third party supplier to provide aconfidential and anonymous communication channel for reporting concerns aboutpossible violations to the Registrant’s Code of Ethical Conduct as well asfinancial and/or accounting irregularities or fraud. A copy of the Code ofEthical Conduct, as amended, is attached as Exhibit 11.1 to this annualreport and is also available on the Registrant’s Web site at www.aezsinc.comunder the Investors — Governance tab. The Code of Ethical Conduct is a “code ofethics” as defined in paragraph (b) of Item 16B to Form 20-F. TheCode of Ethical Conduct applies to all of the Registrant’s employees, directorsand officers, including the Registrant’s principal executive officer, principalfinancial officer, and principal accounting officer or controller, or personsperforming similar functions, and includes specific provisions dealing withintegrity in accounting matters, conflicts of interest and compliance withapplicable laws and regulations. The Registrant will provide this documentwithout charge to any person or company upon request to the Corporate Secretaryof the Registrant, at its head office at 1405 du Parc-Technologique Boulevard,Quebec City, Quebec, G1P 4P5, Canada.

 

## **Item 16C.      Principal Accountant Fees and Services**

## ** **

*(All amounts are in US dollars)*

 

### ***A.            Audit Fees***

### *** ***

During the financial years ended December 31,2009 and 2008, the Registrant’s principal accountant, PricewaterhouseCoopersLLP, billed it aggregate amounts of $435,710 and $332,495, respectively, forthe audit of the Registrant’s annual consolidated financial statements andservices in connection with statutory and regulatory filings.

 

### ***B.            Audit-related Fees***

### *** ***

Duringthe financial years ended December 31, 2009 and 2008, the Registrant’s principalaccountant, PricewaterhouseCoopers LLP, billed it aggregate amounts of $44,485and $219,407, respectively, for audit or attest services not required bystatute or regulation, employee benefit plan audits, due diligence services,and accounting consultations on 

 

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proposedtransactions, including the review of prospectuses and the delivery ofcustomary consent and comfort letters in connection therewith.

 

### ***C.            Tax Fees***

### *** ***

Duringthe financial years ended December 31, 2009 and 2008, the Registrant’s principalaccountant, PricewaterhouseCoopers LLP, billed it aggregate amounts of $63,819and $96,017, respectively, for services related to tax compliance, tax planningand tax advice.

 

### ***D.            All Other Fees***

### *** ***

Duringthe financial years ended December 31, 2009 and 2008, the Registrant’s principalaccountant, Pricewaterhouse Coopers LLP, billed it aggregate amounts of $4,164and $12,962, respectively, for services not included in audit fees,audit-related fees and tax fees consisting primarily of fees fortranslation services.

 

### ***E.            Audit Committee Pre-ApprovalPolicies and Procedures***

### *** ***

Underapplicable Canadian securities regulations, the Registrant is required to disclosewhether its Audit Committee has adopted specific policies and procedures forthe engagement of non-audit services and to prepare a summary of these policiesand procedures. The Audit Committee Charter (filed as Exhibit 11.6 to thisannual report) provides that it is such committee’s responsibility to approveall audit engagement fees and terms as well as reviewing policies for theprovision of non-audit services by the external auditors and, when required,the framework for pre-approval of such services. The Audit Committee delegatesto its Chairman the pre-approval of such non-audit fees. The pre-approval bythe Chairman is then presented to the Audit Committee at its first scheduledmeeting following such pre-approval.

 

Foreach of the years ended December 31, 2009 and 2008, none of the non-auditservices provided by theRegistrant’s external auditor were approved by the AuditCommittee pursuant to the “de minimis exception” to the pre-approvalrequirement for non-audit services.

 

Duringthe financial year ended on December 31, 2009, only full-time permanentemployees of theRegistrant’s principal accountant, PricewaterhouseCoopers LLP,performed work to audit theRegistrant’s financial statements.

 

## **Item 16D.      Exemptions from the Listing Standards for Audit Committees**

## ** **

None.

 

## **Item 16E.       Purchases of Equity Securities by the Issuer and AffiliatedPurchasers**

## ** **

None.

 

## **Item 16F.       Changes in Registrant’s Certifying Accountant**

## ** **

None.

 

## **Item 16G.      Corporate Governance**

## ** **

TheRegistrant is in compliance with the corporate governance requirements of theNASDAQ except as described below. The Registrant is not in compliance with theNASDAQ requirement that a quorum for a meeting of the holders of the commonstock of the Registrant be no less than 33 1/3% of such outstanding shares. Theby-laws of the Registrant provide that a quorum for purposes of any meeting ofshareholders of the Registrant consists of at least 20% of the outstandingvoting shares. The Registrant received an exemption from NASDAQ from thisquorum requirement because the quorum provided for in the by-laws of theRegistrant is consistent with generally accepted business practices in Canada,the Registrant’s country of domicile, and with the TSX, the home countryexchange on which the Registrant’s voting shares are traded.

 

In addition, the Registrant follows certain of itshome country practices in lieu of compliance with the NASDAQ requirements that:(i) independent directors of the Registrant have regularly scheduledmeetings at which only independent directors are present (“executivesessions”); (ii) the compensation of the chief executive officer and theother executive officers of the Registrant be determined, or recommended to theRegistrant’s Board for determination, by a compensation committee comprisedsolely of independent directors; and (iii) the director nominees beselected, or recommended for 

 

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selection by the Registrant’s Board, by anominations committee comprised solely of independent directors. The Chairmanof the Board of the Registrant from time to time ensures that directors holdmeetings at which senior management is not present, and the Registrant’sCorporate Governance, Nominating and Human Resources Committee, which serves asthe Registrant’s compensation and nominations committee, is comprised of fourmembers, four of whom are independent directors. In accordance with applicablecurrent NASDAQ requirements, the Registrant has in the past provided to NASDAQletters from outside counsel certifying that these practices are not prohibitedby the Registrant’s home country law.

 

**PART III**

** **

## **Item 17.         Financial Statements**

## ** **

We have elected to providefinancial statements pursuant to Item 18.

 

## **Item 18.         Financial Statements**

## ** **

The financial statements appear on pages 120through 170.

 

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**ÆternaZentaris Inc.**

 

ConsolidatedFinancial Statements

December 31,2009, 2008 and 2007

(expressedin thousands of US dollars)

 

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**Independent Auditors’ Report**

 

**To theShareholders of**

**ÆternaZentaris Inc.**

 

We have completed integrated audits of Æterna ZentarisInc.’s 2009, 2008 and 2007 consolidated financial statements and of itsinternal control over financial reporting as at December 31, 2009. Ouropinions, based on our audits, are presented below.

 

**Consolidatedfinancial statements**

 

We have audited theaccompanying consolidated balance sheets of Æterna Zentaris Inc. as at December 31,2009 and 2008, and the related consolidated****statements ofoperations, comprehensive loss, accumulated other comprehensive income anddeficit, changes in shareholders’ equity and cash flows****foreach of the years in the three-year period ended December 31, 2009. Wehave also audited the financial statement schedules, Valuation and QualifyingAccounts and Export Sales, in Item 8.A. of this Annual Report on Form 20-F.These consolidated financial statements and financial statement schedules arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements and financialstatement schedules based on our audits.

 

We conducted our auditsof the Company’s financial statements in accordance with Canadian generallyaccepted auditing standards and the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform an audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit of financial statementsincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. A financial statement audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of the Company as at December 31,2009 and 2008 and the results of its operations and its cash flows for each ofthe years in the three-year period ended December 31, 2009****in accordance with Canadian generally accepted accountingprinciples. Furthermore, in our opinion, the financial statement schedules,Valuation and Qualifying Accounts and Export Sales, in Item 8.A. of this AnnualReport on Form 20-F present fairly, in all material respects, theinformation set forth therein when read in conjunction with the relatedconsolidated financial statements.

 

**Internalcontrol over financial reporting**

 

We have also auditedÆterna Zentaris Inc.’s internalcontrol over financial reporting as at December 31, 2009, based oncriteria established in *Internal Control -Integrated Framework issued by the Committee of Sponsoring Organizations of theTreadway Commission* (COSO). The Company’s management is responsiblefor maintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reportingincluded in “Management’s Annual Report on Internal Control over FinancialReporting” appearing on Page 116 of this Annual Report on Form 20-F.Our responsibility is to express an opinion on the Company’s internal controlover financial reporting based on our audit.

 

“PricewaterhouseCoopers”refers to PricewaterhouseCoopers LLP/s.r.l./s.e.n.c.r.l., an Ontario limitedliability partnership, or, as the context requires, the PricewaterhouseCoopersglobal network or other member firms of the network, each of which is aseparate legal entity.

 

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We conducted our audit ofinternal control over financial reporting in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether effective internal control over financial reporting was maintained inall material respects. An audit of internal control over financial reporting includesobtaining an understanding of internal control over financial reporting,assessing the risk that a material weakness exists, testing and evaluating thedesign and operating effectiveness of internal control based on the assessedrisk, and performing such other procedures as we consider necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

 

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (i) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

In our opinion, the Company maintained, in allmaterial respects, effective internal control over financial reporting as at December 31,2009****based on criteria established inInternal Control — Integrated Framework issued by the COSO.

 

 
|  |  

(1) |
|--|-------------|

 
|                                     |   |
|------------------------------------------|--------|
| Quebec City, Province  of Quebec, Canada |   |
| March 23, 2010                      |   |

 

----

(1) Charteredaccountant auditor permit No. 11070

 

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**ÆternaZentaris Inc.**

ConsolidatedBalance Sheets

(expressedin thousands of US dollars)

 
| ** **                                                   | ** ** | **As at December 31,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                   | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                                                   | ** ** | **$**                       | ** ** | **$** | ** ** |
| **ASSETS**                                                   |       |                        |       |   |   |
| **Current assets**                                           | ** ** | ** **                  |       |   |   |
| Cash  and cash equivalents                                   | ** ** | **38,100**                  |       | 49,226 |   |
| Short-term  investments                                      | ** ** | **—**                  |       | 493 |   |
| Accounts  receivable                                         | ** ** | ** **                  |       |   |   |
| Trade                                                        | ** ** | **2,444**                   |       | 3,425 |   |
| Other                                                        | ** ** | **992**                     |       | 1,100 |   |
| Income  taxes                                                | ** ** | **113**                     |       | 48 |   |
| Inventory  (note 9)                                          | ** ** | **4,415**                   |       | 3,385 |   |
| Prepaid  expenses and other current assets                   | ** ** | **2,949**                   |       | 4,047 |   |
|                                                         | ** ** | **49,013**                  |       | 61,724 |   |
| **Restricted cash**(note 10)                                 | ** ** | **878**                     |       | — |   |
| **Property, plant and equipment** (note 11)                  | ** ** | **4,358**                   |       | 6,682 |   |
| **Deferred charges and other long-term assets****(note 12)** | ** ** | **4,733**                   |       | 5,959 |   |
| **Intangible assets****(note 13)**                           | ** ** | **17,034**                  |       | 23,894 |   |
| **Goodwill****(note 14)**                                    | ** ** | **10,246**                  |       | 10,083 |   |
|                                                         | ** ** | **86,262**                  |       | 108,342 |   |
| **LIABILITIES**                                              | ** ** | ** **                  |       |   |   |
| **Current  liabilities**                                     | ** ** | ** **                  |       |   |   |
| Accounts  payable and accrued liabilities (note 15)          | ** ** | **11,919**                  |       | 13,690 |   |
| Income  taxes                                                | ** ** | **965**                     |       | 800 |   |
| Deferred  revenues                                           | ** ** | **6,327**                   |       | 7,631 |   |
| Current  portion of long-term payable (note 8)               | ** ** | **57**                      |       | 49 |   |
|                                                         | ** ** | **19,268**                  |       | 22,170 |   |
| **Deferred  revenues**                                       | ** ** | **45,919**                  |       | 54,433 |   |
| **Long-term  payable****(note 8)**                           | ** ** | **143**                     |       | 172 |   |
| **Employee future  benefits**  (note 16)                     | ** ** | **11,640**                  |       | 10,092 |   |
| **Other long-term  liability**                               | ** ** | **66**                      |       | — |   |
|                                                         | ** ** | **77,036**                  |       | 86,867 |   |
| **Commitments and  contingencies****(note 24)**              | ** ** | ** **                  |       |   |   |
| **SHAREHOLDERS’ EQUITY**                                | ** ** | ** **                  |       |   |   |
| **Share capital** (note 17)                                  | ** ** | **41,203**                  |       | 30,566 |   |
| **Warrants****(note 17)**                                    | ** ** | **2,899**                   |       | — |   |
| **Other capital**                                            | ** ** | **79,943**                  |       | 79,669 |   |
| **Deficit**                                                  | ** ** | **(127,538**                | **)**      | (102,814 | ) |
| **Accumulated other comprehensive income**                   | ** ** | **12,719**                  |       | 14,054 |   |
|                                                         | ** ** | **9,226**                   |       | 21,475 |   |
|                                                         | ** ** | **86,262**                  |       | 108,342 |   |
| Basis of presentation (note 2)                               | ** ** | ** **                  |       |   |   |
| Evaluation of going concern (note 2)                         | ** ** | ** **                  |       |   |   |

 

**Approved by the Board of Directors**

 
|                    |   |                          |
|--------------------|--------|--------------------------|
| Juergen Ernst, MBA |   | Gérard Limoges, FCA |
| Director           |   | Director                 |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**ÆternaZentaris Inc.**

ConsolidatedStatements of Changes in Shareholders’ Equity

Forthe years ended December 31, 2009, 2008 and 2007

(expressedin thousands of US dollars, except share data)

 
| ** **                                                                             | ** ** | **Common  shares** | ** ** | **Share  capital** | ** ** | **Warrants** | ** ** | **Other  capital** | ** ** | **Deficit**  | ** ** | **Accumulated  other  comprehensive  income** | ** ** | **Total**   | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|--------------|------------|--------------------|------------|--------------|------------|-----------------------------------------------|------------|-------------|------------|
| ** **                                                                             | ** ** | **(number of)**    | ** ** | **$**              | ** ** | **$**        | ** ** | **$**              | ** ** | **$**        | ** ** | **$**                                         | ** ** | **$**       | ** ** |
| **Balance — December 31, 2006**                                              | ** ** | **53,169,470**     | ** ** | **168,466**        | ** ** | **—**   | ** ** | **6,226**          | ** ** | **(10,114**  | **)**      | **14,301**                                    | ** ** | **178,879** | ** ** |
| Effect of the application of new accounting  standards                                 |       | —             |       | —             |       | —       |       | —             |       | (587         | )          | (41                                           | )          | (628        | )          |
| Distribution of Atrium (note 6)                                                   |       | —             |       | (137,959           | )          | —       |       | 71,122             |       | —       |       | (5,624                                        | )          | (72,461     | )          |
| Net loss for the year                                                                  |       | —             |       | —             |       | —       |       | —             |       | (32,296      | )          | —                                        |       | (32,296     | )          |
| Foreign currency translation adjustments                                               |       | —             |       | —             |       | —       |       | —             |       | —       |       | 13,783                                        |       | 13,783      |       |
| Variation in the fair value of short-term  investments, net of income taxes            |       | —             |       | —             |       | —       |       | —             |       | —       |       | 51                                            |       | 51          |       |
| Issuances pursuant to the stock option plan                                            |       |               |       |               |       |         |       |               |       |         |       |                                          |       |        |       |
| For cash (note 17)                                                                     |       | 18,000             |       | 33                 |       | —       |       | —             |       | —       |       | —                                        |       | 33          |       |
| Ascribed value from Other capital                                                      |       | —             |       | 26                 |       | —       |       | (26                | )          | —       |       | —                                        |       | —      |       |
| Disposal of shares of Echelon (note 7)                                            |       | —             |       | —             |       | —       |       | —             |       | —       |       | (754                                          | )          | (754        | )          |
| Stock-based compensation costs                                                         |       | —             |       | —             |       | —       |       | 1,984              |       | —       |       | —                                        |       | 1,984       |       |
| **Balance —  December 31, 2007**                                             | ** ** | **53,187,470**     | ** ** | **30,566**         | ** ** | **—**   | ** ** | **79,306**         | ** ** | **(42,997**  | **)**      | **21,716**                                    | ** ** | **88,591**  | ** ** |
| Net loss for the year                                                                  |       | —             |       | —             |       | —       |       | —             |       | (59,817      | )          | —                                        |       | (59,817     | )          |
| Foreign currency translation adjustments                                               |       | —             |       | —             |       | —       |       | —             |       | —       |       | (7,655                                        | )          | (7,655      | )          |
| Variation in the fair value of short-term  investments, net of income taxes            |       | —             |       | —             |       | —       |       | —             |       | —       |       | (7                                            | )          | (7          | )          |
| Stock-based compensation costs                                                         |       | —             |       | —             |       | —       |       | 363                |       | —       |       | —                                        |       | 363         |       |
| **Balance — December 31,  2008**                                             | ** ** | **53,187,470**     | ** ** | **30,566**         | ** ** | **—**   | ** ** | **79,669**         | ** ** | **(102,814** | **)**      | **14,054**                                    | ** ** | **21,475**  | ** ** |
| Net loss for the year                                                                  |       | —             |       | —             |       | —       |       | —             |       | (24,724      | )          | —                                        |       | (24,724     | )          |
| Issuances pursuant to registered direct offerings,  net of transaction costs (note 17) |       | 9,902,484          |       | 10,637             |       | 2,899        |       | —             |       | —       |       | —                                        |       | 13,536      |       |
| Foreign currency translation adjustments                                               |       | —             |       | —             |       | —       |       | —             |       | —       |       | (1,332                                        | )          | (1,332      | )          |
| Variation in the fair value of short-term  investments, net of income taxes            |       | —             |       | —             |       | —       |       | —             |       | —       |       | (3                                            | )          | (3          | )          |
| Stock-based compensation costs                                                         |       | —             |       | —             |       | —       |       | 274                |       | —       |       | —                                        |       | 274         |       |
| **Balance — December 31,  2009**                                             | ** ** | **63,089,954**     | ** ** | **41,203**         | ** ** | **2,899**    | ** ** | **79,943**         | ** ** | **(127,538** | **)**      | **12,719**                                    | ** ** | **9,226**   | ** ** |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**ÆternaZentaris Inc.**

ConsolidatedStatements of Accumulated Other Comprehensive Income and Deficit

(expressedin thousands of US dollars)

 
| ** **                                                                     | ** ** | **As at December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                     | ** ** | **2009**                    | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                     | ** ** | **$**                       | ** ** | **$** | ** ** | **$** | ** ** |
| Accumulated  other comprehensive income:                                       |       |                        |       |   |   |   |   |
| Foreign  currency translation adjustments                                      |       | 12,719                      |       | 14,051 |   | 21,706 |   |
| Variation  in fair market value of short-term investments, net of income taxes |       | —                      |       | 3 |   | 10 |   |
| **Accumulated Other Comprehensive Income**                                     |       | 12,719                      |       | 14,054 |   | 21,716 |   |
| **Deficit**                                                                    |       | (127,538                    | )          | (102,814 | ) | (42,997 | ) |
| Total  Accumulated Other Comprehensive Income and Deficit                      |       | (114,819                    | )          | (88,760 | ) | (21,281 | ) |

 

The accompanying notes arean integral part of these consolidated financial statements.

 

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**ÆternaZentaris Inc.**

ConsolidatedStatements of Operations

Forthe years ended December 31,

(expressedin thousands of US dollars, except share and per share data)

 
| ** **                                                       | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                       | ** ** | **$**      | ** ** | **$**      | ** ** | **$**      | ** ** |
| **Revenues**                                                     |       |       |       |       |       |       |       |
| **License fees**                                                 |       | 42,221     |       | 8,504      |       | 12,843     |       |
| **Sales and royalties**                                          |       | 20,957     |       | 29,462     |       | 28,825     |       |
| **Other**                                                        |       | 59         |       | 512        |       | 400        |       |
| ** **                                                       |       | 63,237     |       | 38,478     |       | 42,068     |       |
| **Operating  expenses**                                          |       |       |       |       |       |       |       |
| Cost  of sales, excluding depreciation and amortization (note 9) |       | 16,501     |       | 19,278     |       | 12,930     |       |
| Research  and development costs                                  |       | 44,217     |       | 57,448     |       | 39,248     |       |
| Research  and development tax credits and grants                 |       | (403       | )          | (343       | )          | (2,060     | )          |
| Selling,  general and administrative expenses                    |       | 16,040     |       | 17,325     |       | 20,403     |       |
| Depreciation  and amortization                                   |       |       |       |       |       |       |       |
| Property,  plant and equipment (note 11)                         |       | 3,285      |       | 1,515      |       | 1,562      |       |
| Intangible  assets (note 13)                                     |       | 7,555      |       | 5,639      |       | 4,004      |       |
| Impairment  of long-lived assets held for sale (note 8)          |       | —     |       | —     |       | 735        |       |
|                                                             |       | 87,195     |       | 100,862    |       | 76,822     |       |
| **Loss from  operations**                                        |       | (23,958    | )          | (62,384    | )          | (34,754    | )          |
| **Other income  (expenses)**                                     |       |       |       |       |       |       |       |
| **Interest income**                                              |       | 349        |       | 868        |       | 1,904      |       |
| Interest  expense                                                |       | (5         | )          | (118       | )          | (85        | )          |
| Foreign  exchange gain (loss)                                    |       | (1,110     | )          | 3,071      |       | (1,035     | )          |
| Loss  on disposal of long-lived assets held for sale (note 8)    |       | —     |       | (35        | )          | —     |       |
| Loss  on disposal of equipment                                   |       | —     |       | (44        | )          | (28        | )          |
|                                                             |       | (766       | )          | 3,742      |       | 756        |       |
| **Loss before  income taxes from continuing operations**         |       | (24,724    | )          | (58,642    | )          | (33,998    | )          |
| **Income tax  (expense) recovery******(note 19)                  |       | —     |       | (1,175     | )          | 1,961      |       |
| **Net loss from  continuing operations**                         |       | (24,724    | )          | (59,817    | )          | (32,037    | )          |
| **Net loss from  discontinued operations** (note 7)              |       | —     |       | —     |       | (259       | )          |
| **Net loss for the  year**                                       |       | (24,724    | )          | (59,817    | )          | (32,296    | )          |
| ** **                                                       |       |       |       |       |       |       |       |
| **Net loss per  share from continuing operations**               |       |       |       |       |       |       |       |
| Basic  and diluted                                               |       | (0.43      | )          | (1.12      | )          | (0.61      | )          |
| **Net loss per  share from discontinued operations**             |       |       |       |       |       |       |       |
| Basic  and diluted                                               |       | —     |       | —     |       | —     |       |
| **Net loss per  share**                                          |       |       |       |       |       |       |       |
| Basic  and diluted                                               |       | (0.43      | )          | (1.12      | )          | (0.61      | )          |
| **Weighted average  number of shares****(note 21)**              |       |       |       |       |       |       |       |
| Basic  and diluted                                               |       | 56,864,484 |       | 53,187,470 |       | 53,182,803 |       |

 

The accompanying notes are an integral part of these consolidated financialstatements.

 

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**ÆternaZentaris Inc.**

Consolidated Statements ofComprehensive Loss

For the years ended December31,

(expressed in thousands of USdollars)

 
| ** **                                                                     | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                                                     | ** ** | **$**    | ** ** | **$**    | ** ** | **$**    | ** ** |
| Net loss for the year                                                          |       | (24,724  | )          | (59,817  | )          | (32,296  | )          |
| Other comprehensive income (loss):                                             |       |     |       |     |       |     |       |
| Foreign currency translation adjustments                                       |       | (1,332   | )          | (7,655   | )          | 13,783   |       |
| Reclassification adjustment related to disposal of  Echelon (note 7)           |       | —   |       | —   |       | (754     | )          |
| Variation in fair market value of short-term  investments, net of income taxes |       | (3       | )          | (7       | )          | 51       |       |
|                                                                           |       |     |       |     |       |     |       |
| Comprehensive loss                                                             |       | (26,059  | )          | (67,479  | )          | (19,216  | )          |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**Æterna Zentaris Inc.**

ConsolidatedStatements of Cash Flows 

Forthe years ended December 31, 

(expressedin thousands of US dollars)

 
| ** **                                                                                                | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                                                                                | ** ** | **$**    | ** ** | **$**    | ** ** | **$**    | ** ** |
| **Cash flows from operating activities**                                                                  |       |     |       |     |       |     |       |
| Net loss for the year                                                                                     |       | (24,724  | )          | (59,817  | )          | (32,296  | )          |
| Net loss from discontinued operations (note 7)                                                            |       | —   |       | —   |       | 259      |       |
| Net loss from continuing operations                                                                       |       | (24,724  | )          | (59,817  | )          | (32,037  | )          |
| Items not affecting cash and cash equivalents                                                             |       |     |       |     |       |     |       |
| Depreciation and amortization                                                                             |       | 10,840   |       | 7,154    |       | 5,566    |       |
| Stock-based compensation costs                                                                            |       | 274      |       | 363      |       | 1,984    |       |
| Future income taxes                                                                                       |       | —   |       | —   |       | (1,868   | )          |
| Inventory write-down (note 9)                                                                             |       | —   |       | 726      |       | —   |       |
| Employee future benefits                                                                                  |       | 1,365    |       | 984      |       | 164      |       |
| Amortization of deferred charges and other  long-term assets                                              |       | 1,819    |       | 729      |       | 510      |       |
| Amortization of deferred revenues                                                                         |       | (13,506  | )          | (6,213   | )          | (7,012   | )          |
| Accretion on long-term borrowings                                                                         |       | —   |       | —   |       | 82       |       |
| Loss on disposal of long-lived assets held for  sale                                                      |       | —   |       | 35       |       | —   |       |
| Loss on disposal of equipment                                                                             |       | —   |       | 44       |       | 28       |       |
| Impairment of long-lived asset held for sale                                                              |       | —   |       | —   |       | 735      |       |
| Foreign exchange loss (gain) on items denominated  in foreign currency                                    |       | 1,098    |       | (3,801   | )          | 641      |       |
| Amortization of prepaid expenses and other  non-cash items                                                |       | 15,192   |       | 10,179   |       | 8,632    |       |
| Changes in operating assets and liabilities (note  18)                                                    |       | (16,496  | )          | 48,345   |       | (3,087   | )          |
| Net cash used in continuing operating activities                                                          |       | (24,138  | )          | (1,272   | )          | (25,662  | )          |
| Net cash provided by discontinued operating  activities (note 7)                                          |       | —   |       | —   |       | 132      |       |
| Net cash used in operating activities                                                                     |       | (24,138  | )          | (1,272   | )          | (25,530  | )          |
| **Cash flows from financing activities**                                                                  |       |     |       |     |       |     |       |
| Proceeds from issuances of common shares and  warrants, net of cash transaction costs of $1,244 (note 17) |       | 14,256   |       | —   |       | —   |       |
| Repayment of long-term debt and long-term payable                                                         |       | (51      | )          | (784     | )          | (751     | )          |
| Issuance of shares pursuant to the exercise of  stock options                                             |       | —   |       | —   |       | 33       |       |
| Deferred share issue expenses                                                                             |       | —   |       | (408     | )          | (366     | )          |
| Net cash provided by (used in) continuing  financing activities                                           |       | 14,205   |       | (1,192   | )          | (1,084   | )          |
| Net cash used in discontinued financing activities  (note 7)                                              |       | —   |       | —   |       | (230     | )          |
| Net cash provided by (used in) financing  activities                                                      |       | 14,205   |       | (1,192   | )          | (1,314   | )          |
| **Cash flows from investing activities**                                                                  |       |     |       |     |       |     |       |
| Purchase of short-term investments                                                                        |       | —   |       | (1,664   | )          | (6,180   | )          |
| Proceeds from sale and maturity of short-term  investments                                                |       | 553      |       | 30,027   |       | 33,405   |       |
| Increase in restricted cash (note 10)                                                                     |       | (866     | )          | —   |       | —   |       |
| Purchase of property, plant and equipment                                                                 |       | (510     | )          | (1,147   | )          | (3,702   | )          |
| Net proceeds from sale of long-lived assets held  for sale                                                |       | —   |       | 14,854   |       | —   |       |
| Proceeds from sale of property, plant and  equipment                                                      |       | 6        |       | —   |       | 729      |       |
| Purchases of amortizable intangible assets                                                                |       | (280     | )          | (67      | )          | (67      | )          |
| Net cash provided by (used in) continuing investing  activities                                           |       | (1,097   | )          | 42,003   |       | 24,185   |       |
| Net cash provided by discontinued investing  activities (note 7)                                          |       | —   |       | —   |       | 2,238    |       |
| Net cash provided by (used in) investing  activities                                                      |       | (1,097   | )          | 42,003   |       | 26,423   |       |
| **Effect of exchange rate changes  on cash and cash equivalents**                                         |       | (96      | )          | (585     | )          | 1,337    |       |
| **Net change in cash and cash equivalents**                                                               |       | (11,126  | )          | 38,954   |       | 916      |       |
| **Cash and cash equivalents — Beginning of  year**                                                   |       | 49,226   |       | 10,272   |       | 9,356    |       |
| **Cash and cash equivalents — End of year**                                                          |       | 38,100   |       | 49,226   |       | 10,272   |       |
| Cash and cash equivalents components:                                                                     |       |     |       |     |       |     |       |
| Cash                                                                                                      |       | 33,100   |       | 13,256   |       | 10,195   |       |
| Cash equivalents                                                                                          |       | 5,000    |       | 35,970   |       | 77       |       |
|                                                                                                      |       | 38,100   |       | 49,226   |       | 10,272   |       |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**Æterna Zentaris Inc.**

Notes to Consolidated Financial Statements

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, except share/option/warrantand per share/option/warrant data and as otherwise noted)

 

**1****              Incorporation andnature of activities**

 

Æterna Zentaris Inc. (“Æterna Zentaris” or the “Company”), incorporatedunder the *Canada Business Corporations Act*, is aglobal biopharmaceutical company focused on oncology and endocrine therapy withexpertise in drug discovery, development and commercialization. The Company’spipeline encompasses compounds at all stages of development, from drugdiscovery through marketed products.

 

**2****              Summary ofsignificant accounting policies**

 

**Basisof presentation**

** **

Theaccompanying consolidated financial statements have been prepared in accordancewith Canadian generally accepted accounting principles (“Canadian GAAP”). Theseconsolidated financial statements differ in certain respects from thoseprepared in accordance with United States generally accepted principles (“USGAAP”). The recognition, measurement and disclosure differences as they relateto the Company are described in note 26, “Differences between Canadian and USGAAP”.

 

**Evaluationof going concern, results of operations and management’s plans**

 

TheCanadian Institute of Chartered Accountants’ (“CICA”) Handbook Section 1400,*General Standards of Financial StatementPresentation*, requires management to make an assessment of anentity’s ability to continue as a going concern, taking into account allavailable information about the future, which is at least, but is not limitedto, 12 months from the balance sheet dates. Disclosure is required of materialuncertainties related to events or conditions that may cast significant doubtupon the entity’s ability to continue as a going concern. Management’sassessment took into account the cash received in connection with the sale, in December 2008,of rights to future royalties (see note 5), the upfront payment received inconnection with the development, commercialization and license agreement withsanofi-aventis U.S. LLC (“sanofi”) on March 5, 2009, discussed in note 4,and the net proceeds received in connection with the two registered directofferings discussed in note 17, as well as the Company’s strategic plan andcorresponding budgets for 2010 and projections for 2011 and 2012. As a resultof this assessment, and despite the announcements in 2009 of negative resultsassociated with our Phase 3 studies with cetrorelix in benign prostatichyperplasia (“BPH”), management believes that the Company has sufficientfinancial resources to fund planned expenditures and other working capitalneeds for at least, but not limited to, the next 12-month period from thebalance sheet date.

 

**Basisof consolidation**

** **

Theseconsolidated financial statements include all companies in which the Company,directly or indirectly holds more than 50% of the voting rights or over whichit exercises control. Companies are included in the consolidation from the datethat control is transferred to the Company, while companies sold are excludedfrom the consolidation from the date that control ceases. The purchase methodof accounting is used to account for acquisitions. All intercompany balancesand transactions are eliminated on consolidation.

 

**Investmentsin affiliated companies**

** **

Whereapplicable, investments in companies over which the Company exercisessignificant influence (generally where the Company holds 20% to 50% of theinvestee’s voting rights) but over which it does not exercise control areaccounted for using the equity method. The Company’s share of its affiliatedresults of operations is recognized in the statement of operations.

 

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**ÆternaZentaris Inc.**

Notes to Consolidated FinancialStatements

December 31, 2009, 2008 and2007

(tabular amounts in thousandsof US dollars, except share/option/warrant and per share/option/warrant dataand as otherwise noted)

 

**Accountingestimates**

** **

Thepreparation of financial statements in conformity with Canadian generallyaccepted accounting principles requires management to make estimates andassumptions that affect the amounts reported in the financial statements. Thoseestimates and assumptions also affect the disclosure of contingencies at thedate of the financial statements as well as the reported amounts of revenuesand expenses during the reported years. Significant estimates are generallymade in connection with the calculation of revenues, research and developmentexpenses, stock-based compensation costs, as well as in determining theallowance for doubtful accounts, inventory and provisions for obsoleteinventory, future income tax assets and liabilities, the useful lives ofproperty, plant and equipment and intangible assets with finite lives, thevaluation of intangible assets and goodwill, the fair value of stock optionsand warrants granted, employee future benefits and certain accrued liabilities.The Company bases its estimates on historical experience, where relevant, andon various other assumptions that management believes to be reasonable underthe circumstances. Actual results could differ from those estimates.

 

**Foreigncurrency translation**

** **

*Reportingcurrency*

 

TheCompany uses the US dollar as its reporting currency. Assets and liabilities ofthe Company and of its self-sustaining subsidiaries whose functional currencyis other than the US dollar are translated using the exchange rate in effect atthe balance sheet date. Revenues and expenses are translated at the averagerate in effect during the year. Translation gains and losses are included inthe consolidated statement of comprehensive loss.

 

*Foreigncurrency transactions and remeasurement*

 

Thefinancial statements of integrated foreign operations and transactionsdenominated in currencies other than the functional currency are remeasuredinto the functional currency using the temporal method. Under this method,monetary assets and liabilities are remeasured to their functional currency atthe exchange rate in effect on the date of the balance sheet. Non-monetaryassets and liabilities are remeasured at historical rates, unless such assetsand liabilities are carried at market, in which case, they are remeasured usingthe exchange rate in effect on the date of the balance sheet. Revenues andexpenses are remeasured at the monthly average exchange rate. Transaction gainsand losses resulting from such remeasurement are reflected in the consolidatedstatement of operations.

 

EffectiveJanuary 1, 2009, due to a change in economic facts and circumstances, theCompany and its US subsidiary adopted the Euro (“EUR”) as their functionalcurrency. This change did not result in any significant impact on the Company’sconsolidated financial statements.

 

**Cashand cash equivalents**

 

Cashand cash equivalents consist of unrestricted cash on hand and balances withbanks, excluding bank advances, as well as short-term, interest-bearingdeposits either with a term of less than three months at the acquisition dateor that are readily convertible to known amounts of cash and which are subjectto an insignificant risk of changes in value.

 

**Short-terminvestments**

 

Short-terminvestments consist mainly of notes and bonds which do not meet the Company’sdefinition of cash and cash equivalents.

 

Inaccordance with the requirements of CICA Handbook Section 3855, *Financial Instruments*, short-term investments are classifiedas available-for-sale investments. The Company recognizes transactions on thesettlement date. These investments are recognized at fair value. Unrealizedgains and losses are recognized, net of income taxes, if any, in othercomprehensive income. Upon the disposal or impairment of these investments,these gains or losses are reclassified to the consolidated statement ofoperations.

 

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**ÆternaZentaris Inc.**

Notes to Consolidated FinancialStatements

December 31, 2009, 2008 and2007

(tabular amounts in thousandsof US dollars, except share/option/warrant and per share/option/warrant dataand as otherwise noted)

 

**Inventory**

 

Inventoryis valued at the lower of cost and net realizable value, which is defined asthe estimated selling price in the ordinary course of business less theestimated costs of completion and the estimated costs necessary to make thesale. Cost is determined on a first-in, first-out basis. The cost of finishedgoods and work in progress includes raw materials, labour and manufacturingoverhead under the absorption costing method.

 

**Restrictedcash**

 

Restrictedcash includes a bank deposit related to the Company’s long-term leaseobligation in Germany. See also note 10.

 

**Property, plant and equipment and depreciation**

 

Property,plant and equipment are recorded at cost, net of related government grants andaccumulated depreciation. Depreciation is calculated using the followingmethods, annual rates and periods:

 
| ** **              | ** ** | **Methods**                         | ** ** | **Annual rates  and period** |
|-------------------------|------------|-------------------------------------|------------|------------------------------|
|                    | ** ** |                                | ** ** |                         |
| Equipment               |       | Declining balance and straight-line |       | 20%                          |
| Furniture  and fixtures |       | Declining balance and straight-line |       | 10% and 20%                  |
| Computer  equipment     |       | Straight-line                       |       | 25% and 331/3%               |
| Leasehold  improvements |       | Straight-line                       |       | Remaining lease term         |

 

**Royalty sale transaction expenses and other deferred charges**

 

TheCompany has deferred direct and incremental costs associated with itstransaction to sell its future rights to a royalty stream and are accounted foras discussed in note 5.

 

Otherdeferred charges relate to upfront payments made related to research anddevelopment collaborations. These charges are included in deferred charges andother long-term assets and are amortized in the consolidated statement ofoperations over the duration of the research and development work related tothe contracts.

 

**Intangibleassets**

** **

Intangibleassets with finite useful lives consist of in-process research and development,acquired in business combinations, patents and trademarks, technology andother. Patents and trademarks are comprised of costs, including professionalfees incurred in connection with the filing of patents and the registration oftrademarks for product marketing and manufacturing purposes, net of relatedgovernment grants and accumulated amortization. Intangible assets with finiteuseful lives are amortized on a straight-line basis over their estimated usefullives of eight to fifteen years for in-process research and development andpatents, ten years for trademarks and from three to ten years for technologyand other.

 

**Goodwill**

** **

Goodwillrepresents the excess of the purchase price over the fair values of the netassets of entities acquired at their respective dates of acquisition. Goodwillis not amortized but is tested for impairment annually, or more frequently ifevents or changes in circumstances indicate that the carrying value of thereporting unit to which the goodwill is assigned may exceed the fair value ofthe reporting unit.

 

In theevent that the carrying amount of a reporting unit, including goodwill, exceedsits fair value, an impairment loss is recognized in an amount equal to theexcess. Fair value of goodwill is estimated in the same way as goodwill is

 

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**Æterna Zentaris Inc.**

Notes to Consolidated Financial Statements

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

determinedat the date of the acquisition in a business combination, that is, the excessof the fair value of the reporting unit over the fair value of the identifiablenet assets of the reporting unit.

 

**Impairmentof long-lived assets**

** **

Property,plant and equipment and intangible assets with finite lives are reviewed forimpairment when events or circumstances indicate that carrying values may notbe recoverable. Impairment exists when the carrying value of the asset or assetgroup is greater than the undiscounted future cash flows expected to beprovided by the asset or asset group. The amount of impairment loss, if any, isthe excess of its carrying value over its fair value, which in turn isdetermined based upon discounted cash flows or appraised values, depending onthe nature of assets.

 

**Employeefuture benefits**

** **

TheCompany’s subsidiary in Germany maintains defined contribution and unfundeddefined benefit plans as well as other benefit plans for its employees. Itsobligations are accrued under employee benefit plans and the related costs. Inthis regard, the following policies have been adopted:

 

·                  thecost of pension and other benefits earned by employees is actuariallydetermined using the projected unit credit method and benefit method proratedon length of service and management’s best estimate of salary escalation, retirementages of employees and employee turnover;

 

·                  thenet actuarial gain (loss) of the benefit obligation is recorded in theconsolidated statement of operations as it arises.

 

For definedcontribution plans, the pension expenses recorded in the consolidated statementof operations is the amount of contribution the Company is required to pay forservices rendered by employees.

 

**Deferredrevenues**

** **

Deferredrevenues relate to the unamortized portion of the cash proceeds received inconnection with the Company’s sale of future rights to a royalty stream.  Those proceeds are recognized as royaltyrevenue based on the “units-of-revenue” method, as discussed in note 5. Alsoincluded in deferred revenues are upfront payments received primarily inconnection with license cooperation agreements. Those payments are recognized as revenues, as discussed below.

 

**Revenuerecognition**

** **

TheCompany is currently in a phase in which potential products are being furtherdeveloped or marketed jointly with strategic partners. Existing licensingagreements usually foresee one-time payments (upfront payments), payments forresearch and development services in the form of cost reimbursements, milestonepayments and royalty receipts for licensing and marketing product candidates. Revenuesassociated with those multiple-element arrangements are allocated to thevarious elements based on their relative fair value.

 

Agreementscontaining multiple elements are divided into separate units of accounting ifcertain criteria are met, including whether the delivered element hasstand-alone value to the customer and whether there is objective and reliableevidence of the fair value of the undelivered obligation(s). The considerationreceived is allocated among the separate units based on each unit’s fair value,and the applicable revenue recognition criteria are applied to each of theseparate units.

 

Licensefees representing non-refundable payments received upon the execution oflicense agreements are recognized as revenue upon execution of the licenseagreements when the Company has no significant future performance obligationsand collectibility of the fees is assured. Upfront payments received at thebeginning of licensing agreements are not recorded as revenue when received butare amortized based on the progress to the related research and development

 

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**ÆternaZentaris Inc.**

Notes to Consolidated FinancialStatements

December 31, 2009, 2008 and2007

(tabular amounts in thousandsof US dollars, except share/option/warrant and per share/option/warrant dataand as otherwise noted)

 

work.This progress is based on estimates of total expected time or duration tocomplete the work, which is compared to the period of time incurred to date inorder to arrive at an estimate of the percentage of revenue earned to date.

 

Milestonepayments, which are generally based on developmental or regulatory events, arerecognized as revenue when the milestones are achieved, collectibility isassured, and when there are no significant future performance obligations inconnection with the milestones.

 

Royaltyrevenue, based on a percentage of sales of certain declared products sold bythird parties, is recorded when the Company has fulfilled the terms inaccordance with the contractual agreement, has no future obligations, theamount of the royalty fee is determinable and collection is reasonably assured.

 

The Company defers recognition of proceeds received in connection withthe sale of rights to future royalties (see note 5) and recognizes thesedeferred revenues over the life of the license agreement, pursuant to the“units-of-revenue” method.

 

Revenuesfrom sales of products are recognized, net of estimated sales allowances andrebates, when title passes to customers, which is at the time goods areshipped, when there are no future performance obligations, when the purchaseprice is fixed and determinable and collection is reasonably assured.

 

**Stock-basedcompensation costs**

** **

Since January 1,2003, the Company accounts for all forms of employee stock-based compensationusing the fair value-based method.

 

Thefair value of stock options is determined on the date of grant using theBlack-Scholes option pricing model and stock-based compensation costs arerecognized over the vesting period of the options and credited to OtherCapital, and any consideration received by the Company on the exercise of stockoptions is credited to Share Capital. Any Other Capital component of thestock-based compensation is transferred to Share Capital upon the issuance ofshares.

 

**Income taxes**

** **

TheCompany follows the liability method of accounting for income taxes. Under thismethod, future income tax assets and liabilities are determined based on thetemporary differences between the carrying amounts and tax bases of the assetsand liabilities. Future income tax assets and liabilities are measured usingsubstantively enacted and enacted tax rates expected to apply in the years inwhich the differences are expected to reverse.

 

TheCompany establishes a valuation allowance against future income tax assets if,based on available information, it is more likely than not that some or all ofthe future income tax assets will not be realized.

 

**Researchand development costs**

** **

Researchcosts are expensed as incurred. Development costs are expensed as incurredexcept for those which meet generally accepted criteria for deferral, in whichcase, the costs are capitalized and amortized to operations over the estimatedperiod of benefit. No costs have been deferred during any of the periodspresented.

 

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**Æterna Zentaris Inc.**

Notes to Consolidated Financial Statements

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**Research anddevelopment tax credits and grants**

** **

TheCompany is entitled to scientific research and experimental development(“SR&ED”) tax credits granted by the Canadian federal government(“Federal”) and the government of the Province of Quebec (“Provincial”).Federal SR&ED tax credits are earned on qualified Canadian SR&EDexpenditures at a rate of 20% and can only be used to offset Federal incometaxes otherwise payable. Refundable Provincial SR&ED tax credits aregenerally earned on qualified salaries, subcontracting and university contractexpenses incurred in the Province of Quebec, at a rate of 17.5% of eligiblebase amounts.

 

Additionally,the Company’s German subsidiary is entitled to research grants from the GermanFederal Ministry of Education and Research. Funding is earned on qualified projects, and corresponding expenses arereimbursed at a rate of 50% of eligible base amounts.

 

Taxcredits and grants are accounted for using the cost reduction method.Accordingly, tax credits and grants are recorded as a reduction of the relatedexpenses or capital expenditures in the period the expenses are incurred,provided that the Company has reasonable assurance the credits or grants willbe realized.

 

**Lossper share**

** **

Basicnet loss per share is calculated using the weighted average number of commonshares outstanding during the year.

 

Dilutednet loss per share is calculated based on the weighted average number of commonshares outstanding during the year, plus the effects of dilutive common shareequivalents such as options and warrants. This method requires that diluted netloss per share be calculated using the treasury stock method, as if all commonshare equivalents had been exercised at the beginning of the reporting period,or period of issuance, as the case may be, and that the funds obtained therebywere used to purchase common shares of the Company at the average trading priceof the common shares during the period.

 

**3****             ****New accounting standards andpronouncements**

 

**a)****    ****Adopted in 2009**

 

In February 2008, the CICA issued Handbook Section 3064, *Goodwill and Intangible Assets*. Thisstandard provides guidance on the recognition of intangible assets and thecriteria for asset recognition, clarifying the applications of the concept ofmatching revenues and expenses, whether these assets are separately acquired orare developed internally. The standard applies to the Company’s interim andannual financial statements for periods beginning on January 1, 2009.Adoption of this standard has not had any impact on the Company’s consolidatedfinancial statements.

 

In January 2009, the CICA issued Handbook Section 1582, *Business Combinations*, which replaces the existingstandards. This section establishes the standards for accounting for businesscombinations and states that all assets and liabilities of an acquired businesswill be recorded at fair value. Obligations for contingent considerations andcontingencies will also be recorded at fair value at the acquisition date. Thestandard also states that acquisition-related costs will be expensed asincurred and that restructuring charges will be expensed in the periods afterthe acquisition date. The Company has early adopted this standard effective January 1,2009 and will apply the provisions thereof prospectively to future businesscombinations.

 

In January 2009, the CICA issued Handbook Section 1601, *Consolidated Financial Statements*, which replaces theexisting standards and establishes the standards for preparing consolidatedfinancial statements and is effective for 2011. The Company has early adoptedthis standard effective January 1, 2009 and will apply the provisionsthereof prospectively, where applicable.

 

In January 2009, the CICA issued Handbook Section 1602, *Non-controlling Interests*, which establishes standards foraccounting for non-controlling interests of a subsidiary in the preparation ofconsolidated financial statements subsequent 

 

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**ÆternaZentaris Inc.**

Notes to Consolidated FinancialStatements

December 31, 2009, 2008 and2007

(tabular amounts in thousandsof US dollars, except share/option/warrant and per share/option/warrant dataand as otherwise noted)

 

to a business combination. The Company has early adopted this standardeffective January 1, 2009 and has applied the provisions thereofretrospectively, without any impact on the Company’s consolidated financialstatements.

 

In January 2009, the CICA’s Emerging Issue Committee (“EIC”)issued Abstract EIC-173, “Credit Risk and the Fair Value of Financial Assets andLiabilities”, which requires entities to take both counterparty creditrisk and their own credit risk into account when measuring the fair value offinancial assets and liabilities, including derivatives. The Company adoptedEIC-173 on January 1, 2009, and such adoption did not have a materialimpact on the Company’s consolidated financial statements.

 

In July 2009, the CICA amended Handbook Section 1506, *Accounting Changes*, to exclude from its scope changes inaccounting policies upon the complete replacement of an entity’s primary basisof accounting.  The amendments apply tointerim and annual financial statements relating to years beginning on or afterJuly 1, 2009. The Company early adopted these amendments on July 1,2009, and such adoption did not have any impact on the consolidated financialstatements.

 

In June 2009, the CICA amended Handbook Section 3862,*Financial Instruments—Disclosures*(“CICAHandbook Section 3862”), to include additional disclosure requirementsabout fair value measurements of financial instruments and to enhance liquidityrisk disclosure requirements for publicly accountable enterprises.  The amendments apply to annual financialstatements for years ending after September 30, 2009. The Company hasadopted these amendments, and there has been no significant impact on theconsolidated financial statements. Additional required disclosures have beenmade where applicable.

 

**b)****    ****Not yet adopted**

 

InDecember 2009, the EIC issued abstract EIC-175, “Multiple DeliverableRevenue Arrangements” (“EIC-175”), which requires a vendor to allocatearrangement consideration at the inception of an arrangement to alldeliverables using the relative selling price method. EIC-175 also changes thelevel of evidence of the standalone selling price required to separatedeliverables when more objective evidence of the selling price is notavailable. Given the requirement to use the relative selling price method ofallocating arrangement consideration, EIC-175 prohibits the use of the residualmethod. EIC-175 may be applied prospectively and is applicable to revenuearrangements with multiple deliverables entered into or materially modified inthe first annual fiscal period beginning on or after January 1, 2011, withearly adoption permitted. The Company is currently evaluating the impact thatthis guidance may have on its consolidated financial statements.

 

**4****             ****Development, commercializationand license agreement**

 

OnMarch 4, 2009, the Company entered into a development, commercializationand license agreement (the “Agreement”) with sanofi. The Agreement was for thedevelopment, registration and marketing of cetrorelix in BPH for the UnitedStates market. Under the terms of the Agreement, sanofi made an upfrontnonrefundable license fee payment to the Company of $30,000,000. Also per theAgreement, the Company would have been entitled to receive certain paymentsupon achieving certain pre-established regulatory and commercial milestones aswell as escalating double-digit royalties on future net sales of cetrorelix forBPH in the United States.

 

Aswith similar prior arrangements, the Company applied the provisions of theEIC’s Abstract No. 142, “Revenue Arrangements with Multiple Deliverables”,and had determined that all deliverables and performance obligationscontemplated by the Agreement should be accounted for as a single unit ofaccounting, limited to amounts that were notcontingent upon the delivery of additional items or the meeting of otherspecified performance conditions which were not known, probable or estimable atthe time at which the Agreement was entered into.

 

OnDecember 18, 2009, and following the Company’s announcement that its secondPhase 3 study with cetrorelix in BPH did not reach its primary endpoint, theCompany disclosed that it had received notice from sanofi to terminate theAgreement. As a result, the Company fully recognized the aforementioned upfrontpayment, as the culmination of the earnings process was deemed to be complete.

 

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**ÆternaZentaris Inc.**

Notes to Consolidated FinancialStatements

December 31, 2009, 2008 and2007

(tabular amounts in thousandsof US dollars, except share/option/warrant and per share/option/warrant dataand as otherwise noted)

 

TheAgreement also stipulated that certain development expenses incurred by theCompany, including those costs associated with an open label extension studyand with the establishment of a supply arrangement, were reimbursable, up topredetermined maximum amounts or limits, by sanofi. Total revenues wererecognized on a gross basis and as corresponding reimbursable costs wereincurred. During the year ended December 31, 2009, revenues recognized inconnection with the reimbursable development activities amounted toapproximately $2,135,000, and corresponding expenses totalled approximately$2,814,000 for the same period.

 

Asa result of entering into the Agreement with sanofi, the Company paid a royaltyto the Tulane Educational Fund (“Tulane”) pursuant to a license agreementwhereby the Company obtained licenses to use Tulane’s patents to develop,manufacture, market and distribute various compounds, including cetrorelix.This royalty, amounting to $3,000,000, was charged in full to selling expensesduring the year ended December 31, 2009 as a result of sanofi’s decisionto terminate the Agreement.

 

**5****              Sale of Cetrotide****® royalty stream**

 

InJune 2003, the Company amended certain provisions of a license and supplyagreement with ARES Trading S.A. (“Merck Serono”) in which the latter wasgranted worldwide marketing, distribution and selling rights, except in Japan,for Cetrotide®, a compound used for *in vitro* fertilization (referred to as theLicense Agreement).  Under the LicenseAgreement, Merck Serono agreed to pay certain lump-sum payments to the Companyeach calendar year up to and including December 31, 2010 as well ascertain variable royalties through the expiry date of the Company’s underlyingpatent rights.

 

In November 2008, the Company entered into apurchase and sale agreement (“PSA”) with CowenHealthcare Royalty Partners L.P. (“Cowen”) relating to the Company’s rights to royalties onfuture sales of Cetrotide® covered by the License Agreement.

 

In connection with the PSA, which was effective forroyalty determination purposes on October 1, 2008 and finalized in December 2008,the Company received $52,500,000 from Cowen, less certain transaction costs of$1,000,000 that had been advanced by Cowen to certain third-party firms andinstitutions on the Company’s behalf, resulting in net proceeds of $51,500,000.  Under the terms of the PSA, the Company isentitled to an additional payment of $2,500,000 contingent on 2010 net sales ofCetrotide® reaching a specified level.

 

Per the PSA, if cetrorelix, the active compound inCetrotide®, is approved for sale by European regulatory authorities in anindication other than *in vitro*fertilization, the Company has agreed to make a one-time cash payment to Cowenin an amount ranging from $5,000,000 up to a maximum of $15,000,000.  The amount which may be due to Cowen will behigher in proportion to the timing of the product’s receiving Europeanregulatory approval; that is, the earlier the product receives regulatoryapproval, the higher the amount payable to Cowen will be. No payment was madeor became payable during 2009.

 

Also per the PSA, for each calendar quarter inwhich a royalty rate reduction—defined as the actual reduction by Merck Serono,for any calendar quarter(s), of the rate applied in calculating variableroyalties under the License Agreement, to amounts less than pre-established percentages—hasoccurred or is continuing, the Company will pay Cowen a quarterly make-wholepayment in an amount equal to the lesser of (i) the variable royalties inrespect of such quarter that would have been received by Cowen if theaforementioned royalty rate reduction had not occurred or been continuing, and (ii) thedifference of $15,000,000 less Cowen’s net reduction payments, as defined. Nomake-whole payments were paid or became payable during 2009.

 

Pursuant to the aforementioned transactions, theCompany has certain obligations in the royalty arrangement, including thesupply of Cetrotide® toMerck Serono, the payment of royalties to a third party under the LicenseAgreement, overseeing Merck-Serono’s compliance with the License Agreement,cooperation in handling any adverse claims or litigation involving the LicenseAgreement and monitoring and defending any patent or trademark infringement.

 

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**Æterna Zentaris Inc.**

Notesto Consolidated Financial Statements

December31, 2009, 2008 and 2007

(tabularamounts in thousands of US dollars, except share/option/warrant and pershare/option/warrant data and as otherwise noted)

 

The Company has recorded the proceeds, as per theprovisions of guidance now codified as the United States Financial AccountingStandards Board’s (“FASB”) *Accounting StandardsCodification*(“ASC”)**Topic 470*, Debt*, as deferred revenues, which are recognizable asroyalty revenues over the life of the License Agreement under the “units-of-revenue” method. Under that method, periodic royalty revenues are calculated bymultiplying the ratio of the remaining deferred revenue amount to the totalestimated remaining royalties that Merck Serono is expected to pay to Cowenover the term of the underlying arrangement by the royalty payments due toCowen for the period.

 

The Company has recognized and will continue torecognize royalty expenses in each period based on the transaction costs, whichhave been capitalized as deferred charges in the accompanying balance sheets(see note 12), in the same manner and over the same period in which the relateddeferred revenues are recognized as royalty revenues.

 

During the years ended December 31, 2009 and2008, the Company recorded approximately $5,686,000 and $1,355,000,respectively as royalty revenues. During the years ended December 31, 2009and 2008, the Company recorded $522,000 and $124,000, respectively, as royaltyexpense, which is included in selling, general and administrative expenses inthe accompanying consolidated statements of operations.

 

**6****              Distributionof the remaining interest in Atrium Biotechnologies Inc.**

 

On October 18, 2006, the Company closed a Secondary Offering inconnection with its divestiture of Atrium Biotechnologies Inc., now AtriumInnovation Inc. (“Atrium”), and on December 15, 2006, the Company’sshareholders approved a reduction in the stated capital of the Company in anamount equal to the fair market value of its remaining interest in Atrium forthe purpose of effecting a special distribution in kind of all subordinatevoting shares of Atrium held by the Company.

 

On January 2, 2007, the Company’s shareholders receivedapproximately 0.2079 of an Atrium subordinate voting share for each one oftheir common shares. This special distribution was accounted for as anonreciprocal transfer to shareholders measured at the carrying value of theinvestment in Atrium on that date. As the special distribution was consideredas a taxable transaction for the Company and treated as a reduction of thestated capital for tax purposes, the share capital of the Company was reducedby the fair value of the Atrium shares distributed of $137,959,000, thelong-term investment in Atrium of $57,128,000 was removed from the balancesheet, and the difference, taking into account the related income taxes of$15,333,000 and cumulative translation adjustment of $5,624,000, was recordedas Other Capital in the amount of $71,122,000.

 

**7****              Disposalof Echelon Biosciences Inc.**

 

OnNovember 30, 2007, the Company sold all issued and outstanding shares ofEchelon Biosciences Inc. (“Echelon”) to Frontier Scientific, Inc. for anupfront payment of $2,600,000 and $600,000 of contingent consideration. Fromthat date, Echelon was excluded from the consolidation, and all historicaloperations and cash flows recorded through the consolidation of Echelon untilthat date have been reported as discontinued operations. The contingentconsideration was based on Echelon achieving specific sales levels in 2008 and2009, though no contingent consideration is payable relative to either of thoseyears.

 

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**ÆternaZentaris Inc.**

Notes to Consolidated FinancialStatements

December 31, 2009, 2008 and2007

(tabular amounts in thousandsof US dollars, except share/option/warrant and per share/option/warrant dataand as otherwise noted)

 

For theyear ended December 31, 2007, consolidated revenues and expenses ofEchelon have been reclassified from continuing operations to discontinuedoperations, as follows:

 
| ** **                                                                    | ** ** | **$**  | ** ** |
|-------------------------------------------------------------------------------|------------|--------|------------|
| **Revenues**                                                                  |       | 2,358  |       |
| **Net loss before the following  items**                                      |       | (206   | )          |
|                                                                          |       |   |       |
| Goodwill impairment                                                           |       | (500   | )          |
| Loss on disposal of Echelon shares, net of  cumulative translation adjustment |       | (44    | )          |
| Income tax recovery                                                           |       | 491    |       |
| **Net loss from discontinued  operations**                                    |       | (259   | )          |

 

**8****              Long-livedassets held for sale**

 

In September 2007, as part of its non-dilutive financing strategyusing non-core assets, the Company decided to dispose of its building and landlocated in Quebec City, as well as certain equipment and its rights tointangible property, Impavido® (miltefosine).

 

In December 2007, management evaluated the net realizable value ofthe Quebec City building and land based on certain preliminary offers receivedfrom third parties. That evaluation resulted in the determination that theassets held for sale were impaired, and, accordingly, the Company recorded animpairment charge of $735,000 against the assets held for sale.

 

On March 1,2008, the Company entered into a definitive purchase and sale agreement withrespect to all rights related to the manufacture, production, distribution,marketing, sale and/or use of Impavido® (miltefosine)with Paladin Labs Inc., for an aggregate purchase price of approximately$9,200,000, payable in cash, subject to certain post-closing purchase priceadjustments. The transaction, which closed on March 31, 2008, generatednet cash proceeds of $8,309,000, resulting in a gain of $775,000.

 

On June 26, 2008, the Company sold the Quebec City building andland for a gross amount of $7,061,000, payable in cash. The net proceedsreceived amounted to $6,545,000, resulting in an additional loss on sale of$810,000.

 

In connection with the sale of the Quebec City building and land, theCompany entered into a long-term lease agreement with the principal tenant ofthe building.  As part of the agreement,the Company agreed to pay the principal tenant CAN$300,000 (approximately$285,000) as an incentive and service fee. This fee is included in the additional loss on sale, and the resultingpayable is non interest-bearing and is due in bi-annual instalments ofCAN$30,000 (approximately $28,500) through January 2013.

 

**9****              Inventory**

 
| ** **       | ** ** | **As at December 31,** | ** ** |
|------------------|------------|-----------------------------|------------|
| ** **       | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **       | ** ** | **$**                       | ** ** | **$** | ** ** |
|             |       |                        |       |   |   |
| Raw materials    |       | 2,998                       |       | 2,367 |   |
| Work in progress |       | 1,417                       |       | 682 |   |
| Finished goods   |       | —                      |       | 336 |   |
|             |       | 4,415                       |       | 3,385 |   |

 

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**ÆternaZentaris Inc.**

Notes to Consolidated FinancialStatements

December 31, 2009, 2008 and2007

(tabular amounts in thousandsof US dollars, except share/option/warrant and per share/option/warrant dataand as otherwise noted)

 

Forthe years ended December 31, 2009, 2008 and 2007, cost of sales, aspresented in the accompanying consolidated statements of operations, representsalmost exclusively the amount of inventory recognized as an expense during theyear.

 

InDecember 2008, the Company wrote down certain inventory items, consistingpredominantly of raw materials, to their estimated net realizable values. Theadjustment, which amounted to approximately $726,000, was recorded as anadditional cost of sales in the accompanying consolidated statement ofoperations.

 

**10****          ****Restricted cash**

 

InJuly 2009, following a mutual agreement between landlord and tenant, inreplacement of a related bank guarantee, the Company transferred approximately$866,000 to a restricted cash account in support of its long-term leaseobligation in Germany (see also note 24).  The fixed amount, includingany interest earned thereon, is restricted for as long as the underlying leasearrangement has not expired and therefore cannot be utilized for currentpurposes as at December 31, 2009.

 

**11****           Property,plant and equipment**

 
| ** **               | ** ** | **As at December 31,** | ** ** |
|--------------------------|------------|-----------------------------|------------|
| ** **               | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **               | ** ** | **Cost**                    | ** ** | **Accumulated  depreciation** | ** ** | **Cost** | ** ** | **Accumulated  depreciation** | ** ** |
| ** **               | ** ** | **$**                       | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** |
|                     |       |                        |       |   |   |   |   |   |   |
| Equipment                |       | 9,941                       |       | 6,831 |   | 9,384 |   | 4,737 |   |
| Furniture and fixtures   |       | 1,653                       |       | 1,382 |   | 1,394 |   | 410 |   |
| Computer equipment       |       | 1,851                       |       | 1,678 |   | 1,071 |   | 874 |   |
| Leasehold improvements   |       | 1,232                       |       | 428 |   | 1,139 |   | 285 |   |
|                     |       |                        |       |   |   |   |   |   |   |
|                     |       | 14,677                      |       | 10,319 |   | 12,988 |   | 6,306 |   |
| Less:                    |       |                        |       |   |   |   |   |   |   |
| Accumulated depreciation |       | 10,319                      |       |   |   | 6,306 |   |   |   |
|                     |       |                        |       |   |   |   |   |   |   |
| Net amount               |       | 4,358                       |       |   |   | 6,682 |   |   |   |

 

Followingthe Company’s announcement that its second Phase 3 study with cetrorelix in BPHdid not reach its primary endpoint and the subsequent termination of theAgreement with sanofi, as discussed in note 4, the Company determined thatcertain items of property, plant and equipment, utilized exclusively in thedevelopment activities related to cetrorelix, were no longer recoverable. As aresult, an impairment charge, which was determined by applying a present valuemodel, representing the full remaining carrying value of these assets, assummarized below, was recorded as additional depreciation expense in December 2009in the accompanying consolidated statement of operations.

 
| ** **              | ** ** | **$** | ** ** |
|-------------------------|------------|-------|------------|
| Equipment               |       | 1,044 |       |
| Furniture and fixtures  |       | 900   |       |
| Total impairment charge |       | 1,944 |       |

 

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**ÆternaZentaris Inc.**

Notes to Consolidated FinancialStatements

December 31, 2009, 2008 and2007

(tabular amounts in thousandsof US dollars, except share/option/warrant and per share/option/warrant dataand as otherwise noted)

 

**12****           Deferredcharges and other long-term assets**

** **
| ** **                                 | ** ** | **As at December 31,** | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                                 | ** ** | **$**                       | ** ** | **$** | ** ** |
|                                       |       |                        |       |   |   |
| Royalty sale transaction expenses (note 5) |       | 4,205                       |       | 4,655 |   |
| Deferred charges                           |       | —                      |       | 929 |   |
| Other                                      |       | 528                         |       | 375 |   |
|                                       |       | 4,733                       |       | 5,959 |   |

 

Includedin the above deferred charges as at December 31, 2008 is $680,111 of costsrelated to the filing of a shelf prospectus. These charges were subsequentlyreclassified as a reduction of share capital and warrants in connection with theFirst Offering, as defined and discussed in note 17.

 

**13****           Intangibleassets**

 
| ** **                                                   | ** ** | **As at December 31,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                   | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                                                   | ** ** | **Cost**                    | ** ** | **Accumulated  amortization** | ** ** | **Cost** | ** ** | **Accumulated  amortization** | ** ** |
|                                                         |       | **$**                       | ** ** | **$** |   | **$** |   | **$** |   |
| In-process research and development, patents and  trademarks |       | 41,715                      |       | 24,681 |   | 42,146 |   | 18,391 |   |
| Technology and other                                         |       | —                      |       | — |   | 767 |   | 628 |   |
|                                                         |       |                        |       |   |   |   |   |   |   |
|                                                         |       | 41,715                      |       | 24,681 |   | 42,913 |   | 19,019 |   |
|                                                         |       |                        |       |   |   |   |   |   |   |
| Less: Accumulated amortization                               |       | 24,681                      |       |   |   | 19,019 |   |   |   |
|                                                         |       |                        |       |   |   |   |   |   |   |
| Net amount                                                   |       | 17,034                      |       |   |   | 23,894 |   |   |   |

 

Followingthe Company’s announcement that its second Phase 3 study with cetrorelix in BPHdid not reach its primary endpoint and the subsequent termination of theAgreement with sanofi, as discussed in note 4, the Company determined that thecarrying value of cetrorelix was no longer recoverable. As a result, animpairment charge, representing the full remaining carrying value of theintangible asset, or approximately $3,854,000, was recorded as additionalamortization expense in December 2009 in the accompanying consolidatedstatement of operations.

 

Managementalso determined that ozarelix—another luteinizing hormone-releasing (“LHRH”)antagonist that, despite its different formulation, works on the same mechanismof action as cetrorelix—was impaired. Additionally, on January 27, 2010,Spectrum Pharmaceuticals, Inc. (“Spectrum”), to whom the Company hadgranted an exclusive license to develop and commercialize ozarelix for allpotential indications in North America and India, announced that it hadterminated its development program with ozarelix in BPH. Consequently, animpairment loss of approximately $1,422,000 was recorded as part ofamortization expense, and all corresponding unamortized deferred revenuesrelated to the use of ozarelix, totalling approximately $1,606,000, were fullyrecognized in the 2009 consolidated statement of operations.

 

In June 2008, Ardana Bioscience Ltd. (“Ardana”), to whom the Company hadgranted an exclusive license for the development and commercialization ofteverelix, an LHRH antagonist, communicated thatit was entering into voluntary administration, and, consequently, clinicalstudies and future development efforts were suspended. The Company subsequentlyterminated the aforementioned agreement, upon which the cash recoverability ofteverelix exclusively had depended. Given these facts, the Company determined that teverelix wasimpaired, and consequently, an impairment 

 

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**ÆternaZentaris Inc.**

Notes to Consolidated FinancialStatements

December 31, 2009, 2008 and2007

(tabular amounts in thousandsof US dollars, except share/option/warrant and per share/option/warrant dataand as otherwise noted)

 

chargeto amortize the full remaining carrying value of the intangible asset, orapproximately $2,362,000, was recorded as additional amortization expense inthe 2008 consolidated statement of operations, and the asset was written off.Additionally, the remaining balance of deferred revenues related to the use ofteverelix, amounting to approximately $1,047,000, was fully recognized in the2008 consolidated statement of operations.

 

Amortizationexpense for intangible assets in each of the next four fiscal years, excludingany impairment charges, is expected to amount to approximately $1,694,000 andto approximately $1,357,000 in 2014.

 

**14****           Goodwill**

 

Thechange in the carrying value is as follows:

 
| ** **                                | ** ** | **$**  | ** ** |
|-------------------------------------------|------------|--------|------------|
|                                      | ** ** |   | ** ** |
| **Balance as at December 31,  2007** |       | 10,492 |       |
|                                      |       |   |       |
| Impact of foreign exchange rate changes   |       | (409   | )          |
|                                      |       |   |       |
| **Balance as at December 31,  2008** |       | 10,083 |       |
|                                      |       |   |       |
| Impact of foreign exchange rate changes   |       | 163    |       |
|                                      |       |   |       |
| **Balance as at December 31,  2009** |       | 10,246 |       |

** **

**15****           Accountspayable and accrued liabilities**

 
| ** **                     | ** ** | **As at December 31,** | ** ** |
|--------------------------------|------------|-----------------------------|------------|
| ** **                     | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                     | ** ** | **$**                       | ** ** | **$** | ** ** |
|                           | ** ** |                        | ** ** |   | ** ** |
| Trade payables                 |       | 8,152                       |       | 10,256 |   |
| Salaries and employee benefits |       | 587                         |       | 899 |   |
| Other accrued liabilities      |       | 3,180                       |       | 2,535 |   |
|                           |       | 11,919                      |       | 13,690 |   |

** **

**16****           Employeefuture benefits**

 

TheCompany’s subsidiary in Germany provides unfunded defined benefit pension plansand unfunded postemployment benefit plans for some groups of employees.Provisions for pension obligations are established for benefits payable in theform of retirement, disability and surviving dependent pensions.

 

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** **

**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, except share/option/warrantand per share/option/warrant data and as otherwise noted)

 

Thefollowing table provides a reconciliation of the changes in the plans’ accruedbenefit obligations:

 
| ** **                                        | ** ** | **Pension benefit plans** | ** ** | **Other benefit plans** | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                                        | ** ** | **2009**                  | ** ** | **2008**                | ** ** | **2007** | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                        | ** ** | **$**                     | ** ** | **$**                   | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** |
|                                              |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| Obligation  — Beginning of year              |       | 9,177                     |       | 8,390                   |       | 7,547 |   | 915 |   | 794 |   | 620 |   |
|                                              |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| Current  service cost                             |       | 205                       |       | 216                     |       | 352 |   | 51 |   | 47 |   | 29 |   |
| Interest  cost                                    |       | 507                       |       | 473                     |       | 269 |   | 50 |   | 44 |   | 52 |   |
| Actuarial  loss (gain)                            |       | 773                       |       | 544                     |       | (490 | ) | (19 | ) | 230 |   | 104 |   |
| Benefits  paid                                    |       | (102                      | )          | (89                     | )          | (70 | ) | (140 | ) | (163 | ) | (81 | ) |
| Effect  of foreign currency exchange rate changes |       | 208                       |       | (357                    | )          | 782 |   | 15 |   | (37 | ) | 70 |   |
|                                              |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| Obligation  — End of year                    |       | 10,768                    |       | 9,177                   |       | 8,390 |   | 872 |   | 915 |   | 794 |   |
|                                              |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| Expenses  recognized                              |       | 1,485                     |       | 1,233                   |       | 131 |   | 82 |   | 321 |   | 185 |   |

 

The significant actuarialassumptions adopted to determine the Company’s accrued benefit obligations areas follows:

 
| ** **                     | ** ** | **Pension benefit plans** | ** ** | **Other benefit plans** | ** ** |
|--------------------------------|------------|---------------------------|------------|-------------------------|------------|
| **Actuarial  assumptions**     | ** ** | **2009**                  | ** ** | **2008**                | ** ** | **2007** | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                     | ** ** | **%**                     | ** ** | **%**                   | ** ** | **%** | ** ** | **%** | ** ** | **%** | ** ** | **%** | ** ** |
|                           |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| Discount  rate for expenses    |       | 5.30                      |       | 5.60                    |       | 4.50 |   | 5.30 |   | 5.60 |   | 4.50 |   |
| Discount  rate for liabilities |       | 5.30                      |       | 5.60                    |       | 5.70 |   | 5.30 |   | 5.60 |   | 5.70 |   |
| Pension  benefits increase     |       | 2.00                      |       | 2.00                    |       | 2.00 |   | 2.00 |   | 2.00 |   | 2.00 |   |
| Rate  of compensation increase |       | 2.75                      |       | 2.75 to 3.75            |       | 2.75 to 3.75 |   | 2.75 |   | 2.75 |   | 2.75 |   |

 

Thelast actuarial reports give effect to the pension and postemployment benefitobligations as at December 31, 2009. The next actuarial reports areplanned for December 2010.

 

Inaccordance with the assumptions used as at December 31, 2009, the futurebenefits expected to be paid can be presented as follows:

 
| ** **        | ** ** | **$** | ** ** |
|-------------------|------------|-------|------------|
| 2010              |       | 327   |       |
| 2011              |       | 368   |       |
| 2012              |       | 505   |       |
| 2013              |       | 532   |       |
| 2014              |       | 538   |       |
| 2015 through 2019 |       | 3,161 |       |
|              |       | 5,431 |       |

 

Cashrequired in the next year to fund the plans will approximate the amount ofexpected benefits.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**Definedcontribution plans**

 

Total expenses for theCompany’s defined contribution plan in its German subsidiary amounted toapproximately $334,400 for the year ended December 31, 2009 ($344,237 for2008 and $285,824 in 2007).

 

TheCompany sponsors a matching defined benefit plan in its Canadian headquarters.Under this plan, the Company may contribute amounts equal to a percentage ofemployee contributions to the plan. During the years ended December 31,2009 and 2008, matching contributions to the plan totalled $59,039 and $67,184,respectively. For the year ended December 31, 2007, the Company did notrecord any contributions.

 

TheCompany also sponsors a 401(k) plan in its US subsidiary. Under this plan,the Company may contribute a discretionary amount equal to a percentage ofemployee contributions to the plan and may also make discretionary profitsharing contributions. During the years ended December 31, 2009 and 2008,matching contributions to the plan amounted to $42,128 and $69,155,respectively. During the year ended December 31, 2007, the Company did notrecord any contributions.

 

**17           Share capital**

 

The Company hasauthorized an unlimited number of common, voting (one vote per share) andparticipating shares with no par value, as well as an unlimited number ofpreferred, first and second ranking shares, issuable in series, with rights andprivileges specific to each class.

 

**Common shares issued in connection with registered direct offerings**

 

OnJune 23, 2009, the Company completed a registered direct offering of5,319,149 units, with each unit consisting of one common share and awarrant to purchase 0.35 of a common share at a price of $1.88 per unit(the “First Offering”). The related warrants represent the right to acquire anaggregate of 1,861,702 common shares, as discussed below. The Company alsogranted warrants to the sole placement agent engaged in connection with theFirst Offering, as discussed below.

 

Totalproceeds raised through the First Offering amounted to $10,000,000, less cashand non-cash transaction costs of $1,554,000. The purchasers in this offeringwere comprised of institutional investors, and the securities described abovewere offered by the Company pursuant to a shelf prospectus dated September 27,2007 and a prospectus supplement dated June 18, 2009.

 

TheCompany granted a total of 5,319,149 warrants (the “First Investor Warrants”)to the institutional investors who participated in the First Offering. EachFirst Investor Warrant entitles the holder to purchase 0.35 of a common shareat an exercise price of $2.06 per share. The First Investor Warrants areexercisable between September 23, 2009 and December 23, 2011, and,upon complete exercise, would result in the issuance of an aggregate of1,861,702 common shares of the Company.

 

The Companyestimated the fair value attributable to the First Investor Warrants of$1,620,998 as of the date of grant by applying the Black-Scholes pricing model,to which the following additional assumptions were applied:  a risk-free annual interest rate of 1.74%,expected volatility of 90.6%, an expected term of 2.5 years, dividendyield of 0.0% and an issue-date market share price of $1.75. Transaction costsallocated to the First Investor Warrants amounted to approximately $247,000.

 

The First InvestorWarrants may be exercised, at the option of the holder, by cash payment of the exercise priceor, upon the existence of certain conditions, by “cashless exercise”, whichmeans that in lieu of paying the aggregate exercise price for the shares beingpurchased upon exercise of the warrants in cash, the holder would receive thenumber of shares underlying the warrants equal to the quotient obtained byapplying a formula, as defined by the terms of each First Investor Warrant. TheCompany will not receive additional proceeds to the extent that warrants areexercised by cashless exercise.

 

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**Æterna Zentaris Inc.**

Notes to Consolidated Financial Statements

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, except share/option/warrantand per share/option/warrant data and as otherwise noted)

 

The exercise price andnumber of common shares issuable on exercise of the First Investor Warrants maybe adjusted in certain circumstances, including stock dividends or splits,subsequent rights offerings, pro-rata distributions and pursuant totransactions involving the merger or consolidation of the Company with anotherentity or other Fundamental Transaction, as defined in the warrant.

 

Additionally, andnotwithstanding anything to the contrary, in the event of any type ofFundamental Transaction, as defined in the warrant, the Company or anysuccessor entity shall, at the Company’s option, have the right to require theholders thereof to exercise the First Investor Warrants, or, at the holder’soption, purchase the First Investor Warrants from the holders by paying theholders an amount of cash equivalent to the Black-Scholes value, as defined, ofthe remaining unexercised portion of the Investor warrant on the date of theconsummation of an aforementioned Fundamental Transaction.

 

The Companygranted a total of 820,668 warrants (the “First Compensation Warrants”) to thesole placement agent and its designated representatives engaged in connectionwith the First Offering.  Each FirstCompensation Warrant entitles the holder to purchase 0.35 of a common share atan exercise price of $2.35 per share. The First Compensation Warrants are exercisable between December 23,2009 and December 23, 2011, and, upon complete exercise, would result inthe issuance of 287,234 common shares of the Company.

 

The Companyestimated the fair value attributable to the First Compensation Warrants of$234,251 as of the date of grant by applying the Black-Scholes pricing model,to which the following additional assumptions were applied:  a risk-free annual interest rate of 1.74%,expected volatility of 90.6%, an expected term of 2.5 years, an expecteddividend yield of 0.0% and an issue-date market share price of $1.75.  The initial fair value of the FirstCompensation Warrants has been accounted for as additional transaction costs,since the instruments were granted to the sole placement agent as part of theterms of the underlying engagement and in recognition of the efforts made inconnection with the First Offering.

 

The terms of theFirst Compensation Warrants, with the exception of the exercise price andperiod of exercise, are substantially the same as those contained in the FirstInvestor Warrants discussed above.

 

On October 23, 2009,the Company completed a second registered direct offering of4,583,335 units, with each unit consisting of one common share and awarrant to purchase 0.40 of a common share, at a price of $1.20 per unit(the “Second Offering”). The related warrants represent the right to acquire anaggregate of 1,833,334 common shares, as discussed below. The Company alsogranted warrants to the sole placement agent engaged in connection with theSecond Offering, as discussed below.

 

Total proceeds raisedthrough the Second Offering amounted to $5,500,002, less cash transaction costsof approximately $410,000. The purchasers in this offering were new andexisting institutional investors, and the securities described above wereoffered by the Company pursuant to a shelf prospectus dated September 27,2007 and a prospectus supplement dated October 19, 2009.

 

The Company granted atotal of 4,583,335 warrants (the “Second Investor Warrants”) to theinstitutional investors who participated in the Second Offering.  Each Second Investor Warrant entitles theholder to purchase 0.40 of a common share at an exercise price of $1.25 pershare.  The Second Investor Warrants areexercisable between October 23, 2009 and October 23, 2014, and, uponcomplete exercise, would result in the issuance of an aggregate of 1,833,334common shares.

 

The Company estimated thefair value attributable to the Second Investor Warrants of $1,302,259 as of thedate of grant by applying the Black-Scholes pricing model, to which thefollowing additional assumptions were applied: a risk-free annual interest rate of 2.46%, expected volatility of 84.3%,an expected term of 5 years, dividend yield of 0.0% and an issue-datemarket share price of $1.09.  Transactioncosts allocated to the Second Investor Warrants amounted to approximately$97,000.

 

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**Æterna ZentarisInc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

The Second Investor Warrants may be exercised, at the option of the holder, by cash payment of theexercise price or, upon the existence of certain conditions, by “cashlessexercise”, as defined and discussed above. The Company will not receiveadditional proceeds to the extent that warrants are exercised by cashlessexercise.

 

The exercise price andnumber of common shares issuable on exercise of the Second Investor Warrantsmay be adjusted in certain circumstances, including stock dividends or splits,subsequent rights offerings, pro-rata distributions and pursuant totransactions involving the merger or consolidation of the Company with anotherentity or other Fundamental Transaction, as defined in the warrant.

 

Additionally, andnotwithstanding anything to the contrary, in the event of any type ofFundamental Transaction, as defined in the warrant, the Company or anysuccessor entity shall, at the Company’s option, have the right to require theholders thereof to exercise their Second Investor Warrants, or, at the holder’soption, purchase the Second Investor Warrants from the holders by paying theholders an amount of cash equivalent to the Black-Scholes value, as defined, ofthe remaining unexercised portion of the Second Investor Warrant on the date ofthe consummation of an aforementioned Fundamental Transaction.

 

The Company granted atotal of 320,832 warrants (the “Second Compensation Warrants”) to the soleplacement agent engaged in connection with the Second Offering.  Each Second Compensation Warrant entitles theholder to purchase 0.40 of a common share at an exercise price of $1.50 pershare.  The Second Compensation Warrantsare exercisable between April 23, 2010 and October 23, 2012, and,upon complete exercise, would result in the issuance of 128,333 common shares.

 

The Company estimated thefair value attributable to the Second Compensation Warrants of $86,653 as ofthe date of grant by applying the Black-Scholes pricing model, to which thefollowing additional assumptions were applied: a risk-free annual interest rate of 1.57%, expected volatility of103.4%, an expected term of 3 years, dividend yield of 0.0% and anissue-date market share price of $1.09. The initial fair value of the Second Compensation Warrants has beenaccounted for as additional transaction costs, since the instruments weregranted to the sole placement agent as part of the terms of the underlyingengagement and in recognition of the efforts made in connection with the SecondOffering.

 

The terms of the SecondCompensation Warrants, with the exception of the exercise price and period ofexercise, are substantially the same as those contained in the Second Investorwarrants discussed above.

 

The Black-Scholes pricingmodel referred to above uses “Level 2” inputs in calculating fair value, asdefined by CICA Handbook Section 3862, which establishes a fair valuehierarchy that prioritizes the inputs used to measure fair value. The hierarchygives the highest priority to unadjusted quoted prices in active markets foridentical assets or liabilities (Level 1 measurement) and the lowest priorityto unobservable inputs (Level 3 measurement). Level 2 inputs are those whichare either directly or indirectly observable as of the reporting date andinclude financial instruments that are valued using models or other valuation methodologies,such as the Black-Scholes pricing model.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**Sharepurchase warrants**

 

Informationthat summarizes the activity related to the Company’s share purchase warrantsfor the year ended December 31, 2009 is provided below.

 
| ** **                                              | ** ** | **Number** | ** ** | **Weighted average  exercise price  (US$)** | ** ** |
|---------------------------------------------------------|------------|------------|------------|---------------------------------------------|------------|
|                                                    | ** ** |       |       |                                        |       |
| Balance  — Beginning of year                       |       | —     |       | —                                      |       |
| Granted                                                 |       | 4,110,603  |       | 1.70                                        |       |
| Balance  — End of year                             |       | 4,110,603  |       | 1.70                                        |       |
|                                                    |       |       |       |                                        |       |
| Share  purchase warrants exercisable — End of year |       | 3,982,270  |       | 1.71                                        |       |

 

The following tablessummarize the share purchase warrants outstanding and exercisable as at December 31,2009:

 
| ** **                 | ** ** | **Warrants outstanding** | ** ** |
|----------------------------|------------|--------------------------|------------|
| **Exercise  price  (US$)** | ** ** | **Number**               | ** ** | **Weighted average  remaining contractual  life (years)** | ** ** | **Weighted average  exercise price  (US$)** | ** ** | **Global  intrinsic  value** | ** ** |
|                       |       |                     |       |   |   |   |   |   |   |
| 1.25                       |       | 1,833,334                |       | 4.81 |   | 1.25 |   | — |   |
| 1.50                       |       | 128,333                  |       | 2.81 |   | 1.50 |   | — |   |
| 2.06                       |       | 1,861,702                |       | 1.98 |   | 2.06 |   | — |   |
| 2.35                       |       | 287,234                  |       | 1.98 |   | 2.35 |   | — |   |
|                       |       |                     |       |   |   |   |   |   |   |
|                       |       | 4,110,603                |       | 3.27 |   | 1.70 |   | — |   |

 
| ** **                 | ** ** | **Warrants currently exercisable** | ** ** |
|----------------------------|------------|------------------------------------|------------|
| **Exercise  price  (US$)** | ** ** | **Number**                         | ** ** | **Weighted average  remaining contractual  life (years)** | ** ** | **Weighted average  exercise price  (US$)** | ** ** | **Global  intrinsic  value** | ** ** |
|                       |       |                               |       |   |   |   |   |   |   |
| 1.25                       |       | 1,833,334                          |       | 4.81 |   | 1.25 |   | — |   |
| 1.50                       |       | —                             |       | — |   | — |   | — |   |
| 2.06                       |       | 1,861,702                          |       | 1.98 |   | 2.06 |   | — |   |
| 2.35                       |       | 287,234                            |       | 1.98 |   | 2.35 |   | — |   |
|                       |       |                               |       |   |   |   |   |   |   |
|                       |       | 3,982,270                          |       | 3.28 |   | 1.71 |   | — |   |

 

**Shareholder rights plan**

 

On March 29,2004, the Company adopted a shareholder rights plan (the “Rights Plan”). Thecontinuation of the Rights Plan and its amendments and restatements wereapproved by the Board of Directors on March 5, 2007 and ratified on May 2,2007 by the Company’s shareholders. The rights issued to the shareholders underthe Rights Plan will be exercisable, under certain conditions, only when aperson or entity, including related parties, acquires or announces his/her orits intention to acquire more than twenty (20) percent of the outstandingcommon shares of the Company (as

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, except share/option/warrantand per share/option/warrant data and as otherwise noted)

 

suchshares may be redesignated or reclassified) without complying with the “permittedbid” provisions of the Rights Plan or without approval of the Company’s Boardof Directors. Should such an acquisition occur, each right would, uponexercise, entitle a holder, other than the person pursuing the acquisitiontogether with any related parties, to purchase common shares of the Company ata fifty (50) percent discount to the market price of the Company’s shares atthat time.

 

**Stock option plan**

 

InDecember 1995, the Company’s Board of Directors adopted a stock optionplan (the “Stock Option Plan”) for its directors, senior executives, employeesand other collaborators who provide services to the Company. The total numberof common shares that may be issued under the Stock Option Plan cannot exceed11.4% of the total number of issued and outstanding common shares at any giventime.

 

InDecember 2009, 1,448,422 options were granted in Canadian dollars, and nooptions were granted in US dollars. Options granted under the Stock Option Planexpire after a maximum period of ten years following the date of grant. Optionsgranted under the Stock Option Plan generally vest over a three-year period.However, most of the options granted in December 2009 vest over a periodof 18 months.

 

Informationthat summarizes the activity under the Stock Option Plan is provided below.

 

**Canadiandollar denominated awards**

 
| ** **                              | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------------------|------------|
| ** **                              | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                              | ** ** | **Number**                        | ** ** | **Weighted  average  exercise  price  (CAN$)** | ** ** | **Number** | ** ** | **Weighted  average  exercise  price  (CAN$)** | ** ** | **Number** | ** ** | **Weighted  average  exercise  price  (CAN$)** | ** ** |
|                                    |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Balance  — Beginning of year (*)   |       | 4,490,759                         |       | 3.28 |   | 4,136,092 |   | 3.83 |   | 3,490,092 |   | 4.00 |   |
| Granted                                 |       | 1,448,422                         |       | 0.95 |   | 735,000 |   | 0.59 |   | 815,000 |   | 3.24 |   |
| Exercised                               |       | —                            |       | — |   | — |   | — |   | (18,000 | ) | 1.96 |   |
| Forfeited                               |       | (15,000                           | )          | 0.55 |   | (165,000 | ) | 3.41 |   | (151,000 | ) | 4.93 |   |
| Expired                                 |       | (3,593                            | )          | 1.73 |   | (215,333 | ) | 4.51 |   | — |   | — |   |
|                                    |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Balance  — End of year             |       | 5,920,588                         |       | 2.72 |   | 4,490,759 |   | 3.28 |   | 4,136,092 |   | 3.83 |   |
|                                    |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Options  exercisable — End of year |       | 3,898,844                         |       | 3.66 |   | 3,462,441 |   | 3.91 |   | 3,300,593 |   | 4.02 |   |

 

----

(*)         Following the one-timedistribution of the Company’s remaining interest in Atrium on January 2,2007 (see note 6), as contemplated under the Stock Option Plan, the Company’sBoard of Directors approved an equitable adjustment to all unexercised optionsoutstanding. The adjustment was a reduction in the exercise price of alloutstanding stock options of CAN$2.02 per common share.  Furthermore, in 2007 the Board of Directorsapproved the extension of the option period from one month to three years withrespect to 875,000 options in connection with the departure of certain membersof executive management.

 

The total intrinsic valuefor stock options exercised in 2007 was CAN$24,040. There is no tax benefitrealized by the Company, since the compensation cost related to stock optionsis not deductible for income tax purposes.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

Thefollowing tables summarize the stock options outstanding and exercisable as at December 31,2009:

 
| ** **                  | ** ** | **Options outstanding** | ** ** |
|-----------------------------|------------|-------------------------|------------|
| **Exercise  price  (CAN$)** | ** ** | **Number**              | ** ** | **Weighted average remaining  contractual life (years)** | ** ** | **Weighted average  exercise price  (CAN$)** | ** ** | **Global  intrinsic  value  (CAN$)** | ** ** |
|                        |       |                    |       |   |   |   |   |   |   |
| 0.55  to 1.72               |       | 2,168,422               |       | 9.59 |   | 0.83 |   | 184 |   |
| 1.73  to 1.82               |       | 1,014,500               |       | 5.05 |   | 1.77 |   | — |   |
| 1.83  to 3.54               |       | 863,500                 |       | 4.24 |   | 3.22 |   | — |   |
| 3.55  to 4.92               |       | 790,333                 |       | 4.04 |   | 4.09 |   | — |   |
| 4.93  to 8.88               |       | 1,083,833               |       | 3.77 |   | 5.99 |   | — |   |
|                        |       |                    |       |   |   |   |   |   |   |
|                        |       | 5,920,588               |       | 6.23 |   | 2.72 |   | 184 |   |

 
| ** **                  | ** ** | **Options currently exercisable** | ** ** |
|-----------------------------|------------|-----------------------------------|------------|
| **Exercise  price  (CAN$)** | ** ** | **Number**                        | ** ** | **Weighted average  remaining  contractual life (years)** | ** ** | **Weighted average  exercise price****(CAN$)** | ** ** | **Global  intrinsic  value  (CAN$)** | ** ** |
|                        |       |                              |       |   |   |   |   |   |   |
| 0.55  to 1.72               |       | 240,008                           |       | 8.90 |   | 0.59 |   | 61 |   |
| 1.73  to 1.82               |       | 921,170                           |       | 4.76 |   | 1.76 |   | — |   |
| 1.83  to 3.54               |       | 863,500                           |       | 4.24 |   | 3.22 |   | — |   |
| 3.55  to 4.92               |       | 790,333                           |       | 4.04 |   | 4.09 |   | — |   |
| 4.93  to 8.88               |       | 1,083,833                         |       | 3.77 |   | 5.99 |   | — |   |
|                        |       |                              |       |   |   |   |   |   |   |
|                        |       | 3,898,844                         |       | 4.48 |   | 3.66 |   | 61 |   |

 

**US dollardenominated awards**

 
| ** **                              | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------------------|------------|
| ** **                              | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                              | ** ** | **Number**                        | ** ** | **Weighted  average  exercise  price  (US$)** | ** ** | **Number** | ** ** | **Weighted  average  exercise  price  (US$)** | ** ** | **Number** | ** ** | **Weighted  average  exercise  price  (US$)** | ** ** |
|                                    |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Balance  — Beginning of year       |       | 313,334                           |       | 2.76 |   | 870,000 |   | 2.79 |   | — |   | — |   |
| Granted                                 |       | —                            |       | — |   | — |   | — |   | 870,000 |   | 2.79 |   |
| Forfeited                               |       | (20,000                           | )          | 1.78 |   | (556,666 | ) | 2.80 |   | — |   | — |   |
| Balance  — End of year             |       | 293,334                           |       | 2.83 |   | 313,334 |   | 2.76 |   | 870,000 |   | 2.79 |   |
|                                    |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Options  exercisable — End of year |       | 233,336                           |       | 2.93 |   | 176,669 |   | 3.08 |   | — |   | — |   |

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, except share/option/warrantand per share/option/warrant data and as otherwise noted)

 
| ** **                 | ** ** | **Options outstanding** | ** ** |
|----------------------------|------------|-------------------------|------------|
| **Exercise  price  (US$)** | ** ** | **Number**              | ** ** | **Weighted average  remaining contractual  life (years)** | ** ** | **Weighted average  exercise price  (US$)** | ** ** | **Global  intrinsic  value** | ** ** |
|                       |       |                    |       |   |   |   |   |   |   |
| 1.82  to 1.87              |       | 115,000                 |       | 7.94 |   | 1.82 |   | — |   |
| 1.88  to 3.96              |       | 178,334                 |       | 7.33 |   | 3.48 |   | — |   |
|                       |       |                    |       |   |   |   |   |   |   |
|                       |       | 293,334                 |       | 7.57 |   | 2.83 |   | — |   |

 
| ** **                 | ** ** | **Options currently exercisable** | ** ** |
|----------------------------|------------|-----------------------------------|------------|
| **Exercise  price  (US$)** | ** ** | **Number**                        | ** ** | **Weighted average  remaining contractual  life (years)** | ** ** | **Weighted average  exercise price  (US$)** | ** ** | **Global  intrinsic  value** | ** ** |
|                       |       |                              |       |   |   |   |   |   |   |
| 1.82  to 1.87              |       | 78,335                            |       | 7.94 |   | 1.82 |   | — |   |
| 1.88  to 3.96              |       | 155,001                           |       | 7.31 |   | 3.50 |   | — |   |
|                       |       |                              |       |   |   |   |   |   |   |
|                       |       | 233,336                           |       | 7.52 |   | 2.93 |   | — |   |

 

As at December 31, 2009, the totalcompensation cost related to unvested stock options not yet recognized amountedto $853,924 ($347,390 in 2008). This amount is expected to be recognized over aweighted average period of 1.44 years (1.56 years in 2008).

 

The Company settles stock options exercised throughthe issuance of common shares from treasury.

 

The factors considered in developing theassumptions used in the Black-Scholes option pricing model are the following:

 

a)              The risk-free interest rate is based on Canadian Government Bondconstant maturity interest rate whose term is consistent with the expected lifeof the stock options.

 

b)             The historical volatility of the Company’s stock price as well as futureexpectations are used to establish the expected stock price volatility.

 

c)              The Company estimates the expected life of stock options based uponemployee’s historical data related to the exercise of stock options andpost-vesting employment terminations.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**Assumptionsused in determining stock-based compensation costs**

 

Thetable below shows the assumptions used in determining stock-based compensationcosts under the Black-Scholes option pricing model:

 
| ** **                             | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                   |       |                              |       |   |   |   |   |
| Expected  dividend yield               |       | 0.0                               | %          | 0.0 | % | 0.0 | % |
| Expected  volatility                   |       | 130.9                             | %          | 60.0 | % | 57.2 | % |
| Risk-free  annual interest rate        |       | 1.2                               | %          | 1.98 | % | 3.88 | % |
| Expected  life (years)                 |       | 1.50                              |       | 3.04 |   | 4.62 |   |
| Weighted  average grant datefair value |       | CAN$0.55                          |       | CAN$0.25 |   | US$1.93 and  CAN$2.25 |   |

 

The Black-Scholes pricingmodel referred above uses “Level 2” inputs in calculating fair value, asdefined by CICA Handbook Section 1862, except for options granted in 2009,to which the Company estimated the expected life using a “Level 3” input.

 

**18           Supplemental disclosure of cash flowinformation**

 
| ** **                                      | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                      | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                      | ** ** | **$**                             | ** ** | **$** | ** ** | **$** | ** ** |
| **Changes in operating assets and liabilities** |       |                              |       |   |   |   |   |
| Accounts  receivable                            |       | 1,098                             |       | 4,353 |   | 1,371 |   |
| Inventory                                       |       | (864                              | )          | 1,171 |   | 148 |   |
| Prepaid  expenses and other current assets      |       | (14,478                           | )          | (10,234 | ) | (9,340 | ) |
| Deferred  charges and other long-term assets    |       | (472                              | )          | (4,689 | ) | — |   |
| Accounts  payable and accrued liabilities       |       | (1,969                            | )          | (1,089 | ) | 5,340 |   |
| Other  long-term liability                      |       | 66                                |       | — |   | — |   |
| Income  taxes                                   |       | 123                               |       | 775 |   | (1,250 | ) |
| Deferred  revenues                              |       | —                            |       | 58,058 |   | 644 |   |
|                                            |       |                              |       |   |   |   |   |
|                                            |       | (16,496                           | )          | 48,345 |   | (3,087 | ) |

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**19           Income taxes**

 

Thereconciliation of the combined Canadian federal and Quebec provincial incometax rate to the income tax (expense) recovery from continuing operations is asfollows:

 
| ** **                                                 | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                 | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                       | ** ** |                              | ** ** |   | ** ** |   | ** ** |
| Combined  federal and provincial statutory income tax rate |       | 30.90                             | %          | 30.90 | % | 32.02 | % |
|                                                       | ** ** | ** **                        | ** ** | **$** | ** ** | **$** | ** ** |

 
| ** **                                                                        | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                        | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                        | ** ** | **$**                             | ** ** | **$** | ** ** | **$** | ** ** |
| Income  tax recovery based on statutory income tax rate                           |       | 7,640                             |       | 18,120 |   | 10,886 |   |
| Change  in valuation allowance                                                    |       | (9,959                            | )          | (17,554 | ) | (6,963 | ) |
| Permanent  difference attributable to the use of local currency for tax reporting |       | 1,727                             |       | — |   | — |   |
| Minimum  tax attributable to German subsidiary                                    |       | —                            |       | (1,175 | ) | — |   |
| Stock-based  compensation costs                                                   |       | (85                               | )          | (112 | ) | (635 | ) |
| Share  issue expenses not affecting earnings                                      |       | 354                               |       | — |   | — |   |
| Difference  in statutory income tax rate of foreign subsidiaries                  |       | 222                               |       | 576 |   | (16 | ) |
| Permanent  difference attributable to unrealized foreign exchange gain/loss       |       | (291                              | )          | 494 |   | — |   |
| Change  in enacted rates used                                                     |       | (89                               | )          | (985 | ) | (1,345 | ) |
| Other                                                                             |       | 481                               |       | (539 | ) | 34 |   |
|                                                                              |       |                              |       |   |   |   |   |
|                                                                              |       | —                            |       | (1,175 | ) | 1,961 |   |

 

*Lossbefore income taxes*

 

Theloss before income taxes from continuing operations is allocated as follows:

 
| ** **     | ** ** | **Years ended December 31,** | ** ** |
|----------------|------------|-----------------------------------|------------|
| ** **     | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **     | ** ** | **$**                             | ** ** | **$** | ** ** | **$** | ** ** |
|           | ** ** |                              | ** ** |   | ** ** |   | ** ** |
| Germany        |       | (20,335                           | )          | (52,730 | ) | (23,276 | ) |
| Canada         |       | (4,200                            | )          | (5,103 | ) | (10,556 | ) |
| United  States |       | (189                              | )          | (809 | ) | (166 | ) |
|           |       |                              |       |   |   |   |   |
|           |       | (24,724                           | )          | (58,642 | ) | (33,998 | ) |

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 
| ** **                                       | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                       | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **$**                             | ** ** | **$** | ** ** | **$** | ** ** |
|                                             | ** ** |                              | ** ** |   | ** ** |   | ** ** |
| Income  tax recovery (expense) isrepresented by: |       |                              |       |   |   |   |   |
| Current                                          |       | —                            |       | (1,175 | ) | 93 |   |
| Future                                           |       | —                            |       | — |   | 1,868 |   |
|                                             |       |                              |       |   |   |   |   |
|                                             |       | —                            |       | (1,175 | ) | 1,961 |   |
|                                             |       |                              |       |   |   |   |   |
| Current:                                         |       |                              |       |   |   |   |   |
| Foreign                                          |       | —                            |       | (1,175 | ) | 93 |   |
|                                             |       |                              |       |   |   |   |   |
| Future:                                          |       |                              |       |   |   |   |   |
| Domestic                                         |       | —                            |       | — |   | (284 | ) |
| Foreign                                          |       | —                            |       | — |   | 2,152 |   |
|                                             |       |                              |       |   |   |   |   |
|                                             |       | —                            |       | — |   | 1,868 |   |
|                                             |       |                              |       |   |   |   |   |
|                                             |       | —                            |       | (1,175 | ) | 1,961 |   |

 

Foreignoperations are predominantly in Germany.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

Significant components offuture income tax assets and liabilities are as follows:

 
| ** **                                       | ** ** | **As at December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                                       | ** ** | **$**                       | ** ** | **$** | ** ** |
| Future  income tax assets                        |       |                        |       |   |   |
| Current                                          |       |                        |       |   |   |
| Deferred  revenues                               |       | 713                         |       | 2,459 |   |
| Inventory                                        |       | 73                          |       | 526 |   |
| Other                                            |       | 108                         |       | — |   |
|                                             |       |                        |       |   |   |
|                                             |       | 894                         |       | 2,985 |   |
|                                             |       |                        |       |   |   |
| Long-term                                        |       |                        |       |   |   |
| Operating  losses carried forward                |       | 27,461                      |       | 15,543 |   |
| Intangible  assets                               |       | 12,328                      |       | 10,817 |   |
| Research  and development costs                  |       | 10,484                      |       | 8,961 |   |
| Employee  future benefits                        |       | 1,014                       |       | 747 |   |
| Property,  plant and equipment                   |       | 702                         |       | 576 |   |
| Share  issue expenses                            |       | 374                         |       | 129 |   |
|                                             |       |                        |       |   |   |
|                                             |       | 52,363                      |       | 36,773 |   |
|                                             |       |                        |       |   |   |
| Valuation  allowance                             |       | (50,350                     | )          | (36,581 | ) |
|                                             |       |                        |       |   |   |
|                                             |       | 2,013                       |       | 192 |   |
|                                             |       |                        |       |   |   |
|                                             |       | 2,907                       |       | 3,177 |   |
|                                             |       |                        |       |   |   |
| Future  income tax liabilities                   |       |                        |       |   |   |
| Current                                          |       |                        |       |   |   |
| Prepaid  expenses and other current assets       |       | 175                         |       | — |   |
|                                             |       |                        |       |   |   |
|                                             |       | 175                         |       | — |   |
|                                             |       |                        |       |   |   |
| Long-term                                        |       |                        |       |   |   |
| Deferred  charges and other long-term assets     |       | 1,343                       |       | 1,566 |   |
| Deferred  revenues                               |       | 1,089                       |       | 528 |   |
| Property,  plant and equipment                   |       | 262                         |       | 330 |   |
| Accounts  receivable                             |       | —                      |       | 65 |   |
| Intangible  assets                               |       | —                      |       | — |   |
| Investment  tax credits                          |       | —                      |       | — |   |
| Other                                            |       | 38                          |       | 688 |   |
|                                             |       |                        |       |   |   |
|                                             |       | 2,732                       |       | 3,177 |   |
|                                             |       |                        |       |   |   |
|                                             |       | 2,907                       |       | 3,177 |   |
|                                             |       |                        |       |   |   |
| **Future income  tax assets (liabilities), net** |       | —                      |       | — |   |

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

As at December 31,2009, the Company has estimated non-refundable research and development taxcredits of $6,737,658 which can be carried forward to reduce Canadian federalincome taxes payable and which expire at dates ranging from 2011 to 2028. Notax benefit has been accounted for in connection with those credits.

 

As at December 31,2009, the Company had available operating losses in Canada. The following tablesummarizes the year of expiry of these operating losses by tax jurisdiction:

 
| ** ** | ** ** | **Canada**  | ** ** |
|------------|------------|-------------|------------|
| ** ** | ** ** | **Federal** | ** ** | **Provincial** | ** ** |
| ** ** | ** ** | **$**       | ** ** | **$** | ** ** |
|       | ** ** |        | ** ** |   | ** ** |
| 2010       |       | 7,343       | ** ** | **—** | ** ** |
| 2014       |       | 9,245       | ** ** | **—** | ** ** |
| 2015       |       | 6,542       |       | 30 |   |
| 2028       |       | 13,147      |       | 10,823 |   |
| 2029       |       | 6,309       |       | 6,285 |   |
|       |       |        |       |   |   |
|       |       | 42,586      |       | 17,138 |   |

 

Furthermore,the Company has available operating losses in Germany, amounting toapproximately $60,421,000, for which there is no expiry date, as well as in theUnited States, totalling $968,102 and expiring as follows:

 
| ** ** | ** ** | **United States** | ** ** |
|------------|------------|-------------------|------------|
| ** ** | ** ** | **$**             | ** ** |
|       | ** ** |              | ** ** |
| 2027       |       | 175               |       |
| 2028       |       | 616               |       |
| 2029       |       | 177               |       |
|       |       |              |       |
|       |       | 968               |       |

 

Thecarryforwards and the tax credits claimed could be subjected to a review and apossible adjustment by tax authorities.

 

**20           Segment information for continuingoperations**

 

Subsequent to the divestiture of Atrium (see note6), the Company operates in one single operating segment, being thebiopharmaceutical segment.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, except share/option/warrantand per share/option/warrant data and as otherwise noted)

 

**Information by geographic region**

 

Revenuesby geographic region are detailed as follows:

 
| ** **      | ** ** | **Years ended December 31,** | ** ** |
|-----------------|------------|-----------------------------------|------------|
| ** **      | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **      | ** ** | **$**                             | ** ** | **$** | ** ** | **$** | ** ** |
|            | ** ** |                              | ** ** |   | ** ** |   | ** ** |
| United  States  |       | 41,434                            |       | 2,987 |   | 5,911 |   |
| Europe          |       |                              |       |   |   |   |   |
| Switzerland     |       | 12,728                            |       | 24,928 |   | 25,347 |   |
| United  Kingdom |       | 35                                |       | 3,823 |   | 5,343 |   |
| Other           |       | 743                               |       | 874 |   | 70 |   |
| Japan           |       | 4,717                             |       | 4,029 |   | 1,862 |   |
| Other           |       | 3,580                             |       | 1,837 |   | 3,535 |   |
|            |       |                              |       |   |   |   |   |
|            |       | 63,237                            |       | 38,478 |   | 42,068 |   |

 

Revenueshave been allocated to geographic regions based on the country of residence ofthe Company’s customers or partners.

 

Companiesrepresenting 10% or more of the Company’s revenues are as follows:

 
| ** ** | ** ** | **Years ended December 31,** | ** ** |
|------------|------------|-----------------------------------|------------|
| ** ** | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** ** | ** ** | **%**                             | ** ** | **%** | ** ** | **%** | ** ** |
|       | ** ** |                              | ** ** |   | ** ** |   | ** ** |
| Company  1 |       | 54                                |       | — |   | — |   |
| Company  2 |       | 21                                |       | 66 |   | 59 |   |
| Company  3 |       | —                            |       | 10 |   | 13 |   |

 

Netlong-lived assets by geographic region are detailed as follows:

 
| ** **     | ** ** | **As at December 31,** | ** ** |
|----------------|------------|-----------------------------|------------|
| ** **     | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **     | ** ** | **$**                       | ** ** | **$** | ** ** |
|           | ** ** |                        | ** ** |   | ** ** |
| Germany        |       | 31,016                      |       | 39,934 |   |
| United  States |       | 551                         |       | 615 |   |
| Canada         |       | 71                          |       | 110 |   |
|           |       |                        |       |   |   |
|           |       | 31,638                      |       | 40,659 |   |

 

Long-livedassets consist of property, plant and equipment, intangible assets andgoodwill.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**21           Loss per share**

 

Theinformation utilized in the computation of net loss per share, as presented inthe accompanying consolidated statements of operations, is as follows:

 
| ** **                                                                                                                                                                                             | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                                                             | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                                                                                                                             | ** ** | **$**                             | ** ** | **$** | ** ** | **$** | ** ** |
|                                                                                                                                                                                                   | ** ** |                              | ** ** |   | ** ** |   | ** ** |
| **Net loss from continuing operations**                                                                                                                                                                |       | (24,724                           | )          | (59,817 | ) | (32,037 | ) |
| ** **                                                                                                                                                                                             |       |                              |       |   |   |   |   |
| **Net loss from discontinued operations**                                                                                                                                                              |       | —                            |       | — |   | (259 | ) |
|                                                                                                                                                                                                   |       |                              |       |   |   |   |   |
| **Net loss**                                                                                                                                                                                           |       | (24,724                           | )          | (59,817 | ) | (32,296 | ) |
| ** **                                                                                                                                                                                             |       |                              |       |   |   |   |   |
| **Basic weighted average number of shares  outstanding**                                                                                                                                               |       | 56,864,484                        |       | 53,187,470 |   | 53,182,803 |   |
|                                                                                                                                                                                                   |       |                              |       |   |   |   |   |
| Dilutive  effect of stock options                                                                                                                                                                      |       | 310,556                           |       | 18,315 |   | 500,171 |   |
|                                                                                                                                                                                                   |       |                              |       |   |   |   |   |
| **Diluted weighted average number of shares  outstanding**                                                                                                                                             |       | 57,175,040                        |       | 53,205,785 |   | 53,682,974 |   |
|                                                                                                                                                                                                   |       |                              |       |   |   |   |   |
| **Items excluded from the calculation of diluted  net loss per share because the exercise price was greater than the average  market price of the common shares or due to their anti-dilutive effect** |       |                              |       |   |   |   |   |
| ** **                                                                                                                                                                                             |       |                              |       |   |   |   |   |
| Stock  options                                                                                                                                                                                         |       | 5,493,922                         |       | 4,069,093 |   | 3,164,499 |   |
| Warrants  (number of equivalent shares)                                                                                                                                                                |       | 4,110,603                         |       | — |   | — |   |
|                                                                                                                                                                                                   |       | 9,604,525                         |       | 4,069,093 |   | 3,164,499 |   |

 

For theyears ended December 31, 2009, 2008 and 2007, the diluted net loss pershare was the same as the basic net loss per share since the effect of theassumed exercise of stock options and warrants (2009 only) to purchase commonshares is anti-dilutive. Accordingly, the diluted net loss per share for theyears presented was calculated using the basic weighted average number ofshares outstanding.

 

**22           Capital disclosures**

 

The Company’s objective inmanaging capital, composed of shareholders’ equity and cash and cashequivalents, is to ensure sufficient liquidity to fund research and developmentactivities, general and administrative expenses, working capital and capitalexpenditures.

 

The Company has endeavouredto optimize its liquidity needs by non-dilutive sources, including the sale ofnon-core assets and rights to future royalties, investment tax credits andgrants, interest income, licensing, service and royalties. More recently,however, the Company has raised additional capital via the registered directofferings discussed in note 17.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

** **

Thecapital management objective of the Company remains the same as that ofprevious years.  The policy on dividendsis to retain cash to keep funds available to finance the activities required toadvance the Company’s product development pipeline.

** **

TheCompany is not subject to any capital requirements imposed by any regulators orby any other external source.

** **

**23           Financial instruments and financialrisk management**

 

**Fairvalue**

** **

The Company has established the followingclassifications for its financial instruments in accordance with CICA Handbook Section 3862:

 

·                  cash and cash equivalents and restricted cash (2009only) are classified under “Assets Held for Trading”;

·                  short-term investments (2008 only) are classifiedunder “Available-for-Sale Assets”;

·                  accounts receivable are classified under “Loans andReceivables”; and

·                  accounts payable and accrued liabilities, long-termpayable and other long-term liability are classified under “Other FinancialLiabilities”.

 

The carrying values of all of the aforementionedfinancial instruments approximate their fair values due to their short-termmaturity or to the prevailing interest rates of these instruments, which arecomparable to those of the market.

 

**Financial risk management**

 

Disclosures relating tothe nature and extent of the Company’s exposure to risks arising from financialinstruments, including credit risk, liquidity risk, foreign currency risk andinterest rate risk, and how the Company manages those risks, are presentedbelow.

 

*a)**           **Credit risk*

 

Credit risk is the riskof an unexpected loss if a customer or counterparty to a financial instrumentfails to meet its contractual obligations. The Company regularly monitors itscredit risk exposure and takes steps to mitigate the likelihood of theseexposures from resulting in actual loss.

 

Financial instrumentsthat potentially subject the Company to concentrations of credit risk consistprimarily of cash and cash equivalents, restricted cash, short-term investmentsand accounts receivable.  Cash and cashequivalents and restricted cash balances are maintained with high-creditquality financial institutions. Short-term investments (2008 only) consist ofnotes issued by high-credit quality corporations and institutions. Also, anyaccounts receivable balances due to the Company that are past due as at December 31,2009 are insignificant, both individually and in the aggregate. Consequently,management considers the risk of non-performance related to cash and cashequivalents, restricted cash, short-term investments and accounts receivable tobe minimal.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, except share/option/warrantand per share/option/warrant data and as otherwise noted)

 

*b)**           **Foreign Currency Risk*

 

Since the Companyoperates on an international scale, it is exposed to currency risks as a resultof potential exchange rate fluctuations related to non-intragroup transactions.Fluctuations in the US dollar (“US$”) and the EUR exchange rates could have apotentially significant impact on the Company’s results of operations. The following variations are reasonably possible over a 12-month period:

 

·                  Foreign exchange rate variation of -5%(depreciation of the EUR) and +5%(appreciation of the EUR) against the US$, from a period-end rate of EUR1.00 =US$1.4272.

 

If these variations wereto occur, the impact on the Company’s consolidated net loss for each categoryof financial instruments held at December 31, 2009 would be as follows:

** **
| ** **                                                       | ** ** | ** **           | ** ** | **Balances denominated********in US$** | ** ** |
|------------------------------------------------------------------|------------|----------------------|------------|----------------------------------------|------------|
| ** **                                                       | ** ** | **Carrying  amount** | ** ** | **-5%**                                | ** ** | **+5%** | ** ** |
| ** **                                                       | ** ** | **$**                | ** ** | **$**                                  | ** ** | **$** | ** ** |
| **Assets**                                                       |       |                 |       |                                   |       |   |   |
| Cash  and cash equivalents                                       |       | 27,244               | ** ** | **1,362**                              | ** ** | **(1,362** | **)** |
| **Total impact on consolidated net loss -  (increase)/decrease** | ** ** | ** **           | ** ** | **1,362**                              | ** ** | **(1,362** | **)** |

 

*c)    Liquidity risk*

 

Liquidity risk is therisk that the Company will not be able to meet its financial obligations asthey become due. The Company manages liquidity risk through the management ofits capital structure and financial leverage, as outlined in note 22. TheCompany also manages liquidity risk by continuously monitoring actual andprojected cash flow (note 2). The Board of Directors reviews and approves theCompany’s operating and capital budgets, and reviews any material transactionsoutside of the normal course of business.

 

The Company’s investmentpolicy ensures the safety and preservation of its principal, as outlined above,to ensure the Company’s liquidity needs are met.

 

*d)**           **Financial liabilities as at December 31, 2009*

 
| ** **                                | ** ** | **Carrying  Amount** | ** ** | **2010** | ** ** | **2011-2012** | ** ** | **After 2012** | ** ** |
|-------------------------------------------|------------|----------------------|------------|----------|------------|---------------|------------|----------------|------------|
| ** **                                | ** ** | **$**                | ** ** | **$**    | ** ** | **$**         | ** ** | **$**          | ** ** |
| Accounts  payable and accrued liabilities |       | 11,919               |       | 11,919   |       | —        |       | —         |       |
| Long-term  payable                        |       | 200                  |       | 57       |       | 114           |       | 29             |       |
| Other  long-term liability                |       | 66                   |       | —   |       | —        |       | 66             |       |
| ** **                                |       | 12,185               |       | 11,976   |       | 114           |       | 95             |       |

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**24           Commitments, contingencies andguarantee**

 

Inaddition to the long-term payable discussed in note 8, the Company is committedto various operating leases for its premises plus service and manufacturingcontracts, as follows:

 
| **Year**   | ** ** | **Minimum Lease  Commitments** | ** ** | **Service &  Manufacturing  Commitments** | ** ** | **Total Commitments** | ** ** |
|------------|------------|--------------------------------|------------|----------------------------------------------------|------------|-----------------------|------------|
| ** ** | ** ** | **$**                          | ** ** | **$**                                              | ** ** | **$**                 | ** ** |
| 2010       |       | 2,008                          |       | 5,256                                              |       | 7,264                 |       |
| 2011       |       | 2,015                          |       | 1,545                                              |       | 3,560                 |       |
| 2012       |       | 2,023                          |       | —                                             |       | 2,023                 |       |
| 2013       |       | 1,973                          |       | —                                             |       | 1,973                 |       |
| 2014       |       | 1,921                          |       | —                                             |       | 1,921                 |       |
| Thereafter |       | 2,781                          |       | —                                             |       | 2,781                 |       |
| Total      |       | 12,721                         |       | 6,801                                              |       | 19,522                |       |

 

Asdiscussed in note 5, in connection with the PSA entered into with Cowen, theCompany has agreed to make a one-time cash payment to Cowen in the event thatcetrorelix is approved for sale by European regulatory authorities in anindication other than *in vitro*fertilization. Such a payment, which is not probable or reasonably estimable asat December 31, 2009, could range from $5,000,000 to a maximum of$15,000,000. Also as discussed in note 5, the Company could also be required topay Cowen a quarterly make-whole payment.

 

Rentexpense for operating leases, which may have escalating rentals over the termof the lease, are recorded on a straight-line basis over the term of the lease.The rent expense under the operating leases for the periods ended December 31,2009, 2008 and 2007 was approximately $2,133,000, $1,700,647 and $1,937,000,respectively.

 

In October 2007,the Company entered into a $100,000 letter of credit agreement in favour of itslandlord in the United States with respect to the Company’s long-term leaseobligation. The amount of the letter of credit was reduced, in August 2009,to $75,000, as per the original landlord-tenant agreement, and is payable tothe landlord in the event that the Company fails to perform any of itsobligations under the related lease agreement.

 

**Contingencies**

 

In thenormal course of operations, the Company may become involved in various claimsand legal proceedings mainly related to contract terminations, employeelay-offs and other employee-related matters. As at December 31, 2009,there are no known or anticipated contingencies or disputes pending against theCompany.

 

**25****                                 ****Comparativefigures**

 

Toconform to the presentation adopted in the current year, certain amounts fromthe prior year have been reclassified.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**26           Differences between Canadian and USGAAP**

 

TheCompany is required to reconcile its financial statements for significantmeasurement differences between Canadian GAAP and US GAAP. Furthermore,additional significant disclosures required under US GAAP and Regulation S-X ofthe Securities and Exchange Commission in the United States (“SEC”) are alsoprovided in the accompanying consolidated financial statements and notes. Thefollowing summarizes the significant quantitative differences between Canadianand US GAAP, as well as other significant disclosures required under US GAAPand Regulation S-X of the SEC not already provided in the accompanyingconsolidated financial statements.

 

Thefollowing summary sets out the material adjustments to the Company’s reportednet loss, net loss per share and shareholders’ equity that would be made toconform with US GAAP:

 

**Reconciliationof net loss to US GAAP**

** **
| ** **                                                                   | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                   | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                   | ** ** | **$**                             | ** ** | **$** | ** ** | **$** | ** ** |
|                                                                         | ** ** |                              |       |   |   |   |   |
| Net  loss for the year under Canadian GAAP                                   |       | (24,724                           | )          | (59,817 | ) | (32,296 | ) |
| Variation  in warrant liability, including amortization of transaction costs | (a)        | 1,557                             |       | — |   | — |   |
| Amortization  of in-process research and development costs                   | (b)        | 6,373                             |       | 3,747 |   | 1,546 |   |
| Deferred  taxes                                                              | (c)        | —                            |       | — |   | (5,430 | ) |
| Reclassification  adjustment related to the sale of Echelon                  | (d)        | —                            |       | — |   | (754 | ) |
| Income  tax effects of the above adjustments                                 |       | —                            |       | — |   | (494 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| Net  loss for the year under US GAAP                                         |       | (16,794                           | )          | (56,070 | ) | (37,428 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| Of  which:                                                                   |       |                              |       |   |   |   |   |
|                                                                         |       |                              |       |   |   |   |   |
| Net  loss from continuing operations                                         |       | (16,794                           | )          | (56,070 | ) | (36,415 | ) |
| Net  loss from discontinued operations                                       |       | —                            |       | — |   | (1,013 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| Basic  net loss per share                                                    |       | (0.30                             | )          | (1.05 | ) | (0.70 | ) |
| From  continuing operations                                                  |       | (0.30                             | )          | (1.05 | ) | (0.68 | ) |
| From  discontinued operations                                                |       | —                            |       | — |   | (0.02 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| Diluted  net loss per share                                                  |       | (0.30                             | )          | (1.05 | ) | (0.70 | ) |
| From  continuing operations                                                  |       | (0.30                             | )          | (1.05 | ) | (0.68 | ) |
| From  discontinued operations                                                |       | —                            |       | — |   | (0.02 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| **Weighted average  number of shares (note 21)****under US GAAP**            |       |                              |       |   |   |   |   |
| Basic  and diluted                                                           |       | 56,864,484                        |       | 53,187,470 |   | 53,182,803 |   |

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**Reconciliationof shareholders’ equity to conform to US GAAP**

** **

Thefollowing summary sets out the significant differences between the Company’sreported shareholders’ equity under Canadian GAAP as compared to US GAAP.

 
| ** **                                                  | ** ** | ** ** | **As at  December 31, 2009** | ** ** | **As at  December 31, 2008** | ** ** |
|-------------------------------------------------------------|------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                                                  | ** ** | ** ** | **$**                             | ** ** | **$**                             | ** ** |
|                                                        |       | ** ** |                              | ** ** |                              | ** ** |
| Shareholders’  equity in accordance with Canadian GAAP |       |       | 9,226                             |       | 21,475                            |       |
| Net  impact of liability accounting for warrants            | (a)        |       | (1,351                            | )          | —                            |       |
| In-process  research and development                        | (b)        |       | (2,146                            | )          | (8,341                            | )          |
|                                                        |       |       |                              |       |                              |       |
| Shareholders’  equity in accordance with US GAAP       |       |       | 5,729                             |       | 13,134                            |       |

 

**Balancesheets**

 

The following table summarizesthe significant differences between pertinent additional balance sheet itemsunder Canadian GAAP as compared to US GAAP as at December 31, 2009 and2008:

 
| ** **        | ** ** | ** ** | ** ** | **As at********December 31, 2009** | ** ** | **As at********December 31, 2008** | ** ** |
|-------------------|------------|------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **        | ** ** | ** ** | ** ** | **As  Reported**                        | ** ** | **US  GAAP**                            | ** ** | **As  Reported** | ** ** | **US  GAAP** | ** ** |
| ** **        | ** ** | ** ** | ** ** | **$**                                   | ** ** | **$**                                   | ** ** | **$** | ** ** | **$** | ** ** |
| ** **        | ** ** | ** ** | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Warrant liability |       | (a)        |       | —                                  |       | 1,351                                   |       | — |   | — |   |
| Intangible assets |       | (b)        |       | 17,034                                  |       | 14,888                                  |       | 23,894 |   | 15,553 |   |

 

**Statementsof cash flows**

 

For each of the years ended December 31, 2009,2008 and 2007, there are no significant differences between the statements ofcash flows under Canadian GAAP as compared to US GAAP.

 

**a)****             ****Warrants**

 

Under Canadian GAAP, theCompany has classified and is accounting for all of its outstanding commonshare purchase warrants (see note 17) as equity, on the basis that thesewarrants do not embody a contractual obligation on the Company to deliver cashor another financial asset to the holder of these warrants. The conditionalwritten put option that arises upon the occurrence of a Fundamental Transaction,as defined in all outstanding warrants and including a change in control, wasnot considered to be probable under the CICA’s Emerging Issues CommitteeAbstract No. 70, *Presentation of aFinancial Instrument Labelled as a Share When a Future Event or Circumstance May Affectthe Issuer’s Obligations*. Under US GAAP, the Company has determinedthat the common share purchase warrants are within the scope of guidance nowcodified as the FASB’s ASC Topic 480, *DistinguishingLiabilities from Equity*(“Topic 480”), and as such has classifiedand is accounting for these instruments as a liability. Topic 480 states thatfinancial instruments which contain a written put option, even if thatrepurchase feature is conditional on a defined contingency, should beclassified as a liability if such contingency ultimately could result in thetransfer of assets by the issuer.

 

The total warrantliability would be included for US GAAP purposes within the long-termliabilities section of the consolidated balance sheet and carried at fairvalue, less unamortized transaction costs. Any changes to the fair value 

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, except share/option/warrantand per share/option/warrant data and as otherwise noted)

 

of the warrant liabilitywould be reflected within other income (expenses) in the consolidated statementof operations. There were no common share purchase warrants issued oroutstanding during 2008 or 2007.

 

The table presented belowshows the assumptions applied to the Black-Scholes pricing model in order todetermine the fair value of all outstanding warrants as at December 31,2009.

 
| ** **                      | ** ** | **First Investor Warrants and  First Compensation Warrants** | ** ** | **Second Investor  Warrants** | ** ** | **Second  Compensation  Warrants** | ** ** |
|---------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------|------------|------------------------------------|------------|
| ** **                      | ** ** | ** **                                                   | ** ** | ** **                    | ** ** | ** **                         | ** ** |
| Market-value  per share price   |       | $                                                            | 0.81       |                          | $          | 0.81                               |       | $ | 0.81 |   |
| Risk-free  annual interest rate |       | 1.14                                                         | %          | 2.59                          | %          | 1.46                               | %          |
| Expected  volatility            |       | 119.0                                                        | %          | 83.7                          | %          | 101.5                              | %          |
| Expected  life (years)          |       | 2.0                                                          |       | 4.8                           |       | 2.8                                |       |
| Expected  dividend yield        |       | 0.0                                                          | %          | 0.0                           | %          | 0.0                                | %          |
|                                 |            |                                                              |            |                               |            |                                    |            |  |  |  |

 

The fair value of theCompany’s warrant liability was determined using the Black-Scholes pricingmodel. The valuation methodology uses “Level 2” inputs in calculating fairvalue, as defined in guidance now codified as ASC Topic 820, *Fair Value Measurements and Disclosures*(“Topic820”), which establishes a fair value hierarchy that prioritizes the inputsused to measure fair value. The hierarchy gives the highest priority tounadjusted quoted prices in active markets for identical assets or liabilities(Level 1 measurement) and the lowest priority to unobservable inputs (Level 3measurement). Level 2 inputs are those which are either directly or indirectlyobservable as of the reporting date and include financial instruments that arevalued using models or other valuation methodologies, such as the Black-Scholespricing model.

 

**b)****            ****Researchand development costs**

 

UnderUS GAAP, prior to the issuance of Topic 805, as defined and discussed below,in-process research and development acquired in a business combination wasrequired to be written off at the time of acquisition. Under Canadian GAAP,in-process research and development acquired in a business combination iscapitalized and amortized over its estimated useful life.

 

**c)****             ****Deferredincome taxes**

 

Thisadjustment reflects differences related to the accounting for valuationallowance for US GAAP purposes that arise from timing differences.

 

**d)****            ****Cumulativetranslation adjustment related to the sale of Echelon**

 

UnderCanadian GAAP, a gain or loss equivalent to a proportionate amount of theexchange gain or loss accumulated in the translation adjustment is recognizedin income when there has been a reduction of a net investment in a foreignoperation. Under US GAAP, a gain or loss should only be recognized in income inthe case of a substantial or complete liquidation of a net investment in aforeign operation, being the substantial or complete liquidation of theCompany.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**New accounting standards andpronouncements**

 

TheFASB’s ASC became effective July 1, 2009, and is now the single officialsource of authoritative, non-governmental, US GAAP. As a result, mostreferences appearing below conform to the ASC.

 

**i)     Adopted in 2009**

 

**ASC Topic808, *Collaborative Arrangements* (“Topic 808”)**

 

Topic 808 providesguidance for accounting for arrangements under which companies participate inthe development and commercialization of intellectual property intocommercially viable products. Topic 808 defines a collaborative arrangement asa contractual arrangement that involves a joint operating activity.  These arrangements involve two or moreparties that are both (a) active participants in the activity and (b) exposedto significant risks and rewards dependent on the commercial success of theactivity. A company may receive revenues and incur costs under sucharrangements as well as make or receive payments from the other participant inthe arrangement. Topic 808 concludes that revenues earned and costs incurred bya company should be presented gross or net depending on whether the company isthe principal participant in the arrangement. Topic 808 is effective forfinancial statements issued for fiscal years beginning after December 15,2008, and interim periods within those fiscal years. The Company adopted theprovisions of Topic 808 on January 1, 2009, and such adoption has not hadany impact on the Company’s consolidated financial statements.

 

**ASC Topic805, *Business Combinations* (“Topic 805”)**

 

In December 2007,the FASB issued guidance now codified as Topic 805, which is a revision ofpreviously existing guidance on accounting for business combinations. Topic 805retains the fundamental concept of the purchase method of accounting andintroduces new requirements for the recognition and measurement of assetsacquired, liabilities assumed and non-controlling interests. Topic 805 iseffective for fiscal years beginning after December 15, 2008. The Companywill apply the provisions of Topic 805 to any business combinations enteredinto in the future.

 

**ASC Topic810, *Consolidation* (“Topic 810”)**

 

In December 2007,the FASB issued guidance now codified as Topic 810, which changes theaccounting and reporting for minority interests, which will be recharacterizedas noncontrolling interests and classified as a component of equity. This newconsolidation method significantly changes the accounting for transactions withminority interest holders. Topic 810 is effective prospectively to businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008. TheCompany will apply the provisions of Topic 810 to any business combinationsentered into, where applicable, in the future.

 

**ASC Topic815, *Derivatives and Hedging* (“Topic 815”)**

 

In March 2008,the FASB issued guidance now codified as Topic 815, which amends and expandsthe disclosure requirements outlined in previous authoritative literature.Topic 815 is effective for financial statements issued for periods beginningafter November 15, 2008. The Company adopted Topic 815 on January 1,2009, and there has been no impact on the Company’s consolidated financialstatements.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**ASC Topic105, *Generally Accepted Accounting Principles***

 

In June 2009, the FASBissued guidance now codified as Topic 105, as the single source ofauthoritative non-governmental US GAAP. Topic 105 does not change current USGAAP, but is intended to simplify user access to all authoritative US GAAP byproviding all authoritative literature related to a particular topic in oneplace. All existing accounting standard documents will be superseded and allother accounting literature not included in the ASC will be considerednon-authoritative. These provisions of Topic 105 are effective for interim andannual periods ending after September 15, 2009 and, accordingly, areeffective for the Company for the current fiscal reporting period. The adoptionof this pronouncement did not have an impact on the Company’s financialcondition or results of operations, but has and will continue to impact theCompany’s financial reporting process by eliminating all references topre-codification standards. On the effective date of Topic 105, the ASCsuperseded all then-existing non-SEC accounting and reporting standards, andall other non-grandfathered non-SEC accounting literature not included in theASC became non-authoritative.

 

**ASC Topic855, *Subsequent Events* (“Topic 855”)**

 

In May 2009, theFASB issued guidance now codified as Topic 855, which establishes generalstandards of accounting for and disclosure of events that occur after thebalance sheet date but before financial statements are issued or are availableto be issued. The Company adopted Topic 855 in May 2009. Subsequently, in February 2010,the FASB amended this guidance in order to remove potential conflicts withcorresponding literature issued by the SEC. The Company adopted the amendments upon issuance.

 

**ASC Topic350, *Intangibles-Goodwill and Other* (“Topic350”)**

 

On April 25, 2008,the FASB issued guidance now codified as Topic 350, which amends the factorsthat should be considered in developing renewal or extension assumptions usedto determine the useful life of a recognized intangible asset. The intent ofthis guidance is to improve the consistency between the useful life of arecognized intangible asset and the period of expected cash flows used tomeasure the fair value of the asset under Topic 805. Topic 350 is effective forfinancial years beginning after December 15, 2008 and interim periodswithin those fiscal years. The guidance for determining the useful life of arecognized intangible asset shall be applied prospectively to intangible assetsacquired after the effective date. The disclosure requirements shall be appliedprospectively to all intangible assets recognized as of, and subsequent to, theeffective date. The Company adopted Topic 350 on January 1, 2009, andthere has been no impact on the Company’s consolidated financial statements.

 

**ASC Topic825, *Financial Instruments* (“Topic 825”)**

 

In April 2009, theFASB issued guidance now codified as Topic 825, which requires disclosuresabout fair value of financial instruments for annual and interim reportingperiods of publicly traded companies and requires those disclosures insummarized financial information at interim reporting periods. The Companyadopted Topic 825 in April 2009, and such adoption has not had asignificant impact on the Company’s consolidated financial statements.

 

**Topic 805**

 

On April 1, 2009,the FASB issued guidance now codified as Topic 805, which addresses applicationissues raised with respect to initial recognition and measurement, subsequentmeasurement and accounting and disclosure of assets and liabilities arisingfrom contingencies in a business combination. Topic 805 is effective forbusiness combinations with an acquisition date on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008. TheCompany will adopt Topic 805, where relevant, for any future businesscombinations entered into.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**Topic 820**

 

In April 2009, the FASB issued guidance nowcodified as Topic 820, which provides additional guidance for estimating fairvalue when the volume and level of activity for the asset or liability havesignificantly decreased. Topic 820 also includes guidance on identifyingcircumstances that indicate a transaction is not orderly. Topic 820 iseffective for interim and annual reporting periods ending after June 15,2009, and shall be applied prospectively. Early adoption is permitted forperiods ending after March 15, 2009, while earlier adoption for periodsending before March 15, 2009, is not permitted. The Company adopted Topic820 on April 1, 2009, and there has been no significant impact on theCompany’s consolidated financial statements.

 

**Topic 350**

 

Topic 350 now includes implementation guidance indetermining whether a component of an operating segment is a reporting unit and applies tobusiness combinations for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or after December 15, 2008. The Company will apply the provisions of Topic350, whereapplicable, to any future business combinations entered into.

 

**ASC Topic 715, *Compensation-RetirementBenefits* (“Topic 715”)**

 

On December 30,2008, the FASB issued guidance now codified as Topic 715, which significantly expands the disclosures required byemployers for postretirement plan assets. Topic 715 requires plan sponsors toprovide extensive new disclosures about assets in defined benefitpostretirement benefit plans as well as any concentrations of associated risks.Topic 715 also requires newdisclosures similar to those in Topic 820, in terms of the three-level fairvalue hierarchy, including a reconciliation of the beginning and endingbalances of plan assets that fall within Level 3 of the hierarchy. This newguidance contained in Topic 715 is effective for periods ending after December 15,2009, and the pertinent disclosure requirements are annual and do not apply tointerim financial statements. The Company adopted these amendments in December 2009,and such adoption has not resulted in any impact on the Company’s consolidatedfinancial statements.

 

**Topic 820**

 

In August 2009, theFASB amended Topic 820 to provide clarification as to how to measure the fairvalue of liabilities in circumstances when a quoted price in an active marketfor the identical liability is not available. These amendments are effectivefor the first reporting period, including interim periods, beginning after theissuance of this guidance. Adoption of this guidance has not had a significantimpact on the Company’s consolidated financial statements.

 

**ii)    Not yet adopted**

 

**ASC Topic860, *Transfers and Servicing* (“Topic 860”)**

 

In June 2009, the FASB issued guidance nowcodified as Topic 860, which removes the concept of a qualifyingspecial-purpose entity and the exception from applying Topic 810 to qualifyingspecial-purpose entities. This guidance contained in Topic 860 must be appliedas of the beginning of each reporting entity’s first annual reporting periodthat begins after November 15, 2009, for interim periods within that firstannual reporting period and for interim and annual reporting periodsthereafter. Earlier application is prohibited. Topic 860 must be applied totransfers occurring on or after the effective date. The Company does not expectthat adoption of this guidance will have a significant impact on itsconsolidated financial statements.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

**Topic 810**

 

In June 2009, theFASB issued guidance now codified as Topic 810, which amends the consolidationguidance for variable interest entities. Amendments include the elimination ofthe exemption for qualifying special purpose entities, a new approach fordetermining who should consolidate a variable-interest entity and changes towhen it is necessary to reassess who should consolidate a variable-interestentity. This guidance is effective for years beginning after November 15,2009, for interim periods within those years, and for interim and annualreporting periods thereafter. The Company does not believe that adoption ofthis guidance will have a significant impact on its consolidated financialstatements.

 

**SEC StaffAccounting Bulletin (“SAB”) No. 112 (“SAB 112”)**

 

In June 2009, theSEC issued SAB 112, which amends or rescinds portions of the interpretiveguidance included in the Staff Accounting Bulletin Series in order to makethe relevant interpretive guidance consistent with current authoritativeaccounting and auditing guidance and SEC rules and regulations, and inorder to bring existing guidance into conformity with recent pronouncements bythe FASB, namely, Topic 805 and Topic 810. SAB 112 will be effective uponpublication in the Federal Register. The Company does not expect that adoptionof this SAB will have a significant impact on its consolidated financialstatements.

 

**ASC Topic605, *Revenue Recognition*(“Topic 605”)**

 

****In October 2009,****the FASB amended Topic 605 toinclude a consensus ratified by the FASB’s Emerging Issues Task Force relatingto multiple-deliverable revenue arrangements. These amendments significantlychange certain guidance pertaining to revenue arrangements with multiple deliverablesand modify the separation criteria of Topic 605 by eliminating the criterionfor objective and reliable evidence of fair value for the undelivered productsor services. Theamendments also eliminate the use of the residual method of allocationand requires, instead, that arrangement consideration be allocated, at theinception of the arrangement, to all deliverables based on their relativeselling price. Thisguidance is effective for revenue arrangements entered into ormaterially modified in fiscal years beginning on or after June 15, 2010.Early adoption is permitted. Management is currently evaluating the impact thatthis guidance may have on the Company’s consolidated financial statements.

 

**Other disclosures**

 

*Research and development tax credits*

 

UnderCanadian GAAP, all research and development tax credits are recorded as areduction of costs in the consolidated statements of operations. Under US GAAP,tax credits that reduce current income taxes payable are recorded in incometaxes. These tax credits amounted to $nil in 2009, $nil in 2008 and $1,862,000in 2007. This accounting difference has no impact on the net loss and the netloss per share figures for the reporting years.

 

Furthermore,under US GAAP, the future income tax assets related to the unrecognized taxcredits totalled approximately $6,738,000 in 2009, $5,742,000 in 2008 and$7,004,000 in 2007. However, a valuation allowance corresponding to the sameamounts has been accounted for in each of these years.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

*Long-livedassets*

 

UnderUS GAAP, long-lived assets by geographic region only consist of property, plantand equipment which are detailed as follows:

 
| ** **     | ** ** | **As at December 31,** | ** ** |
|----------------|------------|-----------------------------|------------|
| ** **     | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **     | ** ** | **$**                       | ** ** | **$** | ** ** |
|           | ** ** |                        | ** ** |   | ** ** |
| Germany        |       | 3,736                       |       | 5,968 |   |
| United  States |       | 551                         |       | 615 |   |
| Canada         |       | 71                          |       | 99 |   |
|           |       |                        |       |   |   |
|           |       | 4,358                       |       | 6,682 |   |

 

*Researchand collaboration agreements*

 

As part of its strategyto enhance development capabilities and to partially fund capital requirements,the Company has entered into research and development collaboration agreementswith several pharmaceutical companies. Pursuant to these collaborationarrangements, the Company often receives upfront payments, license fees andmilestone payments and has the potential to receive royalty payments in thefuture. Upfront payments are typically non-refundable, received upon thesignature of an agreement, or shortly thereafter, and are amortized over theestimated corresponding research and development period. License fees typicallyare contractually obligated payments that the Company receives and uses to fundresearch and development activities over the term of collaboration and includemilestone payments, as well as contract services. Milestone payments arecontingent payments that are made upon the achievement of specified milestones,such as at the time of selection of candidates for drug development, thecommencement or termination of clinical trials or the receipt of regulatoryapprovals and achievement of a certain level of sales. If drugs aresuccessfully developed and commercialized as a result of collaborationagreements, the Company will receive royalty payments based upon a percentageof net sales of those drugs developed under the collaboration. Finally,contract service fees relate to research and development activities performedby the Company on behalf of the counterparty to the related arrangement and forwhich the Company has the right to receive compensation.

 

With the exception of theAgreement with sanofi, which is discussed in note 4, all other significantcollaboration agreements are discussed below.

 

*Ardana*

 

In 2002, the Company hadentered into a license and collaboration agreement with Ardana, a subsidiary ofArdana plc. Ardana was granted an exclusive worldwide license to develop andcommercialize a growth hormone (“GH”) secretagogue. In light of Ardana’s havingentered into voluntary administration, as discussed in note 13, the Companysigned, in June 2009, an agreement with Ardana’s administrators to acquireall assets, including the rights previously transferred in 2002, related to theGH secretagogue.

 

Revenues recognized underthe agreement with Ardana for the years ended December 31, 2009, 2008 and2007 were $nil, approximately $197,000 and $3,000,000, respectively. Nocorresponding research and development costs were incurred by the Company underthe agreement for any of the three years ended December 31, 2009.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

In 2002, the Companygranted an exclusive license to Ardana for the development andcommercialization of teverelix, an LHRH antagonist, for all therapeutic usesworldwide with the exception of Japan, Korea and Taiwan. On April 2, 2004,Ardana acquired full worldwide rights and was assigned the intellectual propertyrights relating to teverelix and the underlying microcrystalline suspensiontechnology for the use thereof. As discussed in note 13, this agreement wasterminated by the Company in light of Ardana’s having entered into voluntaryadministration.

 

Revenues recognized underthis agreement with Ardana for the years ended December 31, 2009, 2008 and2007 were $nil, approximately $3,621,000 and $3,500,000, respectively.Corresponding research and development costs incurred under the agreement forthe years ended December 31, 2009, 2008 and 2007 were $nil, approximately$61,000 and $100,000, respectively.

 

*KeryxBiopharmaceuticals, Inc.*

 

The Company is party to alicense and collaboration agreement with Keryx Biopharmaceuticals, Inc.(“Keryx”). Under the terms of this agreement, Keryx undertakes, at its owncost, all development activities necessary to obtain regulatory and marketingapprovals of perifosine, a signal transduction inhibitor, for all uses in theUnited States, Canada and Mexico. The agreement provides for, among otherthings, the availability of data generated by both parties free of charge. In September 2002,the Company received an upfront payment of approximately $500,000 and iseligible to receive payments of up to an aggregate of $18,300,000 upon Keryx’ssuccessful achievement of clinical development and regulatory milestones, inaddition to scale-up royalties (from high single to low double-digit) on futurenet sales in the United States, Canada and Mexico.

 

Revenues recognized underthe agreement with Keryx for the years ended December 31, 2009, 2008 and2007 were approximately $128,000, $410,000 and $1,700,000, respectively.

 

Corresponding researchand development costs incurred under the agreement for the years ended December 31,2009, 2008 and 2007 were approximately $154,000, $448,000 and $900,000,respectively.

 

*NipponKayaku Co. Ltd.*

 

In 2006, the Companyentered into a licensing and collaboration agreement with Nippon Kayaku Co.Ltd. (“Nippon Kayaku”). Under the terms of the agreement, Nippon Kayaku wasgranted an exclusive license to develop and market ozarelix, an LHRHantagonist, for all potential oncological indications in Japan. In return, theCompany received approximately $1,900,000 as an upfront payment upon signature.The agreement provides for, among other things, the availability of datagenerated by both parties free of charge. The Company is entitled to receivepayments of up to an aggregate of approximately $23,800,000 upon NipponKayaku’s successful achievement of clinical development, regulatory milestonesand a certain level of sales, in addition to low double-digit royalties onpotential net sales. In turn, as indicated below regarding the relatedagreement, Spectrum is entitled to receive fifty percent of any upfront, milestonepayments and royalties received from any research and collaboration agreementsigned by the Company for the development and commercialization of ozarelix inJapan.

 

Revenues recognized underthe agreement for the years ended December 31, 2009, 2008 and 2007 wereapproximately $882,000, $445,000 and $500,000, respectively. Correspondingresearch and development costs incurred under the agreement for the years endedDecember 31, 2009, 2008 and 2007 were approximately $397,000, $nil andapproximately $100,000, respectively.

 

*Shionogiand Co.*

 

In 1995, the Companyentered into a research and collaboration agreement with Shionogi and Co.(“Shionogi”). The Company granted Shionogi a license to develop, use,commercialize and manufacture cetrorelix in Japan and for all humanindications. Under the agreement, Shionogi is responsible, at its own cost, forall activities necessary to obtain regulatory and marketing approvals forcetrorelix. The agreement provides, among other things, availability of datagenerated by both parties free of charge. Upon signature of this agreement, theCompany received approximately 

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

$1,400,000 as an upfrontpayment and was eligible to receive milestone payments of up to an aggregate ofapproximately $7,100,000 upon Shionogi’s successful achievement of clinicaldevelopment and regulatory milestones. To date, the Company has receivedapproximately $5,800,000 of these milestone payments. Since the development ofcetrorelix is completed in *in vitro*fertilization (“IVF”), Control Ovarian Stimulation (“COS”) and AssistedReproductive Technology (“ART”) in Japan, and given the other events related tocetrorelix in BPH, discussed in notes 4 and 13, the Company does not expect toreceive any additional milestone payments or any other development revenuesunder this agreement.

 

Revenues recognized underthe agreement with Shionogi for the years ended December 31, 2009, 2008 and2007 were approximately $2,262,000, $1,000 and $nil, respectively.

 

Corresponding researchand development costs incurred under the agreement for the years ended December 31,2009, 2008 and 2007 were approximately $838,000, $13,000 and $nil, respectively.

 

*SolvayPharmaceuticals BV*

 

In 2002, the Companyentered into a research and collaboration agreement with Solvay PharmaceuticalsBV, a subsidiary of Solvay SA (“Solvay”). The Company granted Solvay anexclusive license to develop, use, commercialize and manufacture cetrorelixworldwide (ex-Japan) and for all indications excluding IVF/COS/ART. Thisagreement, as subsequently amended, was terminated in May 2007.

 

Revenues recognized underthe agreement with Solvay for the year ended December 31, 2007 were approximately$2,000,000, and corresponding research and development costs incurred for thesame period were approximately $1,900,000.

 

*Spectrum*

 

In 2004, the Companyentered into a licensing and collaboration agreement with Spectrum forozarelix, an LHRH antagonist. Under the terms of the agreement, the Companygranted Spectrum an exclusive license to develop and commercialize ozarelix forall potential indications in North America and India. The agreement provides,among other things, availability of data generated by both parties free ofcharge. Upon signature of this agreement, the Company received approximately$2,400,000 as an upfront payment, of which approximately $1,200,000 was paid incash and the balance paid through the issuance of shares of the capital ofSpectrum. The Company is entitled to receive payments of up to an aggregate ofapproximately $24,400,000 upon Spectrum’s successful achievement of clinicaldevelopment and regulatory milestones, in addition to royalties (scale-uproyalties from high single to low double-digit) on potential net sales. Inconsideration of the amounts paid by Spectrum under this agreement, Spectrum isentitled to receive fifty percent of any upfront, milestone payments androyalties received from any research and collaboration agreement signed by theCompany for the development and commercialization of ozarelix in Japan.

 

As discussed in note 13,on January 27, 2010, Spectrum announced that it had terminated itsdevelopment program with ozarelix in BPH. Also as discussed in note 13,management determined that ozarelix was fully impaired, and, consequently, allremaining deferred revenues related to the use of ozarelix, including thosedeferred revenues related to the agreement with Spectrum, were fully recognizedin the Company’s 2009 consolidated statement of operations.

 

Revenues recognized underthe agreement with Spectrum for the years ended December 31, 2009, 2008and 2007 were approximately $860,000, $678,000 and $1,900,000, respectively.Corresponding research and development costs incurred under the agreement forthe years ended December 31, 2009, 2008 and 2007 were approximately$109,000, $255,000 and $600,000, respectively.

 

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**ÆternaZentaris Inc.**

## **Notes to Consolidated Financial Statements**

December 31, 2009, 2008 and 2007

(tabular amounts in thousands of US dollars, exceptshare/option/warrant and per share/option/warrant data and as otherwise noted)

 

*Tulane*

 

In 2002, the Companysigned license agreements with Tulane with regard to various compounds,including cetrorelix. Under the agreements, the Company obtained exclusiveworldwide licenses to use Tulane’s patents to develop, manufacture, market anddistribute these compounds.

 

The agreements providefor the payment by the Company of single-digit royalties on future worldwidenet sales for all indications except BPH, for which the payment of lowsingle-digit royalties is required. Tulane is entitled to receive a lowdouble-digit royalty on any lump sum, periodic or other cash payments receivedby the Company from sub-licensees.

 

Costs incurred under theagreements with Tulane for the years ended December 31, 2009, 2008 and2007 were approximately $4,703,000, $311,000 and $100,000, respectively. Theexpense recognized in 2009 notably includes the royalty paid by the Company inconnection with the Agreement entered into with, and subsequently terminatedby, sanofi (see note 4).

 

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## **Item 19.         Exhibits**

## ** **

**Exhibit Index**

 
| 1.1  |   | Restated Certificate of  Incorporation and Restated Articles of Incorporation of the Registrant  (incorporated by reference to Exhibit 4.1 of the Registrant’s  registration statement on Form F-3 filed with the Commission on  February 23, 2010, File No. 333-165037)                                                                                                                |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 1.2  |   | Code of General By-Laws  adopted by the Registrant on November 29, 1995 (incorporated by  reference to Exhibit 1.2 of the Registrant’s annual report on  Form 20-F for the financial year ended December 31, 2007 filed with  the Commission on March 28, 2008)                                                                                                                    |
| 2    |   | Amended and Restated  Shareholder Rights Plan Agreement between the Registrant and Computershare  Trust Company of Canada dated as of March 29, 2010 (incorporated by  reference to Exhibit 99.1 to the Registrant’s report on Form 6-K  furnished to the Commission on March 29, 2010)                                                                                                 |
| 4.1  |   | Stock Option Plan of  the Registrant (incorporated by reference to Exhibit 4.1 of the  Registrant’s annual report on Form 20-F for the financial year ended  December 31, 2008 filed with the Commission on March 30, 2009)                                                                                                                                                             |
| 4.2  |   | Employment Agreement  dated July 18, 2007 between Paul Blake, M.D. and the Registrant  (incorporated by reference to Exhibit 4.2 of the Registrant’s annual  report on Form 20-F for the financial year ended December 31, 2007  filed with the Commission on March 28, 2008)                                                                                                      |
| 4.3  |   | Service Contract dated  December 5, 2007 between Æterna Zentaris GmbH and Prof. Juergen Engel,  Ph.D. Consent of the Registrant’s Independent Registered Public Accounting  Firm (incorporated  by reference to Exhibit 4.3 of the Registrant’s annual report on  Form 20-F for the financial year ended December 31, 2007 filed with  the Commission on March 28, 2008) |
| 4.4  |   | Amendment #1 to Service  Contract dated September 1, 2008 between Æterna Zentaris GmbH and Prof.  Juergen Engel, Ph.D. (incorporated by reference to Exhibit 4.4 of the  Registrant’s annual report on Form 20-F for the financial year ended  December 31, 2008 filed with the Commission on March 30, 2009)                                                                 |
| 4.5  |   | Employment Agreement  dated September 1, 2008 between the Registrant and Prof. Juergen Engel,  Ph.D. (incorporated by reference to Exhibit 4.5 of the Registrant’s  annual report on Form 20-F for the financial year ended  December 31, 2008 filed with the Commission on March 30, 2009)                                                                                        |
| 4.6  |   | Employment Agreement  dated May 7, 2007 between the Registrant and Nicholas J. Pelliccione  (incorporated by reference to Exhibit 4.7 of the Registrant’s annual  report on Form 20-F for the financial year ended December 31, 2007  filed with the Commission on March 28, 2008)                                                                                                 |
| 4.7  |   | Service Contract dated  May 18, 2006 among Æterna Zentaris GmbH, the Registrant and Matthias  Seeber (incorporated by reference to Exhibit 4.7 of the Registrant’s  annual report on Form 20-F for the financial year ended  December 31, 2008 filed with the Commission on March 30, 2009)                                                                                   |
| 4.8  |   | Amendment #1 to Service  Contract dated December 9, 2008 among Æterna Zentaris GmbH, the  Registrant and Matthias Seeber (incorporated by reference to Exhibit 4.8  of the Registrant’s annual report on Form 20-F for the financial year  ended December 31, 2008 filed with the Commission on March 30,  2009)                                                              |
| 4.9  |   | Amendment to Amended  Employment Agreement dated as of June 20, 2007 among the Registrant,  Æterna Zentaris, Inc. and Dennis Turpin (incorporated by reference to  Exhibit 4.8 of the Registrant’s annual report on Form 20-F for the  financial year ended December 31, 2007 filed with the Commission on  March 28, 2008)                                              |
| 4.10 |   | Purchase Agreement by  and among Æterna Zentaris IVF GmbH, Æterna Zantaris GmbH, the Registrant and  Cowen Healthcare Royalty Partners L.P. dated November 11, 2008  (incorporated by reference to the Registrant’s report on Form 6-K  furnished to the Commission on November 24, 2008)                                                                                          |
| 4.11 |   | License and Cooperation  Agreement for Perifosine by and between Zentaris AG and AOI Pharma, Inc.  dated September 18, 2002 (incorporated by reference to Exhibit 99.1  to the Registrant’s report on Form 6-K furnished to the Commission on  March 30, 2010).                                                                                                                    |
| 4.12 |   | Addendum agreement to  License and Cooperation Agreement for Perifosine by and between Zentaris AG  and AOI Pharma, Inc. dated December 3, 2003 (incorporated by  reference to Exhibit 99.2 to the Registrant’s report on Form 6-K  furnished to the Commission on March 30, 2010).                                                                                                |
| 4.13 |   | First Amendment to  License and Cooperation Agreement for Perifosine by and between Æterna  Zentaris GmbH and AOI Pharma Inc., dated November 29, 2007 (incorporated by  reference to Exhibit 99.3 to the Registrant’s report on Form 6-K  furnished to the Commission on March 30, 2010)                                                                                               |
| 8.1  |   | Subsidiaries of the  Registrant                                                                                                                                                                                                                                                                                                                                                                                  |
| 11.1 |   | Code of Ethical Conduct  of the Registrant (incorporated by reference to Exhibit 11.1 of the  Registrant’s annual report on Form 20-F for the financial year ended  December 31, 2008 filed with the Commission on March 30, 2009)                                                                                                                                                      |
| 11.2 |   | Audit Committee Charter  of the Registrant                                                                                                                                                                                                                                                                                                                                                                       |
| 12.1 |   | Certification of the  Principal Executive Officer pursuant to §302 of the Sarbanes-Oxley Act of  2002                                                                                                                                                                                                                                                                                                       |
| 12.2 |   | Certification of the  Principal Financial Officer pursuant to §302 of the Sarbanes-Oxley Act of  2002                                                                                                                                                                                                                                                                                                       |
| 13.1 |   | Certification of the  Principal Executive Officer pursuant to 18 U.S.C. Section 1350 as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                             |
| 13.2 |   | Certification of the  Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                             |
| 15.1 |   | Consent of the  Independent Auditors                                                                                                                                                                                                                                                                                                                                                                             |

 

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**SIGNATURES**

 

The registrant herebycertifies that it meets all of the requirements for filing on Form 20-Fand that it has duly caused and authorized the undersigned to sign this annualreport on its behalf.

 

 
|   | ÆTERNA ZENTARIS INC.                          |
|--------|----------------------------------------------------|
|   |                                               |
|   | /s/  Dennis Turpin                                 |
|   |                                               |
|   | Dennis Turpin                                      |
|   | Senior Vice President  and Chief Financial Officer |

 

**Date:  March 30, 2010**

 

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