Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 

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| **x**      | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                             |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                                                                                               |
| ** ** | **For the quarterly period ended September 30, 2010.**                                                                                                                                   |
| ** ** | ** **                                                                                                                                                                               |
| **or**     |
| ** ** | ** **                                                                                                                                                                               |
| **o**      | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                            |
| ** ** | ** **                                                                                                                                                                               |
| ** ** | **For the Transition Period  From              to            .** |

 

**Commission file number 001-33782**

 

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**ARYxTHERAPEUTICS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                   | ** ** | **77-0456039**                       |
|----------------------------------------------------------------|------------|--------------------------------------|
| (State or Other Jurisdiction of Incorporation or Organization) |       | (I.R.S. Employer Identification No.) |

 

**6300 Dumbarton Circle, Fremont, California 94555**

(Address of Principal Executive Officesincluding zip code)

 

**(510) 585-2200**

(Registrant’s Telephone Number, IncludingArea Code)

 

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Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Exchange Act during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). Yes o  No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

| Large accelerated filer o                                              |   | Accelerated filer o          |
|------------------------------------------------------------------------|--------|-----------------------------------|
|                                                                   |   |                              |
| Non-accelerated filer o (Do not  check if a smaller reporting company) |   | Smaller reporting  company x |

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act).    Yes  o    No  x

 

Asof October 31, 2010, the registrant had 33,461,975 shares of common stockoutstanding.

 

 

 

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**ARYx THERAPEUTICS, INC.**

 

**FORM 10-Q FOR THE QUARTER ENDEDSeptember 30, 2010**

 

**INDEX**

 
| ** **                                                                                                            | ** **                                                                                  | **Page**   |
|-----------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|------------|
| **PART I — FINANCIAL INFORMATION**                                                                          |
| ** **                                                                                                            | ** **                                                                                  | ** ** |
| Item 1.                                                                                                               | Condensed Consolidated  Financial Statements (Unaudited)                                    |       |
| Condensed Consolidated Balance Sheets as of  September 30, 2010 and December 31, 2009                       | 2                                                                                           |
| Condensed Consolidated Statements of Operations for  the three and nine months ended September 30, 2010 and 2009 | 3                                                                                           |
| Condensed Consolidated Statements of Cash Flow for the  nine months ended September 30, 2010 and 2009            | 4                                                                                           |
| Notes to Condensed Consolidated Financial Statements                                                                  | 5                                                                                           |
| Item 2.                                                                                                               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 13         |
| Item 3.                                                                                                               | Quantitative  and Qualitative Disclosures About Market Risk                                 | 24         |
| Item 4.                                                                                                               | Controls and  Procedures                                                                    | 24         |
|                                                                                                                  |                                                                                        |       |
| **PART II  — OTHER INFORMATION**                                                                            |
| Item 1.                                                                                                               | Legal Proceedings                                                                           | 24         |
| Item 1A.                                                                                                              | Risk Factors                                                                                | 25         |
| Item 2.                                                                                                               | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 45         |
| Item 3.                                                                                                               | Defaults  Upon Senior Securities                                                            | 45         |
| Item 4.                                                                                                               | (Removed and  Reserved)                                                                     | 45         |
| Item 5.                                                                                                               | Other Information                                                                           | 46         |
| Item 6.                                                                                                               | Exhibits                                                                                    | 46         |
|                                                                                                                  |                                                                                        |       |
| SIGNATURE                                                                                                             | 47                                                                                          |

 

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**PART I— FINANCIAL INFORMATION**

 

**ITEM 1.  CONDENSED FINANCIAL STATEMENTS**

 

**ARYxTHERAPEUTICS, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Inthousands)**

 
| ** **                                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                 | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ** **                                                 | ** ** | **(unaudited)**        | ** ** | **(Note 1)**     | ** ** |
| **ASSETS**                                                 |       |                   |       |                  |       |
| Current assets:                                            |       |                   |       |                  |       |
| Cash and cash equivalents                                  |       | $                      | 2,954      |                  | $          | 7,409 |   |
| Marketable securities                                      |       | —                 |       | 353                   |       |
| Restricted cash - current                                  |       | 150                    |       | 150                   |       |
| Prepaid research and development expenses                  |       | 67                     |       | 220                   |       |
| Other prepaid, receivable, and current assets              |       | 511                    |       | 483                   |       |
| Total current assets                                       |       | 3,682                  |       | 8,615                 |       |
| Restricted cash                                            |       | 518                    |       | 1,003                 |       |
| Property and equipment, net                                |       | 1,578                  |       | 2,258                 |       |
| Other assets                                               |       | 194                    |       | 97                    |       |
| **Total assets**                                           |       | $                      | 5,972      |                  | $          | 11,973 |   |
|                                                       |       |                   |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY (DEFICIT)**   |       |                   |       |                  |       |
| Current liabilities:                                       |       |                   |       |                  |       |
| Accounts payable                                           |       | $                      | 233        |                  | $          | 685 |   |
| Accrued compensation                                       |       | 8                      |       | 893                   |       |
| Accrued research and development expenses                  |       | 28                     |       | 70                    |       |
| Current portion of notes payable                           |       | 6,825                  |       | 4,658                 |       |
| Current portion of interest payable                        |       | 38                     |       | 1,257                 |       |
| Other accrued liabilities                                  |       | 657                    |       | 926                   |       |
| Total current liabilities                                  |       | 7,789                  |       | 8,489                 |       |
| Deferred lease credit                                      |       | 747                    |       | 1,053                 |       |
| Notes payable                                              |       | 4,748                  |       | 5,042                 |       |
| Interest payable                                           |       | 423                    |       | 305                   |       |
| Commitments and contingencies                              |       |                   |       |                  |       |
| Stockholders’ equity (deficit):                       |       |                   |       |                  |       |
| Common stock                                               |       | 33                     |       | 28                    |       |
| Additional paid-in capital                                 |       | 191,882                |       | 184,165               |       |
| Accumulated deficit                                        |       | (199,650               | )          | (187,109              | )          |
| Total stockholders’ equity (deficit)                  |       | (7,735                 | )          | (2,916                | )          |
| Total liabilities and stockholders’ equity  (deficit) |       | $                      | 5,972      |                  | $          | 11,973 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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**ARYx THERAPEUTICS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(In thousands, except per share amounts)**

**(Unaudited)**

 
| ** **                                                                    | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                    | ** ** | **September 30,**                             | ** ** | **September 30,**                            | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                    | ** ** | **2010**                                           | ** ** | **2009**                                          | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                          |       |                                               |       |                                              |       |   |   |   |   |
| Costs and expenses:                                                           |       |                                               |       |                                              |       |   |   |   |   |
| Research and development                                                      |       | 829                                                |       | 4,994                                             |       | 4,075 |   | 18,054 |   |
| Selling, general and administrative                                           |       | 1,316                                              |       | 2,638                                             |       | 7,331 |   | 7,863 |   |
| Total costs and expenses                                                      |       | 2,145                                              |       | 7,632                                             |       | 11,406 |   | 25,917 |   |
| Loss from operations                                                          |       | (2,145                                             | )          | (7,632                                            | )          | (11,406 | ) | (25,917 | ) |
|                                                                          |       |                                               |       |                                              |       |   |   |   |   |
| Interest and other income, net                                                |       | 6                                                  |       | 1                                                 |       | 64 |   | 66 |   |
| Interest expense                                                              |       | (375                                               | )          | (519                                              | )          | (1,199 | ) | (1,515 | ) |
| Loss on investments                                                           |       | —                                             |       | —                                            |       | — |   | (14 | ) |
| Net loss                                                                      |       | (2,514                                             | )          | (8,150                                            | )          | (12,541 | ) | (27,380 | ) |
|                                                                          |       |                                               |       |                                              |       |   |   |   |   |
| Basic and diluted net loss per share                                          |       | $                                                  | (0.08      | )                                                 | $          | (0.30 | ) | $ | (0.39 | ) | $ | (1.00 | ) |
| Weighted average shares used to compute basic and  diluted net loss per share |       | 33,458                                             |       | 27,443                                            |       | 32,088 |   | 27,387 |   |
|                                                                               |            |                                                    |            |                                                   |            |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these financialstatements.

 

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**ARYx THERAPEUTICS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOW**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,**                            | ** ** | **September 30,** | ** ** |
| ** **                                                                   | ** ** | **2010**                                          | ** ** | **2009** | ** ** |
| **Cash flows from operating  activities:**                                   | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net loss                                                                     |       | $                                                 | (12,541    | ) | $ | (27,380 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                |       | 688                                               |       | 819 |   |
| Amortization of warrants                                                     |       | 180                                               |       | 164 |   |
| Impairment of long-lived assets                                              |       | —                                            |       | 26 |   |
| Stock-based compensation                                                     |       | 777                                               |       | 1,724 |   |
| Realized loss on marketable securities                                       |       | (18                                               | )          | — |   |
| Change in assets and liabilities:                                            |       |                                              |       |   |   |
| Prepaid research and development expenses                                    |       | 153                                               |       | 186 |   |
| Other prepaid, receivable, and assets                                        |       | (125                                              | )          | 320 |   |
| Accounts payable and other accrued liabilities                               |       | (1,865                                            | )          | (1,502 | ) |
| Accrued compensation                                                         |       | (885                                              | )          | 107 |   |
| Accrued research and development expenses                                    |       | (42                                               | )          | (3,346 | ) |
| Deferred lease credit                                                        |       | (306                                              | )          | — |   |
| Net cash used in operating activities                                        |       | (13,984                                           | )          | (28,882 | ) |
|                                                                         |       |                                              |       |   |   |
| **Cash flows from investing  activities:**                                   |       |                                              |       |   |   |
| Purchases of marketable securities                                           |       | —                                            |       | (11,162 | ) |
| Proceeds from sales of marketable securities                                 |       | 370                                               |       | — |   |
| Proceeds from maturities of marketable securities                            |       | —                                            |       | 12,208 |   |
| Decrease in restricted cash                                                  |       | 485                                               |       | 200 |   |
| Purchases of fixed assets                                                    |       | (8                                                | )          | (97 | ) |
| Net cash provided by investing activities                                    |       | 847                                               |       | 1,149 |   |
|                                                                         |       |                                              |       |   |   |
| **Cash flows from financing activities:**                                    |       |                                              |       |   |   |
| Proceeds from exercise of stock options and  issuance of common stock        |       | 1                                                 |       | 192 |   |
| Issuance of equity, net of cost                                              |       | 6,391                                             |       | (92 | ) |
| Proceeds from issuance of notes payable                                      |       | 6,291                                             |       | — |   |
| Principal payments on notes payable                                          |       | (4,001                                            | )          | (1,521 | ) |
| Net cash provided by (used in) financing  activities                         |       | 8,682                                             |       | (1,421 | ) |
|                                                                         |       |                                              |       |   |   |
| **Net decrease in cash and cash  equivalents**                               |       | (4,455                                            | )          | (29,154 | ) |
| Cash and cash equivalents at beginning of period                             |       | 7,409                                             |       | 35,999 |   |
| **Cash and cash equivalents at end  of period**                              |       | $                                                 | 2,954      |   | $ | 6,845 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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**ARYx THERAPEUTICS, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Inthis report, “ARYx,” “we,” “us” and “our” refer to ARYx Therapeutics, Inc.“Common Stock” refers to ARYx’s common stock, par value $0.001 per share.

 

**1.  Organization and Summary of SignificantAccounting Policies**

 

***The Company***

 

We are a biopharmaceutical company focused on developing a portfolio ofinternally discovered product candidates designed to eliminate known safetyissues associated with well-established, commercially successful drugs. We useour RetroMetabolic Drug Design technology to design structurally uniquemolecules that retain the efficacy of these original drugs but are metabolizedthrough a potentially safer pathway to avoid specific adverse side effectsassociated with these compounds. Our product candidate portfolio includes anoral prokinetic agent, naronapride (ATI-7505), designed to have the same therapeuticbenefits as cisapride approved for Phase 3 clinical development for thetreatment of chronic constipation, gastroparesis, functional dyspepsia,irritable bowel syndrome with constipation, and gastroesophageal refluxdisease; an oral anticoagulant, tecarfarin (ATI-5923), designed to have thesame therapeutic benefits as warfarin, currently in Phase 2/3 clinicaldevelopment for the treatment of patients who are at risk for the formation ofdangerous blood clots; an oral antiarrhythmic agent, budiodarone (ATI-2042),designed to have the efficacy of amiodarone in Phase 2 clinicaldevelopment for the treatment of atrial fibrillation, a form of irregularheartbeat; and a novel, next-generation atypical antipsychotic agent, ATI-9242,currently in Phase 1 clinical development for the treatment ofschizophrenia and other psychiatric disorders. Additionally, we have severalproduct candidates in preclinical development. Each of our product candidatesis an orally available, patentable new chemical entity designed to addresssimilar indications as those of the original drug upon which each is based. Ourproduct candidates target what we believe to be multi-billion dollar marketopportunities.

 

We were incorporated in the State of California on February 28,1997 and reincorporated in the State of Delaware on August 29, 2007. Wemaintain a wholly owned subsidiary, ARYx Therapeutics Limited, with registeredoffices in the United Kingdom, which has had no operations since its inceptionin September 2004 and was established only to serve as a legal entity asrequired in support of our clinical trial activities conducted in Europe. Wecurrently are focused on the human drug development business and operate in asingle business segment with regard to the development of human pharmaceuticalproducts.

 

In February 2010 we shifted our primary focus to exploringstrategic alternatives available to us to complete a transaction that couldcreate significant value for stockholders. Those alternatives could includepartnerships on one or more of the three lead product candidates, the sale ofcompany assets, in whole or in part, or some other arrangement through whichthe value of our assets to stockholders could be optimized (“Strategic Process”).Concurrent with beginning the Strategic Process, we restructured our operationsin order to conserve resources and support the process of reviewing strategicalternatives. This followed an initial reduction in our workforce headcount in October 2009.Through these two restructuring steps and following the departure inJune 2010 of Peter G. Milner, M.D., our former President of Research andDevelopment, our headcount has been reduced from 73 to 16 employees. Therestructuring was necessary as we have three compounds at proof-of-concept stagebut insufficient cash resources to develop these product candidates further orto complete licensing agreements in a timely manner with a high level ofcertainty. Our operations have consumed a substantial amount of cash sinceinception and we expect to continue to incur net losses for the foreseeablefuture. Our ability to continue operations will be dependent on our ability toobtain substantial additional funding. We may seek to raise necessaryadditional funds through public or private equity, debt financings,collaborative arrangements with corporate partners or other sources availableto us. This may include proceeds, if any, from sales of common stock under ourat market issuance sales agreement with McNicoll, Lewis & Vlak LLC andWm Smith & Co., pursuant to which we may issue and sell up to $6.0million of our common stock subject to limitations with respect to the marketliquidity of our common stock.

 

Therestructuring of operations we announced on February 18, 2010 included asubstantial reduction in force from 56 employees to 17 employees, and furtherreduced to 16 employees following the departure of Peter G. Milner, M.D., ourformer President of Research and Development, effective June 15, 2010. Thepositions impacted were across all business functions, including the researchand development, clinical, operations and general and administrativedepartments. The restructuring plan was primarily designed to reduce operatingexpenses and conserve cash resources as we explore various strategic options. Therestructuring was substantially completed during the first quarter of 2010.Additionally, we announced the shift of our primary focus to the exploration ofstrategic alternatives available to us to realize optimal value for ourlate-stage assets.

 

Employeesaffected by the reductions in force were provided with severance payments,continuation of current benefits and outplacement assistance. Severancepayments to employees terminated as part of the February 2010restructuring consisted of 50% 

 

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cashand 50% common stock in order to minimize the associated cash expense, with anaggregate 460,940 shares of common stock issued under our equity incentive planas a severance payout.

 

As a result of the February 2010 restructuring of operations, weincurred an aggregate restructuring charge of approximately $1.6 million less acredit of approximately $0.3 million due to stock option cancellations in thefirst six months of 2010. These amounts were included within our general andadministrative expense. Of this amount, approximately $0.1 million wasrecognized as expense during the second quarter of 2010. The restructuringcharge includes costs for severance pay, employee benefits and outplacementservices. The aggregate restructuring charge included approximately$1.0 million of cash expenditures and approximately $0.3 million ofnon-cash charges, net of adjustments related to stock compensation expense. Aspart of the restructuring effort and during the course of our continuingoperations, we will be assessing on a quarterly basis any possible impairmentof assets related to idle facilities and equipment resulting from theFebruary 2010 restructuring and may incur additional expense related toany such impairment. During the first three quarters of 2010 we made anassessment in accordance with ASC 360 to determine if there had been anymaterial impairment of assets resulting from the February 2010restructuring and concluded that given the range of possible outcomes relatedto our exploration of strategic alternatives, no material impairment hadoccurred.

 

On August 13, 2010, we secured bridge financing in two related loantransactions — a bridge loan financing with entities affiliated with MPMCapital and Ayer Capital Management, L.L.P. (collectively the “Bridge Investors”)and the concurrent restructuring of our outstanding loans with LighthouseCapital Partners V, L.P. (“Lighthouse”). Under the terms of a secured note and warrant purchase agreement dated August 13,2010, we issued and sold secured promissory notes (the “Notes”) in theprincipal amount of up to $4.0 million and warrants to purchase an aggregate of2,000,000 shares of our common stock to the Bridge Investors in two tranches(the “Bridge Financing”). We completed the first tranche for $2.0 million ofNotes and warrants to purchase 1,000,000 shares of our common stock on August 13,2010.  We completed the second tranchefor $2.0 million of Notes and warrants to purchase 1,000,000 shares of commonstock on September 30, 2010. Concurrently with the initial tranche of theBridge Financing, we amended our existing loan arrangement with Lighthouse toprovide for the conversion of approximately $2.3 million of loan paymentsscheduled for the third quarter of 2010 into a new loan to us by Lighthouse(the “New Commitment”).  Upon the initialclosing of the Bridge Financing, we made an approximately $2.0 million paymentto Lighthouse out of the proceeds of the initial closing, and Lighthouseimmediately loaned approximately the same amount back to us as part of the NewCommitment.  On September 1, 2010,we made a subsequent payment of approximately $300,000 to Lighthouse, whichLighthouse immediately loaned back to us as the balance of the NewCommitment.  We believe that our cash andcash equivalents on hand as of September 30, 2010 are sufficient to fundour operations to December 31, 2010. We will need to seek additional sources of funding to allow us tocontinue our operations as we continue to explore strategic options availableto us.

 

***Basis of Presentation***

 

Theaccompanying unaudited condensed consolidated financial statements include theaccounts of our wholly-owned subsidiary, ARYx Therapeutics, Ltd. Allintercompany accounts and transactions have been eliminated. These unauditedcondensed consolidated financial statements have been prepared in accordancewith U.S. generally accepted accounting principles, or GAAP, for interimfinancial information on the same basis as the annual financial statements andwith instructions to Form 10-Q and Rule 10-01 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby GAAP for complete financial statements. These interim financial statementsinclude all adjustments (consisting only of normal recurring adjustments) thatmanagement believes are necessary for the fair presentation of the balances andresults for the periods presented. Interim financial results are notnecessarily indicative of results to be expected for the full fiscal year orany future interim period.

 

Thebalance sheet data at December 31, 2009 has been derived from our auditedconsolidated financial statements for the year ended December 31, 2009,contained in our Annual Report on Form 10-K. The unaudited condensedconsolidated financial statements and related disclosures contained in thisreport have been prepared with the presumption that users of the interim financialstatements have read or have access to our audited financial statements for thepreceding year. Accordingly, these interim financial statements should be readin conjunction with our audited financial statements and notes thereto for theyear ended December 31, 2009, contained in our Annual Report onForm 10-K. In order to ensure the comparability of our financialstatements to prior periods our policy is to reclassify certain items withinour financial statements so that amounts are comparable across reportingperiods. For the period ended December 31, 2009, certain balances related tothe classification of warrants issued to Lighthouse have been reclassified as acontra-liability to make our financial statements comparable.

 

***Risks and Uncertainties***

 

As of September 30, 2010, we had cash, cash equivalents andmarketable securities on hand of approximately $3.0 million, currentpayables and accrued liabilities of approximately $0.9 million andapproximately $6.9 million in current notes and interest payable. As ofSeptember 30, 2010, we had outstanding non-current liabilities of$5.9 million. Since our inception, we have incurred significant netoperating losses and, as of September 30, 2010, we had an accumulateddeficit of $199.6 million. We have generated no revenue from product salesto date and we have funded operations principally from the sale of ourconvertible preferred and common stock and payments received under ourcollaboration agreements. We have not achieved sustainable profitability and 

 

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anticipatethat we will continue to incur significant net losses for the foreseeablefuture. There can be no assurances that we will achieve positive cash flow inthe foreseeable future or at all. Additionally, we do not anticipate that ourcash on hand as of September 30, 2010 will be sufficient to fund our operationsfor the following twelve months. However, we believe that our cash on hand willprovide us with sufficient funds to operate through the end of 2010. Thesefactors raise substantial doubt about our ability to continue as a goingconcern. Management’s plans as to these matters are described above. These financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.

 

We have no products that have received regulatory approval. Anyproducts we develop will require approval from the U.S. Food and DrugAdministration or foreign regulatory agencies prior to commercial sales. Therecan be no assurance that our products will receive the necessary approvals. Ifwe are denied such approvals or such approvals are delayed, it could have amaterial adverse effect to our operations. To achieve profitable operations, wemust successfully develop, test, manufacture and market products. There can beno assurance that any such products can be developed successfully ormanufactured at an acceptable cost and with appropriate performancecharacteristics, or that such products will be successfully marketed. Thesefactors could have a material adverse effect on our future financial results.

 

Financial instruments that potentially subject us to a concentration ofcredit risk consist of cash, cash equivalents and marketable securities. Wedeposit excess cash and cash equivalents with multiple financial institutionsin the United States. Deposits in these financial institutions may exceed theamount of insurance provided on such deposits. We have not experienced anylosses on our deposits of cash and cash equivalents.

 

***Use of Estimates***

 

Thepreparation of financial statements in conformity with GAAP requires managementto make judgments, assumptions and estimates that affect the reported amountsin the consolidated financial statements and accompanying notes. On an ongoingbasis, we evaluate our critical accounting policies and estimates, includingthose related to clinical trial accruals and stock-based compensation.Management bases its estimates on historical experience and on assumptionsbelieved to be reasonable under the circumstances. Actual results could differfrom those estimates.

 

***Comprehensive Loss***

 

Comprehensive loss is comprised of net loss and other comprehensiveincome/loss. The only component of our other comprehensive income/loss is theunrealized gains and losses, if any, on our marketable securities holdings.Comprehensive loss for the three months ended September 30, 2010 and 2009was $2.5 million and $8.1 million, respectively, and for the ninemonths ended September 30, 2010 and 2009 was $12.5 million and $27.4 million,respectively.

 

***Net Loss Per Share***

 

Basic net loss per share is computed by dividing net loss by theweighted average number of fully vested common shares outstanding during theperiod. Diluted net loss per share is computed by giving effect to allpotential dilutive common shares, including stock options and warrants. For allperiods presented in this report, stock options and warrants were not includedin the computation of diluted net loss per share because the inclusion wouldprovide an anti-dilutive effect. The following table presents the calculationof basic and diluted net loss per share:

 
| ** **                                                                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| *Numerator:*                                                                    | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                        |       | $                                                    | (2,514     | )                                                   | $          | (8,150 | ) | $ | (12,541 | ) | $ | (27,380 | ) |
| *Denominator:*                                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average commons shares outstanding                                     |       | 33,462                                               |       | 27,453                                              |       | 32,094 |   | 27,399 |   |
| Less: weighted average unvested restricted common  shares                       |       | (4                                                   | )          | (10                                                 | )          | (6 | ) | (12 | ) |
| Weighted average shares used in computing basic  and diluted net loss per share |       | 33,458                                               |       | 27,443                                              |       | 32,088 |   | 27,387 |   |
| Basic and diluted net loss per share                                            |       | $                                                    | (0.08      | )                                                   | $          | (0.30 | ) | $ | (0.39 | ) | $ | (1.00 | ) |

 

***Income Taxes***

 

We use the asset andliability method of accounting for income taxes in accordance with ASC740, *Income Taxes*. Deferredtax assets and liabilities are determined based on differences betweenfinancial reporting and the tax basis of assets and liabilities and are 

 

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measured using enacted taxrates and laws that will be in effect when the differences are expected toreverse. A valuation allowance is provided when it is more likely than not thatsome portion or all of a deferred tax asset will not be realized.

 

Aspermitted under the provisions of ASC 740, we will classify interest andpenalties related to unrecognized tax benefits as part of our income taxprovision, although there have been no such interest or penalties recognizedto-date.

 

***Recent Accounting Pronouncements***

 

In January 2010, the FASB issued ASU No. 2010-06, whichrevised guidance intended to improve disclosures related to fair valuemeasurements. This guidance requires new disclosures as well as clarifiescertain existing disclosure requirements. New disclosures under this guidancerequire separate information about significant transfers in and out of Level 1and Level 2 and the reason for such transfers, and also require purchases,sales, issuances, and settlements information for Level 3 measurement to beincluded in the rollforward of activity on a gross basis. ASU No. 2010-06also clarifies the requirement to determine the level of disaggregation forfair value measurement disclosures and the requirement to disclose valuationtechniques and inputs used for both recurring and nonrecurring fair valuemeasurements in either Level 2 or Level 3. The new disclosures and clarificationsof existing disclosures are effective for interim and annual reporting periodsbeginning after December 15, 2009, except for the disclosures aboutpurchases, sales, issuances, and settlements in the roll forward activity inLevel 3 fair value measurements.  Thosedisclosures are effective for fiscal years beginning December 15, 2010,and for the interim periods within those fiscal years.  We do not expect adoption of thispronouncement to have a material impact to our financial statements.

 

**2. Fair Value Measurement**

 

Thefollowing tables summarize the fair value of our financial assets as ofSeptember 30, 2010 and December 31, 2009 that were recorded at fairvalue on a recurring basis consistent with the fair value hierarchy provisionsof ASC 820.

 
| ** **                                     | ** ** | **September 30, 2010** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **Total Fair  Value**       | ** ** | **Quoted Prices in  Active Markets for  Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable Inputs  (Level 2)** | ** ** | **Significant  Unobservable Inputs  (Level 3)** | ** ** |
| ** **                                     | ** ** | **(in thousands)**          | ** ** |
|                                           |       |                             |       |   |   |   |   |   |   |
| Money market funds                             |       | 2,272                            |       | — |   | 2,272 |   | — |   |
| Certificate of Deposit                         |       | 150                              |       | 150 |   | — |   | — |   |
| Auction rate securities:                       |       |                             |       |   |   |   |   |   |   |
| Balance as of December 31, 2009           |       | 353                              |       | — |   | — |   | 353 |   |
| Purchases                                      |       | —                           |       | — |   | — |   | — |   |
| Sales and maturities                           |       | (370                             | )          | — |   | — |   | (370 | ) |
| Transfers in (out) of Level 2 and Level 3 |       | —                           |       | — |   | — |   | — |   |
| Gain on sale of securities                     |       | 17                               |       | — |   | — |   | 17 |   |
| Ending balance as of September 30, 2010        |       | —                           |       | — |   | — |   | — |   |
| Total                                          |       | $                                | 2,422      |   | $ | 150 |   | $ | 2,272 |   | $ | — |   |
|                                                |            |                                  |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                     | ** ** | **December 31, 2009** | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|
| ** **                                     | ** ** | **Total Fair  Value**      | ** ** | **Quoted Prices in  Active Markets for  Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable Inputs  (Level 2)** | ** ** | **Significant  Unobservable Inputs  (Level 3)** | ** ** |
| ** **                                     | ** ** | **(in thousands)**         | ** ** |
|                                           |       |                            |       |   |   |   |   |   |   |
| Money market funds                             |       | 7,192                           |       | — |   | 7,192 |   | — |   |
| Certificate of Deposit                         |       | 150                             |       | 150 |   | — |   | — |   |
| Auction rate securities:                       |       |                            |       |   |   |   |   |   |   |
| Balance as of January 1, 2009             |       | 367                             |       | — |   | — |   | 367 |   |
| Purchases                                      |       | —                          |       | — |   | — |   | — |   |
| Sales and maturities                           |       | —                          |       | — |   | — |   | — |   |
| Transfers in (out) of Level 2 and Level 3 |       | —                          |       | — |   | — |   | — |   |
| Gain on sale of securities                     |       | (14                             | )          | — |   | — |   | (14 | ) |
| Ending balance as of December 31, 2009    |       | 353                             |       | — |   | — |   | 353 |   |
| Total                                          |       | $                               | 7,695      |   | $ | 150 |   | $ | 7,192 |   | $ | 353 |   |
|                                                |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 

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Ourfinancial assets valued using Level 1 inputs consist primarily of certificatesof deposit at a financial institution. Our financial assets valued using Level 2 inputs consist of cash held inmoney market funds with fair values that are determined by our institutionalportfolio managers whose valuations are based upon market-corroborated inputssuch as broker/dealer quotes, reported trades, bids and offers that we believeare reasonable. Previously, the fair value of our auction rate security wasmeasured using Level 3 inputs as determined by a discounted cash flow modelthat considered expected cash flows from the auction rate instrument includingexpected interest payments, market yields for similarly rated instruments, ourestimates of time to liquidity for the security, and a marketability discount.Transfers between levels are determined and recognized at the end of eachreporting period.

 

**3.  Debt Financing**

 

As of September 30, 2010, we had loan commitments outstanding withLighthouse, the Bridge Investors and Oxford Finance Corporation, or Oxford.Prior to September 30, 2010 we also had loan commitments outstanding withGeneral Electric Commercial Finance, or GE.

 

On August 13, 2010, we entered into an agreement with the BridgeInvestors pursuant to which we agreed to issue and sell in a private placementNotes in the aggregate principal amount of up to $4.0 million, and Warrants topurchase up to an aggregate of 2,000,000 shares of our common stock, subject tothe terms and conditions set forth in the agreement.  The Notes are secured by a security interestin all of our assets, including our intellectual property.

 

OnAugust 13, 2010, we closed on the first tranche of $2.0 million of Notespursuant under the terms and conditions of the Bridge Financing and, as aresult, issued Warrants to the Bridge Investors to purchase 1,000,000 shares ofour common stock.  On September 30,2010, we closed on the second tranche of $2.0 million of Notes and issuedWarrants to purchase an additional 1,000,000 shares of our common stock.

 

The Notes accrue interest at a continuously compounding rate of 12.0%per annum.  Unless earlier paid pursuantto the terms of the agreement or accelerated in connection with an event ofdefault, we will make interest only payments through December 31, 2010,followed by 24 equal monthly payments of principal and interest throughJanuary 1, 2013. In the event we sell any or all of our assets or enterinto certain strategic transactions, we may be required to repay the Notes atan earlier date under the terms of the Bridge Financing.

 

TheWarrants had a purchase price of $0.0125 per underlying share of common stockand are exercisable for a term of five years from the date of issuance at anexercise price of $0.50 per share. On October 12, 2010, we filed aregistration statement registering for resale the shares of common stockissuable upon the exercise of the Warrants pursuant to the Registration RightsAgreement we entered into with the Bridge Investors.

 

Wereceived net proceeds of approximately $1.8 million in connection with theinitial tranche of the Bridge Financing, after deducting certain expensespayable by us. The net proceeds from the initial tranche of the BridgeFinancing were used by us to make an approximately $2.0 million repayment onour existing loan obligation with Lighthouse pursuant to the terms of our loanarrangement with Lighthouse, as more fully described below. We received netproceeds of approximately $2.0 million in connection with the second tranche ofthe Bridge Financing after deducting certain expenses payable by us. Wecurrently anticipate the remaining proceeds from the Bridge Financing will beused for working capital and other corporate and operational purposes,including permitted payments to our lenders.

 

Concurrentlywith the Bridge Financing, we and Lighthouse entered into Amendment No. 8to that certain Loan and Security Agreement No. 4521 dated March 28,2005, as amended. The amendment to the Lighthouse agreement provides for theconversion of up to approximately $2.3 million of loan payments scheduled forthe third quarter of 2010 into the New Commitment. Upon the closing of theinitial tranche of the Bridge Financing, we used the net proceeds from suchclosing to make an approximately $2.0 million repayment of our loan obligationto Lighthouse and, pursuant to the terms of the amendment, Lighthouse promptlyloaned approximately the same amount to us as part of the New Commitment. On September 1,2010, we made a subsequent payment of approximately $300,000 to Lighthousewhich was promptly loaned back to us from Lighthouse as the balance of the NewCommitment.

 

TheNew Commitment is due and payable on December 31, 2010 in one lump sumpayment equal to the aggregate principal amount plus accrued interest throughthe due date at a stated interest rate of 13.0% per annum. In the event weenter into certain strategic transactions with proceeds of at least $40.0million prior to the applicable due date, the New Commitment will be amortizedand payable in equal monthly installments of principal and interest over the 18months following the closing of such strategic 

 

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transaction.Upon the occurrence of an event of default or liquidation event, all outstandingamounts under the New Commitment shall be immediately due and payable.

 

The terms of the Lighthouse loan further provide that any assignment ofthe Notes without Lighthouse’s consent would now constitute an event of defaultunder the Lighthouse loan agreement. We also granted Lighthouse a securityinterest in all of our assets including our intellectual property in connectionwith the amendment to the Lighthouse loan agreement and the New Commitment.

 

As of September 30, 2010, following our receipt of the NewCommitment, the total principal amount borrowed under the Lighthouse loans was$21.3 million and the total unpaid principal balance outstanding was$7.9 million. The total accrued and unpaid balloon interest outstandingwas $0.4 million as of September 30, 2010. We recorded interest expenserelated to the Lighthouse loan, including amortization of expense related tothe terminal payments and the warrants issued under the agreement, of $302,000and $488,000 for the three months ended September 30, 2010 and 2009,respectively, and $1.1 million and $1.4 million for the nine months endedSeptember 30, 2010 and 2009, respectively.

 

The total principal amount borrowed under the Bridge Financingarrangement was $4.0 million and the total unpaid principal balanceoutstanding as of September 30, 2010, was $4.0 million. We recordedinterest expense related to the Bridge Financing, including amortization ofexpense related to capitalized loan expenses and the warrant issued under theagreement, of $57,900 and none for the three months ended September 30,2010 and 2009, respectively, and $57,900 and none for the nine months ended September30, 2010 and 2009, respectively.

 

The total principal amount borrowed under the Oxford loan was$1.0 million and the total unpaid principal balance outstanding as ofSeptember 30, 2010, was $459,000. The total accrued and unpaid ballooninterest outstanding was $12,000 as of September 30, 2010. We recorded interestexpense related to the Oxford loan, including amortization of expense relatedto the terminal payment and the warrant issued under the agreement, of $17,800and $27,000 for the three months ended September 30, 2010 and 2009,respectively, and $60,500 and $87,000 for the nine months ended September 30,2010 and 2009, respectively. Pursuant to the terms of the Oxford loan, Oxfordmaintains a security interest in certain of our fixed assets.

 

The total principal amount borrowed under the GE loans was $1.9 millionand as of September 30, 2010 the loans had been fully repaid. We recordedno interest expense related to the GE loans for the three months ended September 30,2010 and $5,000 for the three months ended September 30, 2009. For thenine months ended September 30, 2010 and 2009, respectively, we recorded$650 and $20,000 in interest expense related to the GE loans.

 

**4.  Equity Financing**

 

On October 6, 2009, we entered into a common stock purchaseagreement, or the Purchase Agreement, with Commerce Court Small Cap ValueFund, Ltd., or Commerce Court, providing for a financing arrangement thatis sometimes referred to as a committed equity line financing facility. ThePurchase Agreement provides that, upon the terms and subject to the conditionsset forth in the Purchase Agreement, Commerce Court is committed to purchase upto $35.0 million of shares of our common stock over the 24-month term ofthe Purchase Agreement under certain specified conditions and limitations,provided that in no event may we sell under the Purchase Agreement more than5,380,090 shares of common stock, which is equal to one share less than 20% ofour outstanding shares of common stock on October 6, 2009, the closingdate of the Purchase Agreement, less the number of shares of common stock weissued to Commerce Court on the closing date as Commitment Shares describedbelow. Furthermore, in no event will Commerce Court be obligated to purchaseany shares of our common stock which, when aggregated with all other shares ofour common stock then beneficially owned by Commerce Court, would result in thebeneficial ownership by Commerce Court of more than 9.9% of the thenoutstanding shares of our common stock.

 

On January 4, 2010, we delivered notice to Commerce Court, assubsequently amended, to effect a draw down of up to $1.4 million. The first tradingday of the 10-day pricing period for this draw down was January 5, 2010.In connection with this draw down, we issued an aggregate of 490,864 shares ofour common stock to Commerce Court, at a purchase price of approximately $2.85per share and an aggregate purchase price of $1.4 million. The settlementdate for this draw down was January 20, 2010. The share price at whichCommerce Court purchased these shares from us was established under thePurchase Agreement by reference to the volume weighted average prices of ourcommon stock on The NASDAQ Global Market during the pricing period, net adiscount of approximately 6.1% per share. We received net proceeds from thesale of these shares of approximately $1.38 million after deducting ouroffering expenses of approximately $25,000, including a placement agent fee of$14,000 paid to Reedland Capital Partners connection with this draw down.

 

On February 19, 2010, we delivered notice to Commerce Court, toeffect a draw down under the Purchase Agreement. The first trading day of the10-day pricing period for this draw down was February 22, 2010. Inconnection with this draw down, we issued an aggregate of 2,764,546 shares ofour common stock to Commerce Court, at a purchase price of approximately $1.19 pershare and

 

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anaggregate purchase price of approximately $3.29 million. The settlementdate for this draw down was March 8, 2010. The share price at whichCommerce Court purchased these shares from us was established under thePurchase Agreement by reference to the volume weighted average price of ourcommon stock on The NASDAQ Global Market during the pricing period, net adiscount of approximately 7.0% per share. We received net proceeds from thesale of these shares of approximately $3.24 million after deducting ouroffering expenses of approximately $45,000, including a placement agent fee of$33,000 paid to Reedland Capital Partners in connection with this draw down.

 

On March 11, 2010, we delivered notice to Commerce Court to effecta draw down under the Purchase Agreement. The first trading day of the 10-daypricing period for this draw down was March 12, 2010. In connection withthis draw down, we issued an aggregate of 1,710,784 shares of our common stockto Commerce Court, at a purchase price of approximately $1.07 per share and anaggregate purchase price of approximately $1.83 million. The settlementdate for this draw down was March 26, 2010. The share price at whichCommerce Court purchased these shares from us was established under thePurchase Agreement by reference to the volume weighted average price of ourcommon stock on The NASDAQ Global Market during the pricing period, net adiscount of approximately 7.0% per share. We received net proceeds from thesale of these shares of approximately $1.8 million after deductingoffering expenses of approximately $30,000, including a placement agent fee of$18,311 payable to Reedland Capital Partners in connection with this draw down.

 

As of March 26, 2010, we had issued the maximum amount of commonstock available for sale under the Commerce Court Purchase Agreement andtherefore we will no longer be able to utilize the facility for additionalfunding.

 

OnMay 20, 2010, we entered into an at market issuance sales agreement, orSales Agreement, with McNicoll, Lewis & Vlak LLC, or MLV, and WmSmith & Co., or Wm Smith, pursuant to which we may issue and sellshares of our common stock having an aggregate offering price of up to $6.0million from time to time through MLV and Wm Smith as our sales agents. Salesof our common stock through MLV and Wm Smith, if any, will be made on TheNASDAQ Global Market by means of ordinary brokers’ transactions at marketprices, in block transactions or as otherwise agreed by us and these salesagents. Subject to the terms and conditions of the Sales Agreement, MLV and WmSmith will use commercially reasonable efforts to sell our common stock fromtime to time, based upon our instructions (including any price, time or sizelimits or other customary parameters or conditions we may impose). We will paythese sales agents an aggregate commission rate of 3.0% of the gross proceedsof the sales price per share of any common stock sold through the sales agentsunder the Sales Agreement. The number of shares we are able to sell under thisarrangement will be limited in practice based on the trading volume of ourcommon stock. As of September 30, 2010 we had not issued or sold anyshares of our common stock pursuant to the Sales Agreement. In connection withthis financing arrangement, we incurred costs of approximately $150,000 thatwere expensed during the second quarter of 2010 and are included within ourselling, general and administrative expense.

 

**5.  Warrants**

 

We issue freestanding warrants from time to time pursuant to variouscontractual arrangements. As of September 30, 2010, the following warrantsto purchase our common stock were issued and outstanding:

 
| **Warrant Holder** | ** ** | **Issue Date** | ** ** | **In Connection With** | ** ** | **Warrant to Purchase** | ** ** | **Shares** | ** ** | **Exercise  Price  (per share)** | ** ** | **Expire Date** | ** ** |
|-------------------------|------------|---------------------|------------|----------------------------------|------------|-----------------------------------|------------|------------|------------|---------------------------------------|------------|----------------------|------------|
| ATEL                    |       | 12/23/2002          |       | Leasing  arrangement             |       | Common  Stock                     |       | 5,611      |       | $                                     | 8.91       |                 | 11/13/2012 |   |
| Lighthouse (1)          |       | 10/19/2007          |       | Debt  financing                  |       | Common  Stock                     |       | 83,332     |       | $                                     | 10.80      |                 |       | (1) |
| Lighthouse (2)          |       | 10/17/2008          |       | Debt  restructure                |       | Common  Stock                     |       | 158,770    |       | $                                     | 3.975      |                 |       | (2) |
| Various investors       |       |                | (3)        | Private  placement of equity     |       | Common  Stock                     |       | 2,769,864  |       | $                                     | 2.64       |                 | 11/14/2013 |   |
| Oxford (4)              |       | 12/31/2008          |       | Equipment  financing             |       | Common  Stock                     |       | 8,547      |       | $                                     | 2.34       |                 | 12/31/2013 |   |
| MPM Capital             |       |                | (5)        | Bridge  financing                |       | Common  Stock                     |       | 1,000,000  |       | $                                     | 0.50       |                 |       | (5) |
| Ayer Capital            |       |                | (5)        | Bridge  financing                |       | Common  Stock                     |       | 1,000,000  |       | $                                     | 0.50       |                 |       | (5) |
|                    |       |                |       |                             |       |                              |       | 5,026,124  |       |                                  |       |                 |       |

 

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(1)                                 Exercisable, inwhole or in part, at anytime at the option of the holder or deemed to have beenautomatically exercised in full immediately prior to the expiration of thewarrant; expires at the earlier of (i) the close of business onOctober 19, 2014, or (ii) the effective date of a merger, as defined inthe agreement.

 

(2)                                 Exercisable, inwhole or in part, at anytime at the option of the holder or deemed to have beenautomatically exercised in full immediately prior to the expiration of thewarrant; expires at the earlier of (i) the close of business onOctober 17, 2013, or (ii) the effective date of a merger, as defined inthe agreement.

 

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(3)                                 Warrants topurchase 2,446,928 shares of our common stock were issued on November 14,2008 and warrants to purchase 447,936 shares of our common stock were issued onNovember 24, 2008, of which warrants to purchase 322,936 shares of ourcommon stock are currently outstanding; the warrants are exercisable, in wholeor in part, at anytime at the option of the holder for a term of five yearsfrom November 14, 2008.

 

(4)                                 Exercisable, inwhole or in part, at anytime at the option of the holder or deemed to have beenautomatically exercised in full immediately prior to the expiration of thewarrant if the fair market value of one share of our common stock is greaterthan the exercise price of the warrant on such date.

 

(5)                                 Warrants topurchase an aggregate of 2,000,000 shares of our common stock were issued on August 13,2010 and September 30, 2010. The warrants are exercisable, in whole or inpart, at anytime at the option of the holder for a term of five years from theissue date.

 

We follow guidance under ASC 480 to measure the fair value of thesewarrants on date of issuance. The fair value of the warrant issued to ATEL for$42,000 was capitalized as a prepayment on a lease and was amortized tointerest expense over the 36 month lease term. The fair value of the firstwarrant issued to Lighthouse for $738,000 was capitalized in three separatetranches as debt issuance cost, subsequently reclassified to contra-liability,with the first tranche amortized to interest expense over the fundingcommitment period ended December 31, 2005. The remainder was amortized tointerest expense over the duration of the interest-only period plus the term ofthe loan over 42 months. The fair value of the second warrant issued toLighthouse for $523,000 was capitalized in two separate tranches as debtissuance cost, subsequently reclassified to contra-liability, with the firsttranche amortized to interest expense over the funding commitment period endedMarch 1, 2008, and the remainder amortized to interest expense over theduration of the interest-only period plus the term of the loan over36 months. The fair value of the third warrant issued to Lighthouse for$396,000 was capitalized as debt issuance cost, subsequently reclassified tocontra-liability, and amortized to interest expense over the duration of theinterest-only period plus the term of the restructured loan over36 months. The fair value of the warrants issued in connection with theOxford equipment loan for $17,000 was capitalized as debt issuance cost,subsequently reclassified to contra-liability, and will be amortized tointerest expense over the duration of the loan over 36 months. The fairvalue of the warrants issued to the Bridge Investors was $550,000 in aggregateand was recorded in two separate tranches as a contra-liability with eachtranche amortized to interest expense over the contractual interest-only andloan amortization period of approximately 28 months.

 

We follow guidance under ASC 718, *Compensation-StockCompensations*, and considered the fair value of the warrants issuedto investors participating in the November 2008 private placement ofequity as cost of equity financing and accordingly, we recorded the fair valueof the warrants to contra-equity. The aggregate fair value of the warrantsissued to the investors was approximately $4.0 million determined usingthe Black-Scholes option valuation model with the following assumptions:risk-free interest rate of 2.44%, contractual life of five years according tothe terms of the warrants, no dividend yield and volatility of 79%.

 

The fair value of our warrants issued in connection with the placementof our long-term debt was amortized to interest expense as follows:

 
| ** **                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended****September**** 30,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                         | ** ** | **2010**                                             | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                         | ** ** | **(in thousands)**                              | ** ** |
| Lighthouse                         |       | $                                                    | 40         |                                                      | $          | 53 |   | $ | 147 |   | $ | 160 |   |
| Oxford                             |       | 1                                                    |       | 1                                                         |       | 4 |   | 4 |   |
| Bridge Investors                   |       | 16                                                   |       | —                                                    |       | 16 |   | — |   |
| Total warrant amortization expense |       | $                                                    | 57         |                                                      | $          | 54 |   | $ | 167 |   | $ | 164 |   |

 

**6. ****Stock-BasedCompensation**

 

Thecomponents of our stock-based compensation expense recognized for the three andnine months ended September 30, 2010 and 2009 were as follows:

 
| ** **                              | ** ** | **Three Months Ended****September**** 30,** | ** ** | **Nine Months Ended****September**** 30,** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                              | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                              | ** ** | **(in thousands)**                                    | ** ** |
| *Research and development:*             |       |                                                       |       |                                                      |       |   |   |   |   |
| Officer compensation                    |       | $                                                          | 14         |                                                      | $          | 71 |   | $ | (39 | ) | $ | 215 |   |
| Employee and consultant compensation    |       | 20                                                         |       | 147                                                       |       | (144 | ) | 461 |   |
| *Selling, general and  administrative:* |       |                                                       |       |                                                      |       |   |   |   |   |
| Director and officer compensation       |       | 94                                                         |       | 303                                                       |       | 371 |   | 929 |   |
| Employee and consultant compensation    |       | 9                                                          |       | 42                                                        |       | (7 | ) | 119 |   |
| Total stock-based compensation expense  |       | $                                                          | 137        |                                                      | $          | 563 |   | $ | 181 |   | $ | 1,724 |   |

 

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We issued an aggregate 596 shares of our commonstock upon the exercise of stock options during the nine months ended September 30,2010.

 

**7. ****SubsequentEvents**

 

On October 29, 2010 we received notice from theUnited States Internal Revenue Service that we had received certification ofour qualification for a research and development grant pursuant to the FederalQualifying Therapeutic Discovery Project (“QTDP”) to which we had applied in July 2010.The grant totaling $943,900 was awarded based on certain research anddevelopment costs incurred to date. We expect to receive payment for the grantin November 2010 and we expect to record it as other income in the fourthquarter of 2010.

 

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

 

*The following discussion of our financial condition and theresults of operations should be read in conjunction with the condensedconsolidated financial statements and notes to condensed consolidated financialstatements included elsewhere in this quarterly report on Form 10-Q. Thisdiscussion contains forward looking statements that involve risks anduncertainties. When reviewing the discussion below, you should keep in mind thesubstantial risks and uncertainties that characterize our business. Inparticular, we encourage you to review the risks and uncertainties described inPart II - Item 1A. “RISK FACTORS” elsewhere in this report. Theserisks and uncertainties could cause actual results to differ materially fromthose projected in forward-looking statements contained in this report orimplied by past results and trends. Forward-looking statements are statementsthat attempt to forecast or anticipate future developments in our business; weencourage you to review the examples of our forward-looking statements underthe heading “Cautionary Note Regarding Forward-Looking Statements” that appearsat the end of this discussion. These statements, like all statements in thisreport, speak only as of their date (unless another date is indicated), and weundertake no obligation to update or revise these statements in light of futuredevelopments.*

 

**Overview**

 

We are a biopharmaceutical company focused on developing a portfolio ofinternally discovered product candidates designed to eliminate known safetyissues associated with well-established, commercially successful drugs. We useour RetroMetabolic Drug Design technology to design structurally uniquemolecules that retain the efficacy of these original drugs but are metabolizedthrough a potentially safer pathway to avoid specific adverse side effectsassociated with these compounds. Our product candidate portfolio includes anoral prokinetic agent, naronapride (ATI-7505), designed to have the sametherapeutic benefits as cisapride approved for Phase 3 clinical development forthe treatment of chronic constipation, gastroparesis, functional dyspepsia,irritable bowel syndrome with constipation, and gastroesophageal refluxdisease; an oral anticoagulant, tecarfarin (ATI-5923), designed to have thesame therapeutic benefits as warfarin, currently in Phase 2/3 clinicaldevelopment for the treatment of patients who are at risk for the formation ofdangerous blood clots; an oral antiarrhythmic agent, budiodarone (ATI-2042),designed to have the efficacy of amiodarone in Phase 2 clinicaldevelopment for the treatment of atrial fibrillation, a form of irregularheartbeat; and a novel, next-generation atypical antipsychotic agent, ATI-9242,currently in Phase 1 clinical development for the treatment ofschizophrenia and other psychiatric disorders. Additionally, we have severalproduct candidates in preclinical development. Each of our product candidatesis an orally available, patentable new chemical entity designed to addresssimilar indications as those of the original drug upon which each is based. Ourproduct candidates target what we believe to be multi-billion dollar marketopportunities.

 

We were incorporated in the State of California on February 28,1997 and reincorporated in the State of Delaware on August 29, 2007. Wemaintain a wholly-owned subsidiary, ARYx Therapeutics Limited, with registeredoffices in the United Kingdom, which has had no operations since its inceptionin September 2004 and was established to serve only as a legal entity asrequired in support of our clinical trial activities conducted in Europe.

 

In February 2010 we shifted our primary focus to exploringstrategic alternatives available to us to complete a transaction that couldcreate significant value for stockholders. Those alternatives could includepartnerships on one or more of the three lead product candidates, the sale ofcompany assets, in whole or in part, or some other arrangement through whichthe value of our assets to stockholders could be optimized (“Strategic Process”).Concurrent with beginning the Strategic Process, we restructured our operationsin order to conserve resources and support the process of reviewing strategicalternatives. This followed an initial reduction 

 

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inour workforce headcount in October 2009. Through these two restructuringsteps and following the departure in June 2010 of Peter G. Milner, M.D.,our former President of Research and Development, our headcount has beenreduced from 73 to 16 employees. The restructuring was necessary as we havethree compounds at proof-of-concept stage but insufficient cash resources todevelop these product candidates further or to complete licensing agreements ina timely manner with a high level of certainty. Our operations have consumed asubstantial amount of cash since inception and we expect to continue to incurnet losses for the foreseeable future. Our ability to continue operations willbe dependent on our ability to obtain substantial additional funding. We mayseek to raise necessary additional funds through public or private equity, debtfinancings, collaborative arrangements with corporate partners or other sourcesavailable to us. This may include proceeds, if any, from sales of common stockunder our at market issuance sales agreement with McNicoll, Lewis &Vlak LLC and Wm Smith & Co., pursuant to which we may issue and sellup to $6.0 million of our common stock.

 

On August 13, 2010, we secured bridge financing in two relatedloan transactions — a bridge loan financing with entities affiliated with MPMCapital and Ayer Capital Management, L.L.P. (collectively the “Bridge Investors”)and the concurrent restructuring of our outstanding loans with LighthouseCapital Partners V, L.P. (“Lighthouse”). Under the terms of a secured note and warrant purchase agreement dated August 13,2010, we issued and sold secured promissory notes (the “Notes”) in theprincipal amount of up to $4.0 million and warrants to purchase an aggregate of2,000,000 shares of our common stock to the Bridge Investors in two tranches(the “Bridge Financing”). We completed the first tranche for $2.0 million ofNotes and warrants to purchase 1,000,000 shares of our common stock on August 13,2010.  We completed the second tranchefor $2.0 million of Notes and warrants to purchase 1,000,000 shares of commonstock on September 30, 2010. Concurrently with the initial tranche of theBridge Financing, we amended our existing loan arrangement with Lighthouse toprovide for the conversion of approximately $2.3 million of loan paymentsscheduled for the third quarter of 2010 into a new loan to us by Lighthouse(the “New Commitment”).  Upon the initialclosing of the Bridge Financing, we made an approximately $2.0 million paymentto Lighthouse out of the proceeds of the initial closing, and Lighthouseimmediately loaned approximately the same amount back to us as part of the NewCommitment.  On September 1, 2010,we made a subsequent payment of approximately $300,000 to Lighthouse, whichLighthouse immediately loaned back to us as the balance of the NewCommitment.  We believe that our cash andcash equivalents on hand as of September 30, 2010 are sufficient to fundour operations to December 31, 2010. We will need to seek additional sources of funding to allow us tocontinue our operations as we continue to explore strategic options availableto us.

 

Since our inception, we have incurred significant net losses, and weexpect to continue to incur net losses for the foreseeable future as we explorestrategic options for the company. We are unable to predict the extent of anyfuture losses or the degree of success we may have in the exploration andexecution of our strategic options.

 

We have established proof of concept with our three leading productcandidates, tecarfarin, budiodarone and naronapride (ATI-7505), which retainthe efficacy of certain commercially successful drugs for well establishedchronic markets while being metabolized through a potentially safer pathwaythan such drugs.  The following is asummary of our product candidates:

 

***Naronapride (ATI-7505)***

 

Naronapride(ATI-7505) is an oral prokinetic agent that has been shown to speed up thepassage of contents through the gut. We have successfully completed fourPhase 2 clinical trials for the treatment of multiple gastrointestinaldisorders including gastroesophageal reflux disease, or GERD, functionaldyspepsia and chronic idiopathic constipation. Naronapride was designed to havethe same therapeutic benefits as cisapride, a drug marketed byJohnson & Johnson under the brand name Propulsid in the United Statesand other countries. Launched in 1993, cisapride was withdrawn from the marketin 2000 due to serious cardiovascular side effects. These side effects occurredas blood levels of cisapride rose significantly when CYP450 clearance wasinhibited due to the co administration of other drugs that were cleared by thesame metabolic pathway. We designed naronapride to be metabolized through theesterase pathway, eliminating metabolism through CYP450 as well as eliminatingthe off-target cardiovascular effects. Nearly 1,000 patients and subjects havebeen treated with naronapride as part of our clinical trial program. InJune 2006, we entered into a collaboration agreement withProcter & Gamble Pharmaceuticals, Inc., or P&G, to developand commercialize naronapride. On July 2, 2008, we received notice fromP&G that it elected to exercise its option to terminate the collaborationagreement effective July 2, 2008. P&G subsequently announced that itis exiting pharmaceutical drug development. Upon termination of thecollaboration agreement by P&G, all rights to naronapride reverted to us.Also on July 2, 2008, we announced the overall successful results of a ThoroughQT trial, or TQT, on naronapride, which we believe supports the agent’sfavorable cardiac safety profile. On August 22, 2008, we announced theresults of a Phase 2b clinical trial testing the safety and efficacy ofnaronapride in patients with chronic idiopathic constipation. The clinicaltrial, conducted by P&G, was designed to enroll 400 patientsevaluating four doses of the agent compared to placebo. As a result of thetermination of the collaboration between the company and P&G, the trial wasterminated early after only 214 patients had been enrolled. In spite of theearly termination of the trial, naronapride achieved statistical significanceat the trial’s primary endpoint in the 80 mg twice-daily dose. Inaddition, all doses tested demonstrated a clinically meaningful and desiredincrease in spontaneous bowel movements over baseline compared to placebo afterone week of treatment. We have had an end of Phase 2 meeting with the FDA toseek their guidance on the size and design of the Phase 3 program required forregistration. Based upon that meeting, we believe we have a clear path forwardin chronic idiopathic constipation that includes safety data in line with ICHguidelines.

 

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Throughthe Strategic Process, we are seeking to identify the best path to maximize thevalue of naronapride and lead to its full development and eventualcommercialization, in the event requisite regulatory approval is obtained.

 

***Tecarfarin***

 

Tecarfarinis an oral anticoagulant agent in Phase 2/3 clinical development for thetreatment of patients who are at risk for the formation of dangerous bloodclots, such as those with atrial fibrillation or those at risk of venousthromboembolism. Tecarfarin was designed to have the same therapeutic benefitsas the drug warfarin which for over 50 years has been the oralanticoagulant of choice. Despite its widespread use, warfarin has severalsignificant limitations. It is metabolized by CYP450 and has many drug-druginteractions that often lead to serious side effects. We designed tecarfarin tobe metabolized through the esterase pathway, eliminating metabolism throughCYP450 and avoiding drug-drug interactions. Warfarin also has a very steep doseresponse curve which means that a small change in dose may lead to asubstantial change in the anticoagulation status of the patient. These twofactors can create significant challenges in maintaining therapeutic levels ofwarfarin and this can put patients at risk for either life-threatening clottingor bleeding, especially in patients with compromised CYP450 clearance. Inpreclinical testing and in clinical testing to date, it appears that tecarfarinmay be inherently more stable than warfarin due to its predictable metabolismthrough the esterase pathway that has a much larger capacity than CYP450. Thelevel of anticoagulation produced by both warfarin and tecarfarin is measuredby the standard assay known as International Normalized Ratio, or INR.

 

Wehave treated over 400 patients with tecarfarin in trials in which we measuredits ability to maintain those patients within a target therapeutic range of INRof 2.0 to 3.0 (2.5 to 3.5 for heart valve patients). Two of the clinical trialsperformed were Phase 2 trials (CLN-504 and CLN-509) and the third was aPhase 2/3 trial, EmbraceAC (CLN-505). In each of these three trials, theresults were nearly identical. Patients on tecarfarin had a time in targettherapeutic range of INR of 71.5% (CLN-504), 73.9% (CLN-509), and 74%(CLN-505). Statistical significance was achieved in CLN-504 when comparing thetecarfarin response to the same patients’ historical experience with warfarin:71.5% time within therapeutic range versus 59.3% time within therapeutic range,respectively (p=0.0009). However, statistical significance was not achieved atthe primary endpoint in the 607-patient CLN-505 clinical trial, directlymeasuring the ability of tecarfarin to maintain patients within the targettherapeutic range of INR as compared to warfarin patients. The endpoint wasmissed due to the unprecedented time within therapeutic range for thewarfarin-treated patients of 73.2% (p=0.506). We believe the warfarin outcomeresulted from the intense monitoring and dose control provided by the trial’scentral dosing methodology, executed in accord with our agreement on the trialdesign with the U.S. Food and Drug Administration, or FDA. In a subgroupresponder analysis of those CLN-505 patients taking medications which inhibitCYP450 metabolism and which can cause drug-drug interactions, the tecarfaringroup showed a significantly larger proportion of responders compared to thewarfarin group (67.9% versus 53.8% respectively p=0.0676). A responder isdefined as a patient who is in range for more than 65% of the time during thetreatment period. In addition, about one-third of the CLN-505 patients who werein the tecarfarin treatment arm and were stable on the drug at the end of thetrial period continued to be treated with tecarfarin in a safety follow-upextension, allowing treatment on the agent for at least one year. During thisextension phase, tecarfarin patients were monitored an average of once everyfour weeks. This group’s average time in therapeutic range of INR was 78.4% ofthe time treated during the extension phase.

 

Basedupon feedback from the FDA subsequent to the completion of the CLN-505 clinicaltrial, we believe one additional Phase 3 trial needs to be conducted topotentially seek regulatory approval of tecarfarin. This trial would alsodirectly compare tecarfarin’s ability to maintain patients in a targetedtherapeutic range of INR compared to warfarin but in a “real-world” setting inwhich monitoring and dosing decisions would be made at the trial sites, whichwould be similar to how warfarin is typically dosed and titrated in clinicalpractice. We believe tecarfarin should compare favorably against warfarin in areal-world setting due to its inherent properties and based upon the clinicalresults we have collected to date. We believe this favorable result will be incontrast to the well-established published data reporting the typical time intherapeutic range of INR expected in patients treated with warfarin in similarhistorical trials. In our most recent discussions, the FDA confirmed that theability to maintain patients within the targeted INR will likely be anacceptable surrogate and primary endpoint for tecarfarin’s clinicaldevelopment, and that the data collected in the CLN-505 clinical trial could beused to support the registration of tecarfarin. Using INR as a surrogatemeasure for the primary endpoint should reduce the size of our planned secondPhase 3 clinical trial compared to clinical trials measuring survivalrates or other outcomes. We have submitted, in writing under a Special ProtocolAssessment, or SPA, our proposed design of the second Phase 3 clinicaltrial. The process to negotiate a final study design with the FDA is ongoing.Through the Strategic Process, we are seeking to identify the best path tomaximize the value of tecarfarin and lead to its full development and eventualcommercialization, in the event requisite regulatory approval is obtained.

 

***Budiodarone***

 

Budiodaroneis an oral antiarrhythmic agent in Phase 2 clinical development for thetreatment of patients with atrial fibrillation. Budiodarone was designed tohave the efficacy of amiodarone, a drug that has been used for many years,despite its adverse side effects, because physicians believe based on their ownexperience, as well as extensive clinical trial results, that amiodarone is the

 

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mosteffective drug for treating patients with atrial fibrillation. Amiodaroneaccumulates in many different organs and can only be metabolized andsubsequently cleared from the body by CYP450. This accumulation can lead toserious side effects that are not immediately reversible upon withdrawal of thedrug. Since budiodarone is predominantly metabolized through the esterasesfound extensively in the organs, it should avoid safety issues associated withaccumulation and have fewer drug-drug interactions. We have completed aPhase 2 pilot trial (CLN-208) with budiodarone involving six atrialfibrillation patients with implanted recordable pacemakers who did not respondto previous drug therapy. This pilot trial suggested that the effect ofbudiodarone improved as the dose increased. Based upon the results of thispilot trial, we conducted an additional Phase 2b clinical trial to furtherdemonstrate the efficacy of budiodarone in patients with atrial fibrillation.The clinical trial, which enrolled 72 patients, was a multi-centered,randomized, double blind, placebo-controlled trial of the efficacy and safetyof budiodarone in patients with paroxysmal atrial fibrillation, or PAF. Allpatients entering this trial had previously implanted dual chamber pacemakerswith diagnostic and recording capability. In December 2008, we announcedsuccessful top-line efficacy results from this Phase 2b clinical trial. Byachieving statistical significance at the two highest doses of the threetested, the results essentially mirrored the findings of the earlierPhase 2 pilot trial also conducted in paroxysmal atrial fibrillationpatients. The Phase 2b trial also demonstrated that patients in the trialquickly returned to their pre-treatment level of atrial fibrillation once thetreatment ended. We have also announced the complete safety results from thisPhase 2b clinical trial that indicate that budiodarone is generally safeand well-tolerated, and appears to avoid the tissue accumulation evident withamiodarone. Through the Strategic Process, we are seeking to identify the bestpath to maximize the value of budiodarone and lead to its full development andeventual commercialization, in the event requisite regulatory approval isobtained.

 

***ATI-9242***

 

ATI-9242is a novel antipsychotic agent in Phase 1 clinical development for thetreatment of schizophrenia and other psychiatric disorders. ATI-9242’s receptorprofile is targeted at the treatment of both the positive and the negativesymptoms of schizophrenia as well as the improvement of cognitive function. Todate, preclinical work has supported this profile. ATI-9242 is also designed toavoid certain drug-drug interactions by avoiding CYP450 enzymes for metabolism,as well as reduce certain metabolic problems associated with this class oftherapy, including weight gain and type 2 diabetes.

 

***Restructuring of Operations***

 

OnOctober 29, 2009, we announced a restructuring of operations whichincluded a reduction in personnel from 73 employees to 56 employees. The staffreduction affected all functions within the company and was accompanied bychanges within the organizational structure to improve the efficiency of ouroperations. We recognized a charge of approximately $375,000 related to therestructuring during the fourth quarter of 2009 which included costs forseverance pay, extended healthcare benefits and outplacement services for theexiting employees. Additionally, we made an assessment to determine if therehad been any material impairment of assets resulting from the restructuring andconcluded that no material impairment had occurred.

 

OnFebruary 18, 2010 we announced an additional restructuring of operationswhich included a substantial reduction in force from 56 employees to 17employees, and further reduced to 16 employees following the departure of PeterG. Milner, M.D., our former President of Research and Development, effectiveJune 15, 2010. The positions impacted were across all business functions,including the research and development, clinical, operations and general andadministrative departments. The restructuring plan was primarily designed toreduce operating expenses and conserve cash resources as we explore variousstrategic options. The restructuring was substantially completed during thefirst quarter of 2010. Additionally, we announced the shift of our primaryfocus to the exploration of strategic alternatives available to us to realizeoptimal value for our late-stage assets.

 

Employeesaffected by the reductions in force were provided with severance payments,continuation of current benefits and outplacement assistance. Severancepayments to employees terminated as part of the February 2010restructuring consisted of 50% cash and 50% common stock in order to minimizethe associated cash expense, with an aggregate 460,940 shares of common stockissued under our equity incentive plan as a severance payout.

 

Asa result of the February 2010 restructuring of operations, we incurred anaggregate restructuring charge of approximately $1.6 million less a credit ofapproximately $0.3 million due to stock option cancellations in the first sixmonths of 2010. Of this amount, approximately $0.1 million was recognized asexpense during the second quarter of 2010. The restructuring charge includescosts for severance pay, employee benefits and outplacement services. Theaggregate restructuring charge included approximately $1.0 million of cashexpenditures and approximately $0.3 million of non-cash charges, net ofadjustments related to stock compensation expense. As part of the restructuringeffort and during the course of our continuing operations, we will be assessingon a quarterly basis any possible impairment of assets related to idlefacilities and equipment resulting from the February 2010 restructuringand may incur additional expense related to any such impairment. During thefirst three quarters of 2010 we made an assessment in accordance with ASC 360to determine if there had been any material impairment of assets resulting fromthe February 2010 restructuring and concluded that given the range of possibleoutcomes related to our exploration of strategic

 

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alternatives,no material impairment had occurred. As a result of our restructuringactivities, we anticipate a substantial reduction in our operating expenses in2010 as compared to our spending levels in 2009.

 

As of September 30, 2010, we had cash, cash equivalents andmarketable securities on hand of approximately $3.0 million, currentpayables and accrued liabilities of approximately $0.9 million andapproximately $6.9 million in current notes and interest payable. As ofSeptember 30, 2010, we had outstanding non-current liabilities of$5.9 million. Since our inception, we have incurred significant netoperating losses and, as of September 30, 2010, we had an accumulateddeficit of $199.6 million. We have not achieved sustained profitabilityand anticipate that we will continue to incur significant net losses for theforeseeable future. There can be no assurances that we will achieve positivecash flow in the foreseeable future or at all. Additionally, we do notanticipate that our cash on hand as of September 30, 2010 will besufficient to fund our operations for the following twelve months. However, webelieve that our cash on hand will provide us with sufficient funds to operateto December 31, 2010. For the year ended December 31, 2009 ourauditor, Ernst & Young LLP, issued an audit opinion which included anexplanatory paragraph raising substantial doubt about our ability to continueas a going concern.

 

***Research and Development Expense***

 

Our research and development expense consists of expenses incurred inidentifying, testing and developing our product candidates. These expensesconsist primarily of fees paid to contract research organizations and otherthird parties to assist us in managing, monitoring and analyzing our clinicaltrials, clinical trial costs paid to sites and investigators’ fees, costs ofnon-clinical studies including toxicity studies in animals, costs of contractmanufacturing services, costs of materials used in clinical trials andnon-clinical studies, laboratory related expenses, research and developmentsupport costs including certain regulatory, quality assurance, projectmanagement and administration, allocated expenses such as facilities andinformation technology that are used to support our research and developmentactivities and related personnel expenses, including stock-based compensation.Research and development costs are expensed as incurred.

 

Clinical trial costs have been a significant component of our researchand development expense. We have conducted our clinical trials primarilythrough coordination with contract research organizations and other third-partyservice providers. We recognize research and development expense for theseactivities based upon a variety of factors, including actual and estimatedpatient enrollment, clinical site initiation activities, direct pass-throughcosts and other activity-based factors.

 

The following table summarizes our research and development, orR&D, expense for the three and nine months ended September 30, 2010 and2009:

 
| ** **                                           | ** ** | **Three Months Ended****September**** 30,** | ** ** | **Nine Months Ended****September**** 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                           | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                                    | ** ** |
| Direct R&D expense by product candidate:         |       |                                                       |       |                                                      |       |   |   |   |   |
| Budiodarone                                          |       | $                                                          | 1          |                                                      | $          | 141 |   | $ | 40 |   | $ | 847 |   |
| Tecarfarin                                           |       | 4                                                          |       | 1,607                                                     |       | 275 |   | 7,098 |   |
| Naronapride (ATI-7505)                               |       | 15                                                         |       | 19                                                        |       | 63 |   | 135 |   |
| ATI-9242                                             |       | 32                                                         |       | 82                                                        |       | 139 |   | 26 |   |
| Other research programs                              |       | —                                                     |       | 78                                                        |       | 57 |   | 178 |   |
| Total direct R&D expense                         |       | 52                                                         |       | 1,927                                                     |       | 574 |   | 8,284 |   |
| R&D personnel, administrative and other  expense |       | 777                                                        |       | 3,067                                                     |       | 3,501 |   | 9,770 |   |
| Total R&D expense                                |       | $                                                          | 829        |                                                      | $          | 4,994 |   | $ | 4,075 |   | $ | 18,054 |   |

 

From our inception through September 30, 2010, we estimate thatapproximately $40.5 million of expense was incurred for our tecarfarinproduct candidate, approximately $25.2 million was incurred for ourbudiodarone product candidate, approximately $22.7 million was incurredfor our naronapride (ATI-7505) product candidate, approximately$5.2 million was incurred for our ATI-9242 product candidate, andapproximately $73.7 million was incurred for costs related to our researchand development personnel, administrative and other research programs.

 

The expenditures summarized in the above table reflect costs directlyattributable to each product candidate and to our other research programs. Wedo not allocate salaries, employee benefits, or other indirect costs to ourproduct candidates or other research programs and have included those expensesin “personnel, administrative and other expense” in the above table.

 

At this time, due to the risks inherent in our business and given thevarious stages of development of our product candidates, we are unable toestimate with any certainty the costs we will incur in support of our productcandidates. Clinical development 

 

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timelines,the probability of success and development costs can differ materially fromexpectations. In addition, we cannot forecast with any degree of certaintywhich product candidates may be subject to future collaborations, when sucharrangements may be secured, if at all, and to what degree such arrangementswould affect our current operating plans and capital requirements.

 

The process of developing and obtaining FDA approval of products iscostly and time consuming. Development activities and clinical trials can takeyears to complete, and failure can occur at any time during the development andclinical trial process. In addition, the results from early clinical trials maynot be predictive of results obtained in subsequent and larger clinical trials,and product candidates in later stages of clinical trials may fail to show thedesired safety and efficacy despite having progressed successfully throughinitial clinical testing. Although our approach to identifying and developingnew product candidates is designed to mitigate risk, the successful developmentof our product candidates is highly uncertain. Further, even if our productcandidates are approved for sale, they may not be successfully commercializedand therefore the future revenue we anticipate may not materialize.

 

Ifwe fail to complete the development of any of our product candidates in atimely manner, it could have a material effect on our operations, financialposition and liquidity. In addition, any failure by us or our partners toobtain, or any delay in obtaining, regulatory approvals for our productcandidates could have a material adverse effect on our results of operations.However, as we explore strategic alternatives, we expect to expend minimalefforts or resources towards further development of our product candidates. Afurther discussion of the risks and uncertainties associated with completingour programs on schedule, or at all, and certain consequences of failing to doso are discussed in Part II—Item 1A. “Risk Factors” section of thisreport.

 

**Critical Accounting Policies and Significant Estimates**

 

We have prepared our consolidated financial statements in accordancewith U.S. generally accepted accounting principles. Accordingly, we have had tomake estimates, assumptions and judgments that affect the amounts reported inour consolidated financial statements. These estimates, assumptions andjudgments about future events and their effects on our results cannot bedetermined with certainty, and are made based upon our historical experienceand on other assumptions that are believed to be reasonable under the circumstances.These estimates may change as new events occur or additional information isobtained, and we may periodically be faced with uncertainties, the outcomes ofwhich are not within our control and may not be known for a prolonged period oftime.

 

Ourcritical accounting policies are more fully described in Note 1 of the auditedconsolidated financial statements for the year ended December 31, 2009,which are included in our annual report on Form 10-K filed with theSecurities and Exchange Commission. There have been no material changes in ourcritical accounting policies and significant estimates during the three andnine months ended September 30, 2010.

 

**Results of Operations**

 

***Comparison of Three and Nine Months EndedSeptember 30, 2010 and 2009***

 

***Research and Development Expense***

 
| ** **                       | ** ** | **Three Months Ended**            | ** ** | ** ** | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|------------|---------------------------------------------|------------|------------|------------|---------------------------------|------------|------------|------------|------------|------------|
| ** **                       | ** ** | **September 30,**                      | ** ** | **Change** | ** ** | **September 30,**          | ** ** | **Change** | ** ** |
| ** **                       | ** ** | **2010**                                    | ** ** | **2009**   | ** ** | **$**                           | ** ** | **%**      | ** ** | **2010**   | ** ** | **2009** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                       | ** ** | **(In thousands, except %)** | ** ** |
| Research and development expense |       | $                                           | 829        |       | $          | 4,994                           |       | $          | (4,165     | )          | (83        | )% | $ | 4,075 |   | $ | 18,054 |   | $ | (13,979 | ) | (77 | )% |
|                                  |            |                                             |            |            |            |                                 |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Forthe three months ended September 30, 2010, as compared to the same periodin 2009, our research and development expense decreased by $4.2 million, or83%. The decrease was due to:

 

·                  a $1.6 million reduction in expensesrelated to our tecarfarin product candidate due to the substantial completionof our Phase 2/3 EmbraceAC clinical study in the second quarter of 2009;

 

·                  a $2.4 million reduction in personnel andadministrative costs resulting primarily from our restructuring of operationsin October 2009 and February 2010;

 

·                  a $0.1 millionreduction in expenditures related to the completionof a Phase 2b clinical study for our budiodarone product candidate in the firsthalf of 2009; and

 

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·                  a $0.1 million reduction in R&D costsrelated to our other R&D activities.

 

Forthe nine months ended September 30, 2010, as compared to the same periodin 2009, our research and development expense decreased by $14.0 million, or77%. The decrease was due to:

 

·                  a $6.8 million reduction in expensesrelated to our tecarfarin product candidate primarily due to the substantialcompletion of our Phase 2/3 EmbraceAC clinical study in the second quarter of2009;

 

·                  a $6.4 million reduction in personnel andadministrative costs resulting primarily from our restructuring of operationsin October 2009 and February 2010; and

 

·                  a $0.8 millionreduction in expenditures related to the completionof a Phase 2b clinical study for our budiodarone product candidate in the firsthalf of 2009.

 

***Selling, General and Administrative Expense***

 
| ** **                                  | ** ** | **Three Months Ended**            | ** ** | ** ** | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|------------|------------|---------------------------------|------------|------------|------------|------------|------------|
| ** **                                  | ** ** | **September 30,**                      | ** ** | **Change** | ** ** | **September 30,**          | ** ** | **Change** | ** ** |
| ** **                                  | ** ** | **2010**                                    | ** ** | **2009**   | ** ** | **$**                           | ** ** | **%**      | ** ** | **2010**   | ** ** | **2009** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                  | ** ** | **(In thousands, except %)** | ** ** |
| Selling, general and administrative expense |       | $                                           | 1,316      |       | $          | 2,638                           |       | $          | (1,322     | )          | (50        | )% | $ | 7,331 |   | $ | 7,863 |   | $ | 532 |   | 7 | % |
|                                             |            |                                             |            |            |            |                                 |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thedecrease in selling, general and administrative expense for the three monthsended September 30, 2010 as compared to the same period in 2009 wasprimarily due to reduced operating expenses resulting from ourOctober 2009 and February 2010 restructuring of operations. Thedecrease in selling, general and administrative expense for the nine monthsended September 30, 2010 as compared to the same period in 2009 wasprimarily due to reduced operating expenses resulting from our October 2009and February 2010 restructuring of operations, partially offset by ourrecognition of a $1.6 million restructuring charge resulting from ourFebruary 2010 restructuring of operations, costs related to the departureof Peter Milner incurred in the second quarter of 2010 and costs related to theat market financing arrangement incurred during the second quarter of 2010.

 

***Interest and Other Income (Expense)***

 
| ** **                     | ** ** | **Three Months Ended**            | ** ** | ** ** | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|---------------------------------------------|------------|------------|------------|---------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **September 30,**                      | ** ** | **Change** | ** ** | **September 30,**          | ** ** | **Change** | ** ** |
| ** **                     | ** ** | **2010**                                    | ** ** | **2009**   | ** ** | **$**                           | ** ** | **%**      | ** ** | **2010**   | ** ** | **2009** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                     | ** ** | **(In thousands, except %)** | ** ** |
| Interest and other income, net |       | $                                           | 6          |       | $          | 1                               |       | $          | 5          |       | 500        | % | $ | 64 |   | $ | 66 |   | $ | (2 | ) | (3 | )% |
|                                |            |                                             |            |            |            |                                 |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest and otherincome, net of other expenses, consist primarily of interest income from ourinvestments in money market funds and marketable securities, realized gains orlosses from the sale of marketable securities and certain expenses such asstate franchise tax. The increase in interest and other income, net of otherexpenses, for the three months ended September 30, 2010 as compared to thesame period in 2009 was primarily due to lower expenses resulting from afederal tax grant for certain investments in fixed assets made in 2009 andlower state franchise tax expense, partially offset by lower interest income.The decrease in interest and other income, net of other expenses, for the ninemonths ended September 30, 2010 as compared to the same period in 2009 was primarilydue to lower interest income resulting from lower cash balances, partiallyoffset by a state franchise tax rebate recognized in the first quarter of 2010and a realized gain of approximately $18,000 related to the sale of our auctionrate security instrument during the first quarter of 2010.

 

***Interest Expense***

 
| ** **       | ** ** | **Three Months Ended**            | ** ** | ** ** | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------|------------|---------------------------------------------|------------|------------|------------|---------------------------------|------------|------------|------------|------------|------------|
| ** **       | ** ** | **September 30,**                      | ** ** | **Change** | ** ** | **September 30,**          | ** ** | **Change** | ** ** |
| ** **       | ** ** | **2010**                                    | ** ** | **2009**   | ** ** | **$**                           | ** ** | **%**      | ** ** | **2010**   | ** ** | **2009** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **       | ** ** | **(In thousands, except %)** | ** ** |
| Interest expense |       | $                                           | 375        |       | $          | 519                             |       | $          | (144       | )          | (28        | )% | $ | 1,199 |   | $ | 1,515 |   | $ | (316 | ) | (21 | )% |
|                  |            |                                             |            |            |            |                                 |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The decrease in interestexpense for the three and nine month periods ended September 30, 2010 ascompared to the same periods in 2009 was primarily due to a reduction of ourdebt balances outstanding with Lighthouse and Oxford resulting from thecontractual pay down of our long-term debt obligations, partially offset byhigher interest expense resulting from the Bridge Financing and Lighthouse debtrestructure in the third quarter of 2010.

 

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**Liquidity and Capital Resources**

 
| ** **                  | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **September 30,**          | ** ** |
| ** **                  | ** ** | **2010**                        | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(In thousands)**         | ** ** |
| Cash provided by (used in): |       |                            |       |   |   |
| Operating activities        |       | $                               | (13,984    | ) | $ | (28,882 | ) |
| Investing activities        |       | 847                             |       | 1,149 |   |
| Financing activities        |       | 8,682                           |       | (1,421 | ) |
| Total cash used             |       | $                               | (4,455     | ) | $ | (29,154 | ) |

 

As of September 30, 2010, we had cash, cash equivalents andmarketable securities on hand of approximately $3.0 million, currentpayables and accrued liabilities of approximately $0.9 million andapproximately $6.9 million in current notes and interest payable. As ofSeptember 30, 2010, we had outstanding non-current liabilities of$5.9 million. Since our inception, we have incurred significant netoperating losses and, as of September 30, 2010, we had an accumulated deficitof $199.6 million. We have not achieved sustained profitability andanticipate that we will continue to incur significant net losses for theforeseeable future. There can be no assurances that we will achieve positivecash flow in the foreseeable future or at all. Additionally, we do notanticipate that our cash on hand as of September 30, 2010 will besufficient to fund our operations for the following twelve months. However, webelieve that our cash on hand as of September 30, 2010 will provide uswith sufficient funds to operate to December 31, 2010.

 

Net cash used in operating activities was $14.0 million and$28.9 million for the nine months ended September 30, 2010 and 2009,respectively. Net cash consumed in each of these periods was primarily usedtowards the funding of our operating costs and expenses in connection with theconduct of our research, development and administrative activities.Additionally, the nine month period ended September 30, 2010 includedapproximately $1.0 million of cash expenditures related to ourFebruary 2010 restructuring of operations.

 

Cash used in, or provided by, investing activities primarily related topurchases, sales and maturities of marketable securities, as well as changes inour restricted cash balances and levels of capital expenditure. For the ninemonths ended September 30, 2010, net sales of marketable securities was$0.4  million as compared to purchases of marketable securities, net of maturities,of $1.1 million for the same period in 2009. During the nine months endedSeptember 30, 2010, we received funds from the contractual release ofapproximately $0.5 million of restricted cash related to our facility leaseagreement and our third party payroll service provider. Purchases of propertyand equipment were $8,400 and $97,000 for the nine months endedSeptember 30, 2010 and 2009, respectively.

 

Net cash provided by financing activities for the nine months endedSeptember 30, 2010 was $8.7 million and was related to proceeds from thesale of common stock pursuant to the Commerce Court equity line agreement alongwith proceeds from our recent Bridge Financing, partially offset by principalpayments on our long-term debt. For the nine months ended September 30,2009, net cash used in financing activities was $1.4 million and consisted ofprincipal payments on our long-term debt and equity financing costs, partiallyoffset by proceeds from employee purchases of our common stock pursuant to ouremployee stock purchase plan.

 

***Debt Arrangements***

 

As of September 30, 2010, we had loan commitments outstanding withLighthouse, the Bridge Investors and Oxford Finance Corporation, or Oxford.Prior to September 30, 2010 we also had loan commitments outstanding withGeneral Electric Commercial Finance, or GE.

 

On August 13, 2010, we entered into an agreement with the BridgeInvestors pursuant to which we agreed to issue and sell in a private placementNotes in the aggregate principal amount of up to $4.0 million, and Warrants topurchase up to an aggregate of 2,000,000 shares of our common stock, subject tothe terms and conditions set forth in the agreement.  The Notes are secured by a security interestin all of our assets, including our intellectual property.

 

OnAugust 13, 2010, we closed on the first tranche of $2.0 million of Notespursuant to the terms and conditions of the Bridge Financing and, as a result,issued Warrants to the Bridge Investors to purchase 1,000,000 shares of ourcommon stock.  On September 30,2010, we closed on the second tranche of $2.0 million of Notes and issuedWarrants to purchase an additional 1,000,000 shares of our common stock.

 

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The Notes accrue interest at a continuously compounding rate of 12.0%per annum.  Unless earlier paid pursuantto the terms of the agreement or accelerated in connection with an event ofdefault, we will make interest only payments through December 31, 2010,followed by 24 equal monthly payments of principal and interest throughJanuary 1, 2013. In the event we sell any or all of our assets or enterinto certain strategic transactions, we may be required to repay the Notes atan earlier date under the terms of the Bridge Financing.

 

TheWarrants had a purchase price of $0.0125 per underlying share of common stockand are exercisable for a term of five years from the date of issuance at anexercise price of $0.50 per share. On October 12, 2010, we filed aregistration statement registering for resale the shares of common stockissuable upon the exercise of the Warrants pursuant to the Registration RightsAgreement we entered into with the Bridge Investors.

 

Wereceived net proceeds of approximately $1.8 million in connection with theinitial tranche of the Bridge Financing, after deducting certain expensespayable by us. The net proceeds from the initial tranche of the BridgeFinancing were used by us to make an approximately $2.0 million repayment onour existing loan obligation with Lighthouse pursuant to the terms of our loanarrangement with Lighthouse, as more fully described below. We received netproceeds of approximately $2.0 million in connection with the second tranche ofthe Bridge Financing after deducting certain expenses payable by us. Theremaining proceeds from the Bridge Financing are being used for working capitaland other corporate and operational purposes, including permitted payments toour lenders.

 

Concurrentlywith the Bridge Financing, we and Lighthouse entered into Amendment No. 8to that certain Loan and Security Agreement No. 4521 dated March 28,2005, as amended. The amendment to the Lighthouse agreement provides for theconversion of up to approximately $2.3 million of loan payments scheduled forthe third quarter of 2010 into the New Commitment. Upon the closing of theinitial tranche of the Bridge Financing, we used the net proceeds from suchclosing to make an approximately $2.0 million repayment of our loan obligationto Lighthouse and, pursuant to the terms of the amendment, Lighthouse promptlyloaned approximately the same amount to us as part of the New Commitment. On September 1,2010, we made a subsequent payment of approximately $300,000 to Lighthousewhich was promptly loaned back to us from Lighthouse as the balance of the NewCommitment.

 

TheNew Commitment is due and payable on December 31, 2010 in one lump sumpayment equal to the aggregate principal amount plus accrued interest throughthe due date at a stated interest rate of 13.0% per annum. In the event weenter into certain strategic transactions with proceeds of at least $40.0million prior to the applicable due date, the New Commitment will be amortizedand payable in equal monthly installments of principal and interest over the 18months following the closing of such strategic transaction. Upon the occurrenceof an event of default or liquidation event, all outstanding amounts under theNew Commitment shall be immediately due and payable.

 

The terms of the Lighthouse loan further provide that any assignment ofthe Notes without Lighthouse’s consent would now constitute an event of defaultunder the Lighthouse loan agreement. We also granted Lighthouse a securityinterest in all of our assets including our intellectual property in connectionwith the amendment to the Lighthouse loan agreement and the New Commitment.

 

As of September 30, 2010, following our receipt of the NewCommitment, the total principal amount borrowed under the Lighthouse loans was$21.3 million and the total unpaid principal balance outstanding was$7.9 million. The total accrued and unpaid balloon interest outstandingwas $0.4 million as of September 30, 2010. We recorded interest expenserelated to the Lighthouse loan, including amortization of expense related tothe terminal payments and the warrants issued under the agreement, of $299,000and $488,000 for the three months ended September 30, 2010 and 2009,respectively, and $1.1 million and $1.4 million for the nine months endedSeptember 30, 2010 and 2009, respectively.

 

The total principal amount borrowed under the Bridge Financingarrangement was $4.0 million and the total unpaid principal balanceoutstanding as of September 30, 2010, was $4.0 million. We recordedinterest expense related to the Bridge Financing, including amortization ofexpense related to capitalized loan expenses and the warrant issued under theagreement, of $57,900 and none for the three months ended September 30,2010 and 2009, respectively, and $57,900 and none for the nine months ended September30, 2010 and 2009, respectively.

 

The total principal amount borrowed under the Oxford loan was$1.0 million and the total unpaid principal balance outstanding as ofSeptember 30, 2010, was $459,000. The total accrued and unpaid ballooninterest outstanding was $12,000 as of September 30, 2010. We recorded interestexpense related to the Oxford loan, including amortization of expense relatedto the terminal payment and the warrant issued under the agreement, of $17,800and $27,000 for the three months ended September 30, 2010 and 2009,respectively, and $60,500 and $87,000 for the nine months ended September 30,2010 and 2009, respectively. Pursuant to the terms of the Oxford loan, Oxfordmaintains a security interest in certain of our fixed assets.

 

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The total principal amount borrowed under the GE loans was $1.9 millionand as of September 30, 2010 the loans had been fully repaid. We recordedno interest expense related to the GE loans for the three months ended September 30,2010 and $5,000 for the three months ended September 30, 2009. For thenine months ended September 30, 2010 and 2009, respectively, we recorded$650 and $20,000 in interest expense related to the GE loans.

 

***Equity Line Financing Facility***

 

On October 6, 2009, we entered into a common stock purchase agreement,or the Purchase Agreement, with Commerce Court Small Cap Value Fund, Ltd.,or Commerce Court, providing for a financing arrangement that is sometimesreferred to as a committed equity line financing facility. The PurchaseAgreement provided that, upon the terms and subject to the conditions set forthin the Purchase Agreement, Commerce Court would be committed to purchase up to$35.0 million of shares of our common stock over the 24-month term of thePurchase Agreement under certain specified conditions. Under the terms of thePurchase Agreement, in no event could we sell more than 5,380,090 shares ofcommon stock, which is equal to one share less than 20% of our outstandingshares of common stock on October 6, 2009, the closing date of the PurchaseAgreement, less the number of shares of common stock we issued to CommerceCourt on the closing date as Commitment Shares described below. Furthermore, inno event would Commerce Court be obligated to purchase any shares of our commonstock which, when aggregated with all other shares of our common stock thenbeneficially owned by Commerce Court, would result in the beneficial ownershipby Commerce Court of more than 9.9% of the then outstanding shares of ourcommon stock. We issued to Commerce Court, upon execution of the PurchaseAgreement, 114,200 shares of our common stock, or the Commitment Shares.

 

On December 11, 2009, we delivered notice to Commerce Court toeffect a draw down of up to $1.0 million. The first trading day of the10-day pricing period for this draw down was December 14, 2009. Inconnection with this draw down, we issued an aggregate of 413,896 shares of ourcommon stock to Commerce Court, at a per share purchase price of approximately$2.42 and an aggregate purchase price of $1.0 million. The settlement datefor this draw down was December 30, 2009. The per share price at whichCommerce Court purchased these shares from us was established under thePurchase Agreement by reference to the volume weighted average prices of ourcommon stock on The NASDAQ Global Market during the pricing period, net adiscount of 7.0% per share. We received net proceeds from the sale of theseshares of approximately $781,000 after deducting our offering expenses ofapproximately $219,000 including a placement agent fee of $10,000 paid toReedland Capital Partners, an Institutional Division of Financial West Group,member FINRA/SIPC. Of the total offering cost, approximately $180,000 wasincurred as one time expenses related to the filing of a registration statementon Form S-1 covering the resale of the shares of Common Stock sold toCommerce Court and legal fees incurred upon entering into the PurchaseAgreement with Commerce Court.

 

On January 4, 2010, we delivered notice to Commerce Court, assubsequently amended, to effect a draw down of up to $1.4 million. The firsttrading day of the 10-day pricing period for this draw down was January 5,2010. In connection with this draw down, we issued an aggregate of 490,864shares of our common stock to Commerce Court, at a purchase price ofapproximately $2.85 per share and an aggregate purchase price of$1.4 million. The settlement date for this draw down was January 20,2010. The share price at which Commerce Court purchased these shares from uswas established under the Purchase Agreement by reference to the volumeweighted average prices of our common stock on The NASDAQ Global Market duringthe pricing period, net a discount of approximately 6.1% per share. We receivednet proceeds from the sale of these shares of approximately $1.38 millionafter deducting our offering expenses of approximately $25,000, including aplacement agent fee of $14,000 paid to Reedland Capital Partners connectionwith this draw down.

 

On February 19, 2010, we delivered notice to Commerce Court, toeffect a draw down under the Purchase Agreement. The first trading day of the10-day pricing period for this draw down was February 22, 2010. Inconnection with this draw down, we issued an aggregate of 2,764,546 shares ofour common stock to Commerce Court, at a purchase price of approximately $1.19per share and an aggregate purchase price of approximately $3.29 million.The settlement date for this draw down was March 8, 2010. The share priceat which Commerce Court purchased these shares from us was established underthe Purchase Agreement by reference to the volume weighted average price of ourcommon stock on The NASDAQ Global Market during the pricing period, net adiscount of approximately 7.0% per share. We received net proceeds from thesale of these shares of approximately $3.24 million after deducting ourestimated offering expenses of approximately $45,000, including a placementagent fee of $33,000 paid to Reedland Capital Partners in connection with thisdraw down.

 

On March 11, 2010, we delivered notice to Commerce Court, toeffect a draw down under the Purchase Agreement. The first trading day of the10-day pricing period for this draw down was March 12, 2010. In connectionwith this draw down, we issued an aggregate of 1,710,784 shares of our commonstock to Commerce Court, at a purchase price of approximately $1.07 per shareand an aggregate purchase price of approximately $1.83 million. Thesettlement date for this draw down was March 26, 2010. The share price atwhich Commerce Court purchased these shares from us was established under thePurchase Agreement by reference to the volume weighted average price of ourcommon stock on The NASDAQ Global Market during the pricing period, net adiscount of approximately 7.0% per share. We received net proceeds from thesale of these shares of approximately $1.8 million after deducting

 

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ourestimated offering expenses of approximately $30,000, including a placementagent fee of $18,311 payable to Reedland Capital Partners in connection withthis draw down.

 

As of March 26, 2010, we had issued the maximum amount of commonstock available under the Commerce Court Purchase Agreement and therefore willno longer be able to utilize the facility.

 

***At Market Issuance Facility***

 

OnMay 20, 2010, we entered into an at market issuance sales agreement, orSales Agreement, with McNicoll, Lewis & Vlak LLC, or MLV, and WmSmith & Co., or Wm Smith, pursuant to which we may issue and sellshares of our common stock having an aggregate offering price of up to $6.0 millionfrom time to time through MLV and Wm Smith as our sales agents. Sales of ourcommon stock through MLV and Wm Smith, if any, will be made on The NASDAQGlobal Market by means of ordinary brokers’ transactions at market prices, inblock transactions or as otherwise agreed by us and these sales agents. Subjectto the terms and conditions of the Sales Agreement, MLV and Wm Smith will usecommercially reasonable efforts to sell our common stock from time to time,based upon our instructions (including any price, time or size limits or othercustomary parameters or conditions we may impose). We will pay these salesagents an aggregate commission rate of 3.0% of the gross proceeds of the salesprice per share of any common stock sold through the sales agents under theSales Agreement. The number of shares we are able to sell under thisarrangement will be limited in practice based on the trading volume of ourcommon stock. As of September 30, 2010 we had not issued or sold anyshares of our common stock pursuant to the Sales Agreement. In connection withthis financing arrangement, we incurred costs of approximately $150,000 thatwere expensed during the second quarter of 2010 and are included within ourselling, general and administrative expense.

 

***Qualifying Therapeutic Discovery Project Grant***

 

OnOctober 29, 2010 we received notice from the United States InternalRevenue Service that we had received certification of our qualification for aresearch and development grant pursuant to the Federal Qualifying TherapeuticDiscovery Project (“QTDP”) to which we had applied in July 2010. The granttotaling $943,900 was awarded based on certain research and development costsincurred to date. We expect to receive payment for the grant in November 2010and we expect to record it as other income in the fourth quarter of 2010.

 

***Future Funding Requirements***

 

Our future funding requirements will depend upon many factors,including:

 

·                  the extent of our success inmonetizing the value of our current product candidate portfolio;

 

·                  the size, complexity andcost of our remaining business operations;

 

·                  the terms and timing of anycollaborative, licensing and other arrangements that we may establish;

 

·                  the cost, timing andoutcomes of regulatory approvals;

 

·                  the timing, receipt andamount of sales or royalties generated, if any, from our product candidates;and

 

·                  the cost of preparing,filing, prosecuting, defending and enforcing any patent claims and otherintellectual property rights.

 

Our ability to continue operations will be dependent on our ability toobtain substantial additional funding and such funding may not be available tous on acceptable terms, or at all. We may seek to raise necessary additionalfunds through public or private equity, debt financings, collaborativearrangements with corporate partners or other sources. If we are unable toraise additional funds when needed, we may not be able to continue our currentoperations and we may not have sufficient resources to fully explore thestrategic options available to us. If we raise additional funds through theissuance of debt securities, these securities could have rights that are seniorto the holders of our common stock and could contain covenants that restrictour operations. If we raise additional funds by issuing equity securities,including sales under our Sales Agreement with MLV and Wm Smith, dilution toour existing stockholders may result. In addition, if we raise additional fundsthrough the sale of equity securities, new investors could have rights superiorto our existing stockholders. To the extent that we raise additional capitalthrough licensing or other arrangements, we may be required to relinquish, onterms that are not favorable to us, rights to some of our technologies orproduct candidates that we would otherwise seek to develop or commercializeourselves for a higher profit margin. The terms of future financings mayrestrict our ability to raise 

 

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additionalcapital, which could delay or prevent the further development of our productcandidates or our ability to fully explore our strategic options. Our failureto raise capital when needed may harm our business and operating results.

 

**Recent Accounting Pronouncements**

 

SeeNote 1 of the Notes to our Condensed Consolidated Financial Statements includedelsewhere in this report for recent accounting pronouncements that could havean effect on us.

 

**Off-Balance Sheet Arrangements**

 

Sinceinception, except for standard operating leases and employment agreements, wehave not engaged in any off-balance sheet arrangements, including the use ofstructured finance, special purpose entities or variable interest entities.

 

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

 

There were no material changes to our market riskfrom those disclosed in our annual report on Form 10-K filed with theSecurities and Exchange Commission on March 30, 2010.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controlsand Procedures***

 

Asof September 30, 2010, an evaluation was performed by management, with theparticipation of our Chief Executive Officer and Chief Financial Officer, ofthe effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15-d and 15(e) under the Securities Exchange Act of 1934, as amended).Disclosure controls and procedures are controls and procedures that aredesigned to ensure that information required to be disclosed in our reportsfiled or submitted under the Securities Exchange Act of 1934, as amended, isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms. Based on thatevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that, subject to the limitations described below, our disclosurecontrols and procedures were effective as of September 30, 2010.

 

***Limitations on the Effectiveness ofControls***

 

Ourmanagement, including our Chief Executive Officer and Chief Financial Officer,does not expect that our disclosure controls and procedures or our internalcontrols will prevent all error and all fraud. A control system, no matter howwell conceived and operated, can provide only reasonable, not absolute,assurance that the objectives of the control system are met. Because of theinherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that all control issues and instances of fraud, ifany, within the company have been detected. These inherent limitations includethe realities that judgments in decision-making can be faulty, and thatbreakdowns can occur because of simple error or mistake. Additionally, controlscan be circumvented by the individual acts of some persons, by collusion of twoor more people, or by management override of the control. The design of anysystem of controls also is based in part upon certain assumptions about thelikelihood of future events, and there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions.Over time, control may become inadequate because of changes in conditions, orthe degree of compliance with the policies or procedures may deteriorate.Because of the inherent limitations in a cost-effective control system,misstatements due to error or fraud may occur and may not be detected.

 

***Changes in Internal Control over Financial Reporting***

 

Nochange was made in our internal control over financial reporting during thequarter ended September 30, 2010 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

**PART II— OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

Fromtime to time we are involved in legal proceedings arising in the ordinarycourse of our business. We believe there is no litigation pending that couldhave, individually or in the aggregate, a material adverse effect on our resultsof operations or financial condition.

 

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**ITEM 1A. RISK FACTORS**

 

*We have identified the following risks and uncertaintiesthat may have a material adverse effect on our business, financial condition orresults of operations. The risks described below are not the only ones we face.Additional risks not presently known to us or that we currently believe areimmaterial may also significantly impair our business operations. Our businesscould be harmed by any of these risks.**Thetrading price of our common stock could decline due to any of these risks, andour investors may lose all or part of their investment.**Wehave marked with an asterisk (*) those risks described below that reflectsubstantive changes from the risks described in our Annual Report onForm 10-K for the year ended December 31, 2009, filed with theSecurities and Exchange Commission on March 30, 2010. In assessing theserisks, you should also refer to the other information contained in thisquarterly report on Form 10-Q, including our financial statements andrelated notes.*

 

**RisksRelated to Our Business**

 

***We will need substantial additionalfunding in the near term and may be unable to raise capital when needed, whichwould force us to limit or cease our operations and related product developmentprograms.****

 

As of September 30, 2010, we had $3.0 million in cash, cashequivalents and marketable securities on hand, which is only sufficient to fundour current operations into the fourth quarter of 2010. As ofSeptember 30, 2010, we had current payables and accrued liabilities of$0.9 million, current notes and related interest payable of $6.9 millionand outstanding non-current liabilities of $5.9 million. Our ability tocontinue operations as a going concern, to evaluate strategic alternatives andpotentially resume development activities with respect to our productcandidates is dependent upon our ability to obtain substantial additionalcapital in the near term. Our operations have consumed substantial amounts ofcash since inception, and we expect to continue to incur net losses for theforeseeable future as we explore strategic options in an effort to optimize thevalue of our assets. While we are currently exploring strategic optionsavailable to us, including collaboration arrangements to continue thedevelopment and potential commercialization of one or more of our lead productcandidates or the sale of any or all of our assets, we cannot forecast with anydegree of certainty whether a strategic transaction and/or collaborationarrangement will be achieved on optimal terms or at all. However, should suchcollaboration arrangements fail to provide sufficient revenue to fund ouroperations adequately, we will need to raise additional capital to fund ouroperations and complete development of our product candidates. Our futurefunding requirements will depend on many factors, including:

 

·                  the terms and timing of anycollaborative, licensing and other arrangements that we may establish, if any;

 

·                  the extent of our success inmonetizing the value of our current product candidate portfolio;

 

·                  the cost, timing andoutcomes of regulatory approvals;

 

·                  the size, complexity andcost of our remaining business operations;

 

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

 

·                  the cost of preparing,filing, prosecuting, defending and enforcing any patent claims and otherintellectual property rights.

 

Until we can generate a sufficient amount of collaboration or productrevenue to finance our cash requirements, which we may never do, we expect tofinance future cash needs primarily through public or private equity offerings,debt arrangements, including our at market issuance sales agreement withMcNicoll, Lewis & Vlak LLC and Wm Smith & Co, and/or apossible sale, collaboration or license of development and/or commercializationrights to one or more of our product candidates. We do not know whetheradditional funding will be available to us on acceptable terms, or at all.

 

If we raise additional funds by issuing equity securities, includingunder our Sales Agreement with MLV and Wm Smith, our stockholders willexperience dilution, which may be significant. Any debt financing or additionalequity that we raise may contain terms that are not favorable to ourstockholders or us. If we raise additional funds through collaboration, salesor licensing arrangements with third parties, we may be required to relinquishsome rights to our technologies or our product candidates, grant licenses onterms that are not favorable to us or enter into a collaboration arrangementfor a product candidate at an earlier stage of development or for a lesseramount than we might otherwise choose.

 

Our existing capital resources are not sufficient to enable us tocontinue the development of any of our product candidates. Additional funds maynot be available when we need them on terms that are acceptable to us, or atall. If adequate funds are not available on a timely basis, we may:

 

·                  terminate or delay futureclinical trials for one or more of our product candidates; or

 

·                  further reduce our headcountand capital or operating expenditures.

 

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As we explore strategic options, no significant development activity iscurrently underway on any of our product candidates, and therefore we are notable to advance their development.

 

***We have incurred significantoperating losses since inception and expect to continue to incur substantialand increasing losses for the foreseeable future. We may never achieve orsustain profitability.****

 

We have a limited operating history and have incurred significantlosses since our inception. As of September 30, 2010, we had anaccumulated deficit of approximately $199.6 million. We expect to continueto incur net losses for the foreseeable future as we explore strategic optionsavailable to us. These losses have had and will continue to have an adverseeffect on our stockholders’ equity and working capital.

 

Because of the numerous risks and uncertainties associated with drugdevelopment, we are unable to predict with certainty the costs we will incur insupport of our product candidates as we pursue strategic options, includingpotential collaboration arrangements. Currently, we have no products approvedfor commercial sale, and, to date, we have not generated any product revenue.We have financed our operations primarily through the sale of equitysecurities, capital lease and equipment financings, debt financings and asingle corporate partnership with Procter & GamblePharmaceuticals, Inc., or P&G, that was terminated in July 2008.We have devoted substantially all of our efforts to research and development,including clinical trials. If we are unable to develop and commercialize any ofour product candidates, if development is delayed, if sales revenue from anyproduct candidate approved by the U.S. Food and Drug Administration, or theFDA, is insufficient or if we fail to enter into partnering arrangements forour product candidates on terms favorable to us, we may never becomeprofitable. Even if we do become profitable, we may not be able to sustain orincrease our profitability on a quarterly or annual basis.

 

***Our loan agreements imposerestrictions on us that may adversely affect our ability to operate our business.****

 

Certain of our loan agreements with our lenders, including our debtarrangements with Lighthouse, Oxford and the Bridge Investors, containcovenants that restrict or limit, among other things, our ability to createliens supporting indebtedness, sell assets, make certain distributions, andincur additional debt. In addition, our debt agreements contain, and those weenter into in the future may contain, restrictive covenants and otherlimitations with which we will need to comply. Our ability to comply with thesecovenants may be affected by many events beyond our control, and we cannotassure you that our future operating results will be sufficient to comply withthe covenants or, in the event of a default under any of our debt agreements, toremedy that default.

 

Our failure to comply with the covenants in our loan agreements andother related transactional documents could result in events of default. Uponthe occurrence of such an event of default, the lenders could elect to declareall amounts outstanding under a particular facility to be immediately due andpayable and terminate all commitments, if any, to extend further credit. Anevent of default or an acceleration under one loan agreement could cause across-default or cross-acceleration of another loan agreement. Such cross-default or cross-acceleration could have a wider impact on our liquidity thanmight otherwise arise from a default or acceleration of a single loan facility.If an event of default occurs, or if other loan agreements cross-default, andthe lenders under the affected loan agreements accelerate the maturity of anyloans or other debt outstanding to us, we may not have sufficient liquidity torepay amounts outstanding under such loan agreements.

 

Our ability to repay, extend or refinance our existing debt obligationsand to obtain future credit will depend primarily on our operating performanceand ability to raise additional capital to continue our operations, which willbe affected by general economic, financial, regulatory, business and otherfactors, many of which are beyond our control. Our ability to refinanceexisting debt obligations will also depend upon the current conditions in thecredit markets and the availability of credit generally. If we are unable to meetour debt service obligations or are unable to obtain future credit onacceptable terms, if at all, we could be forced to restructure or refinance ourindebtedness, seek additional equity capital or sell or liquidate our assets.In such an event, we may be unable to obtain financing or sell our assets onacceptable terms, or at all.

 

***Unfavorable economic and marketconditions may negatively impact our business, results of operations, andfinancial condition, and may make it difficult or costly to raise additionalcapital.****

 

The deterioration in worldwide economic conditions and the disruptionto the credit and financial markets in the United States and worldwide have ledto, among other things, extreme volatility in security prices, decliningvaluations of certain investments, and reduced liquidity and creditavailability. As a company having no commercial operations, a protracteddownturn may hurt our business in a number of ways, including the impact on ourability to access capital and credit markets to meet our financing objectivesto allow us to continue our operations, and on our ability to manage our cashbalance, current portfolio of cash equivalents or investments in marketablesecurities. While we are unable to predict the likely duration and severity ofthese unfavorable economic conditions in the United States and other countries,any of the circumstances mentioned above could adversely affect our business,financial condition, operating results, cash flow or cash position, and ourability to raise capital.

 

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***Our success depends substantially onour most advanced product candidates, which are still under development. If weare unable to bring any or all of these product candidates to market, orexperience significant delays in doing so, our ability to generate productrevenue and our likelihood of success will be harmed.***

 

We have three product candidates in late stage clinical development,with tecarfarin in Phase 3, and budiodarone and naronapride (ATI-7505) inPhase 2b. A fourth product candidate, ATI-9242, entered into aPhase 1 clinical trial in April 2008. Our ability to generate productrevenue in the future will depend heavily on the successful development andcommercialization of these product candidates. Our other product candidates arein the discovery stage. Any of our product candidates could be unsuccessful fora variety of reasons, including that they:

 

·                  may not demonstrateacceptable safety and efficacy in preclinical trials or clinical trials orotherwise may not meet applicable regulatory standards for approval;

 

·                  may not offer therapeutic,safety or other improvements over existing or future drugs used to treat thesame conditions;

 

·                  may not be capable of beingproduced in commercial quantities at acceptable costs; or

 

·                  may not be accepted in themedical community or by third-party payors.

 

We do not expect any of our current product candidates to becommercially available in the next several years, if at all. The results of ourclinical trials to date do not provide assurance that acceptable efficacy orsafety will be shown upon completion of Phase 3 clinical trials. In addition,in February 2010 we shifted our primary focus from product development toexploring strategic alternatives available to us, which will delay our progresstoward the potential commercialization of any of our product candidates.

 

***We expect to depend on collaborativearrangements to complete the development and commercialization of each of ourproduct candidates. Potential collaborative arrangements will likely place thedevelopment of our product candidates outside of our control and will likelyrequire us to relinquish important rights or may otherwise be on termsunfavorable to us.***

 

The strategic options we are currently pursuing include potentialcollaborative arrangements with third parties to develop and commercialize eachof our lead product candidates. Dependence on collaborative arrangements fordevelopment and commercialization of our product candidates will subject us toa number of risks, including:

 

·                  we may not complete acollaborative arrangement in time to avoid delays in clinical development, ifat all, and if no collaborative arrangement is achieved, product developmentmay be halted altogether. Currently, there are no clinical activities underwayon any of our product candidates;

 

·                  we may not be able tocontrol the amount and timing of resources that our collaborators may devote tothe development or commercialization of product candidates or to theirmarketing and distribution;

 

·                  collaborators may delayclinical trials, provide insufficient funding for a clinical trial program,stop a clinical trial or abandon a product candidate, repeat or conduct newclinical trials or require a new formulation of a product candidate forclinical testing;

 

·                  we may have limited controlover our clinical trial design;

 

·                  disputes may arise betweenus and our collaborators that result in the delay or termination of theresearch, development or commercialization of our product candidates or thatresult in costly litigation or arbitration that diverts management’s attentionand resources;

 

·                  our collaborators mayexperience financial difficulties;

 

·                  collaborators may notproperly maintain or defend our intellectual property rights or may use ourproprietary information in such a way as to invite litigation that couldjeopardize or invalidate our proprietary information or expose us to potentiallitigation;

 

·                  business combinations orsignificant changes in a collaborator’s business strategy may adversely affecta collaborator’s willingness or ability to fulfill its obligations under anyarrangement;

 

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·                  a collaborator couldindependently move forward with a competing product candidate developed eitherindependently or in collaboration with others, including our competitors; and

 

·                  any collaborativearrangement may be terminated or allowed to expire, which would delay thedevelopment and may increase the cost of developing our product candidates.

 

***Collaborative arrangements do notcurrently exist for any of our product candidates. If we do not establishcollaborations for each of our naronapride (ATI-7505), budiodarone, tecarfarin,and ATI-9242 product candidates or future product candidates, we may have toalter our development and commercialization plans.***

 

The strategic options we are currently pursuing include potentialcollaborations with leading pharmaceutical and biotechnology companies toassist us in furthering the development and potential commercialization of someof our product candidates, including naronapride (ATI-7505), budiodarone,tecarfarin, and ATI-9242. We are seeking partners because the commercializationof each of our first four product candidates involves a large, primary caremarket that must be served by large sales and marketing organizations andbecause we do not currently have the capabilities to perform Phase 3clinical trials. We face significant competition in seeking appropriatecollaborators, and these collaborations are complex and time-consuming to negotiateand document. We may not be able to negotiate collaborations on acceptableterms, if at all. We are unable to predict when, if ever, we will enter intoany collaborations because of the numerous risks and uncertainties associatedwith establishing collaborations. If we are unable to negotiate an acceptablecollaboration, we may have to curtail the development of a particular productcandidate, reduce or delay its development program or one or more of our otherdevelopment programs, delay its potential commercialization or reduce the scopeof our sales or marketing activities or increase our expenditures and undertakedevelopment or commercialization activities at our own expense. If we elect toincrease our expenditures to fund development or commercialization activitieson our own, we may need to obtain additional capital, which may not beavailable to us on acceptable terms, if at all. If we do not have sufficientfunds, we will not be able to bring our product candidates to market andgenerate product revenues.

 

***The commercial success of ourpotential collaborations will depend in part on the development and marketingefforts of our potential partners, over which we will have limited control. Ifour collaborations are unsuccessful, our ability to develop and commercializeand to generate future revenue from the sale of our products will besignificantly reduced.***

 

Our dependence on future collaboration arrangements will subject ourcompany to a number of risks. Our ability to develop and commercialize each ofour product candidates will depend on our and our potential collaborationpartner(s)’ ability to establish the safety and efficacy of each respectiveproduct candidate, obtain and maintain regulatory approvals and achieve marketacceptance of the product candidate(s) once commercialized. Our potentialcollaboration partner(s) may elect to delay or terminate development ofour product candidates, independently develop products that compete with ours,or fail to commit sufficient resources to the marketing and distribution of ourproduct candidates. The termination of a collaboration agreement may cause usto incur additional and unanticipated costs that may be material to ouroperations.

 

Business combinations, significant changes in business strategy, litigationand/or financial difficulties may also adversely affect the willingness orability of our potential collaboration partners to fulfill their obligations tous. If a partner fails to perform in the manner we expect, our potential todevelop and commercialize the respective product candidate(s) throughother collaborations and to generate future revenue from the sale of theproduct candidate(s) may be significantly reduced. If a conflict ofinterest arises between us and our collaboration partner(s), they may act intheir own self-interest and not in the interest of our company or ourstockholders. If a collaboration partner breaches or terminates theircollaboration agreement with us or otherwise fails to perform their obligationsthereunder in a timely manner, the clinical development or commercialization ofthe respective product candidate(s) could be delayed or terminated. Forexample, we experienced this when P&G terminated our collaborationagreement to develop and commercialize naronapride (ATI-7505), and we mayexperience a similar result with potential collaboration partners in the futurewith respect to any of our product candidates.

 

***If we are not able to obtainrequired regulatory approvals, we will not be able to commercialize our productcandidates, our ability to generate revenue will be materially impaired and ourbusiness will not be successful.***

 

Our product candidates and the activities associated with theirdevelopment and commercialization are subject to comprehensive regulation bythe FDA and other federal and state regulatory agencies in the United Statesand by comparable authorities in other countries. The inability to obtain FDAapproval or approval from comparable authorities in other countries wouldprevent us and our collaborative partners from commercializing our productcandidates in the United States or other countries. Future collaborativeagreements will likely cause us to give up control of interactions andregulatory approval processes with the FDA and other regulatory bodies. We orour partners may never receive regulatory approval for the commercial sale ofany of our product candidates. We have only limited experience in preparing andfiling the applications necessary to gain regulatory approvals and have 

 

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notreceived regulatory approval to market any of our product candidates in anyjurisdiction. The process of applying for regulatory approval is expensive andtime-consuming, and can vary substantially based upon the type, complexity andnovelty of the product candidates involved.

 

Because our product candidates are modeled after drugs which are knownto have safety problems, the FDA and other regulatory agencies may requireadditional safety testing which may delay our clinical progress, increase ourexpected costs or make further development unfeasible. For instance, because ofknown problems with the drug after which it was modeled, we were required toconduct significant monitoring for cardiac toxicity in our clinical trials ofnaronapride (ATI-7505).

 

Changes in regulatory approval policies during the development period,changes in, or the enactment of, additional regulations or statutes or changesin the regulatory review team for each submitted product application may causedelays in the approval or rejection of an application. Even if the FDA or aforeign regulatory agency approves a product candidate, the approval may imposesignificant restrictions on the indicated uses, conditions for use, labeling,advertising, promotion, marketing and/or production of such product and mayimpose requirements for post-approval trials, including additional research anddevelopment and clinical trials. The FDA and other agencies also may imposevarious civil or criminal sanctions for failure to comply with regulatoryrequirements, including substantial monetary penalties and withdrawal ofproduct approval.

 

The FDA has substantial discretion in the approval process and mayrefuse to accept any application or decide that our data are insufficient forapproval and require additional preclinical, clinical or other trials. Forexample, varying interpretations of the data obtained from preclinical andclinical testing could delay, limit or prevent regulatory approval of a productcandidate. Moreover, the FDA may not agree that certain target indications areapprovable. For instance, the FDA has never approved a drug for postprandialdistress syndrome, or PDS, and we cannot be certain that the FDA will recognizePDS as an indication for which naronapride (ATI-7505) or other drugs can beapproved. As another example, while we believe we have clear direction from theFDA as to the development path for our tecarfarin product candidate based onour various discussions, the FDA may change its judgment on the appropriatedevelopment pathway for tecarfarin at any time. Similarly, the clinical trialsto be required by the FDA for approval of new anti-arrythmic therapies maychange as the FDA considers the approval of similar therapies submitted bycompeting pharmaceutical companies.

 

We will need to obtain regulatory approval from authorities in foreigncountries to market our product candidates in those countries. We have not yetinitiated the regulatory process in any foreign jurisdictions. Approval by oneregulatory authority does not ensure approval by regulatory authorities inother jurisdictions. If we fail to obtain approvals from foreign jurisdictions,the geographic market for our product candidates would be limited.

 

***Safety issues relating to ourproduct candidates or the original drugs upon which our product candidates havebeen modeled, or relating to approved products of third parties that are similarto our product candidates, could give rise to delays in the regulatory approvalprocess.***

 

Discovery of previously unknown problems with an approved product mayresult in restrictions on its permissible uses, including withdrawal of themedicine from the market. Each of the opportunities upon which we have chosento focus is based upon our belief that our RetroMetabolic Drug Designtechnology can be used to create a new product based upon an existing productwhich is efficacious in treating a specific condition, but which has a knownsafety problem. Each of our four lead product candidates is modeled on drugswhich have significant safety problems. Budiodarone is modeled on amiodaronewhich is used, but not approved, for atrial fibrillation in spite of knownsafety problems due to its accumulation in the body and interaction with otherdrugs. Both amiodarone and budiodarone contain iodine which can accumulate inthe thyroid and must be monitored for safety purposes. In addition, budiodaroneis partially metabolized by CYP450 and, at certain levels has caused drug-druginteractions with warfarin, which increased INR and could increase the risk ofhemorrhage complications. Tecarfarin is modeled on warfarin which is known tohave safety risks because of its potential for bleeding and for interactionswith numerous other drugs as listed on the package insert for the product.Naronapride (ATI-7505) is modeled on cisapride which was withdrawn from themarket due to fatal cardiac problems. ATI-9242 is modeled to retain certain ofthe positive features of the class of atypical antipsychotic drugs whilelessening certain of the safety issues that vary but exist within the class.The receptor profile which yields the positive and avoids the negative featuresof this class of drugs is a matter of great debate. While we have designedATI-9242 to have an appropriate balance across a very complex set of receptors,we may have targeted an inappropriate profile or the profile attained mayresult in an unanticipated lack of efficacy or safety problems. Although wehave designed our drugs to largely address each of the original drugs’ keysafety problems, we will need to continue to demonstrate this through continuedclinical testing. It is possible that the FDA may impose additionalrequirements on the development or approval of our products because of itsconcern about the original drug’s safety problems. These potential additionalbarriers could delay, increase the cost of, or prevent the commercialization ofour product candidates.

 

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Our product candidates are engineered to be broken down by the body’snatural metabolic processes in a manner we believe to be safer than that of theoriginal drug. There can be no assurance that the products we develop willactually be metabolized as we expect. While we have designed the breakdownproducts to be safe, it is possible that there will be unexpected toxicityassociated with these breakdown products that could cause our products to bepoorly tolerated by, or toxic to, humans. Additionally, while we believe wehave addressed the key safety problem of each of the original drugs, it ispossible that our change to the chemical structure may result in new unforeseensafety issues. Any unexpected toxicity or suboptimal tolerance of our productswould delay or prevent commercialization of these product candidates.Additionally, problems with approved products marketed by third parties thatutilize the same therapeutic target as our product candidates could adverselyaffect the development of our product candidates. For example, the productwithdrawals of Vioxx by Merck & Co., Inc. and Bextra byPfizer because of safety issues caused other drugs that have the sametherapeutic target, such as Celebrex from Pfizer, to receive additionalscrutiny from regulatory authorities. Another prokinetic, tegaserod marketed byNovartis Pharmaceuticals Corporation as Zelnorm, was temporarily withdrawn fromthe market and then reintroduced in a very limited manner due to certaincardiac effects reportedly related to its off-target effects. Although in ourend of Phase 2 meeting with the FDA, they did not indicate any special tests orextraordinary safety monitoring would be required, it is possible that we or afuture collaboration partner may be required by regulatory agencies to performtests or gather data, in addition to those we have planned, in order todemonstrate that naronapride (ATI-7505) does not have the safety problemsassociated with Zelnorm. Any failure or delay in commencing or completingclinical trials or obtaining regulatory approvals for our product candidateswould delay commercialization of our product candidates and severely harm ourbusiness and financial condition.

 

***Any failure or delay in commencingor completing clinical trials for our product candidates could severely harmour business.***

 

To date, we have not completed the clinical trial program of anyproduct candidate. The commencement and completion of clinical trials for ourproduct candidates may be delayed or terminated as a result of many factors,including:

 

·                  our inability or theinability of our collaborators or licensees to manufacture or obtain from thirdparties materials sufficient for use in preclinical and clinical trials;

 

·                  delays in patientenrollment, which we previously experienced in certain trials, and variabilityin the number and types of patients available for clinical trials;

 

·                  difficulty in maintainingcontact with patients after treatment, resulting in incomplete data;

 

·                  poor effectiveness ofproduct candidates during clinical trials;

 

·                  poor patient compliancewhile participating in one of our clinical trials;

 

·                  unforeseen safety issues orside effects; and

 

·                  governmental or regulatorydelays and changes in regulatory requirements, policies and guidelines.

 

Any delay in commencing or completing clinical trials for our productcandidates would delay commercialization of our product candidates and severelyharm our business and financial condition. It is also possible that none of ourproduct candidates will complete clinical trials in any of the markets in whichour collaborators or we intend to sell those product candidates. Accordingly,our collaborators or we would not receive the regulatory approvals needed tomarket our product candidates, which would severely harm our business andfinancial condition.

 

***We rely on third parties to conductour clinical trials. If these third parties do not perform as contractuallyrequired or expected, we may not be able to obtain regulatory approval for orcommercialize our product candidates.***

 

We do not have the ability to independently conduct clinical trials forour product candidates, and thus for each of our product candidates we mustrely on third parties such as contract research organizations, medicalinstitutions, clinical investigators and contract laboratories, to conduct ourclinical trials. We have, in the ordinary course of business, entered intoagreements with these third parties. To date, we have utilized numerous vendorsto provide clinical trial management, data collection and analysis andlaboratory and safety analysis services in the conduct of our clinical trials. Inaddition, to date we have conducted our clinical trials at numerous sites inNorth America and Europe. Nonetheless, we are responsible for confirming thateach of our clinical trials is conducted in accordance with its generalinvestigational plan and protocol. Moreover, the FDA requires us to comply withregulations and standards, commonly referred to as good clinical practices, forconducting and recording and reporting the results of clinical trials to assurethat data and reported results are credible and accurate and that the trialparticipants are adequately protected. Our reliance on third parties that we donot control does not relieve us of these responsibilities and requirements. Ifthese third parties do not 

 

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successfullycarry out their contractual duties or regulatory obligations or meet expecteddeadlines, if the third parties need to be replaced or if the quality oraccuracy of the data they obtain is compromised owing to the failure to adhereto our clinical protocols or regulatory requirements or for other reasons, ourclinical trials may be extended, delayed, suspended or terminated, and we may notbe able to obtain regulatory approval for, or successfully commercialize, ourproduct candidates.

 

***If some or all of our patentsexpire, are invalidated or are unenforceable, or if some or all of our patentapplications do not yield issued patents or yield patents with narrow claims,competitors may develop competing products using our intellectual property andour business will suffer.****

 

Our success will depend in part on our ability to obtain and maintainpatent and trade secret protection for our technologies and product candidatesboth in the United States and other countries. When referring to “our” patentsand other intellectual property in this section, we are referring both topatents and other intellectual property that we own. We rely on composition ofmatter patents for the compounds we develop. We cannot guarantee that anypatents will issue from any of our pending or future patent applications.Alternatively, a third party may successfully circumvent our patents. Ourrights under any issued patents may not provide us with sufficient protectionagainst competitive products or otherwise cover commercially valuable productsor processes, and we cannot guarantee that our issued patents will not be heldinvalid or unenforceable.

 

The degree of future protection for our proprietary technologies andproduct candidates is uncertain because legal means afford only limitedprotection and may not adequately protect our rights or permit us to gain orkeep our competitive advantage. For example, as applied to both existing andfuture patents and other intellectual property:

 

·                  we might not have been thefirst to make the inventions covered by each of our pending patent applicationsand issued patents;

 

·                  we might not have been thefirst to file patent applications for the disclosed inventions;

 

·                  others may independentlydevelop similar or alternative technologies or duplicate our technologies;

 

·                  it is possible that none ofour pending patent applications will result in issued patents;

 

·                  any patents issued to us orour collaborators may not provide protection for commercially viable productsor may be successfully challenged by third parties;

 

·                  the patents of others mayhave an adverse effect on our ability to do business;

 

·                  regulators or courts mayretroactively diminish the value of our intellectual property; or,

 

·                  due to financialconstraints, we may choose to not maintain or further prosecute certain patentsin certain geographies and thereby lose patent protection in those geographies.

 

Even if valid and enforceable patents cover our product candidates andtechnologies, the patents will provide protection only for a limited amount oftime. As our product candidates are based on a parent drug where much researchhas been conducted, we may encounter many competitive patents from coveredanalogs of the parent drug. Our know-how and trade secrets may only provide acompetitive advantage for a short amount of time, if at all. Furthermore, wecannot guarantee that our patents, present or future, will have scopesufficient to prevent competing products.

 

Our ability and our potential collaborators’ ability to obtain andenforce patents is highly uncertain because of the complexity of the scientificand legal issues involved and the subjective nature of issues upon whichreasonable minds may differ. Legislative, judicial, and administrative bodies,both foreign and domestic, may issue laws, decisions, and regulations,respectively, that (a) detrimentally affect our ability to obtainprotection for our technologies, (b) increase our costs of obtaining andmaintaining patents, (c) detrimentally affect our ability to enforce ourexisting patents, (d) narrow the scope of our patent protection, and/or(e) otherwise diminish the value of our intellectual property in at leastthe following ways: 1) U.S. Federal Courts and foreign judicial authoritiesmay render decisions that alter the application of the patent laws anddetrimentally affect our ability to enforce our patents and obtain patentprotection for our technologies; 2) the U.S. Patent and Trademark Office,or USPTO, and foreign counterparts may change the nature of how patentapplications are examined and issue regulations that detrimentally affect ourability to obtain patent protection for our technologies and/or increase thecosts for obtaining and maintaining protection; and/or 3) Congress andother foreign legislative bodies may make changes to their respective patentlaws that may make obtaining and enforcing patents more difficult and/orcostly, and/or otherwise diminish the value of our intellectual property ornarrow the scope of our patent protection.

 

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Even if patents are issued regarding our product candidates or methodsof using them, those patents can be challenged by our competitors who can arguethat such patents are invalid and/or unenforceable. Defending against suchchallenges could be costly, and the outcome is inherently uncertain and mayresult in the loss of some or all of our rights. Patents also may not protectour product candidates if competitors devise ways of making these or similarproduct candidates without legally infringing our patents. The Federal Food,Drug and Cosmetic Act and FDA regulations and policies provide incentives tomanufacturers to challenge patent validity or create modified, non-infringingversions of a drug in order to facilitate the approval of generic substitutes.These same types of incentives encourage manufacturers to submit new drug applicationsthat rely on literature and clinical data not prepared for or by the drugsponsor.

 

Similarly, we may choose to challenge the patents and other rightsalleged or asserted by third parties. Such challenges, whether judicial oradministrative in nature, could be costly and the outcome uncertain. A negativeoutcome could detrimentally affect our ability to do business.

 

While at present we have no such agreements in place, we may enter intoagreements to license technologies and patent rights. Should we fail to complywith the terms of those license agreements, including payment of any requiredmaintenance fees or royalties, or should the licensors fail to maintain theirlicensed interest in the licensed patents, we could lose the rights to thosetechnologies and patents, which may have a detrimental affect on our ability todo business.

 

As of September 30, 2010, we held 43 issued or allowed U.S.patents and had 12 patent applications pending before the USPTO. For some ofour inventions, corresponding foreign patent protection is pending. Of the 43U.S. patents that we hold, 38 patents are compound and composition related,having expiration dates from 2013 to 2025. Our composition of matter patent forbudiodarone, our compound for the treatment of atrial fibrillation, issued in April 2002and has an expiration date in 2020. The composition of matter patent fortecarfarin, our compound for anticoagulation, issued in August 2007 andhas an expiration date in 2025. The composition of matter patent for naronapride(ATI-7505), our compound for the treatment of gastrointestinal disorders,issued in February 2007 and has an expiration date in 2025. Ourcomposition of matter patent applications for ATI-9242, our product candidatefor the treatment of schizophrenia and other psychiatric disorders, arecurrently pending, one in the United States and 15 in foreign jurisdictions.Although third parties may challenge our rights to, or the scope or validityof, our patents, to date we have not received any communications from thirdparties challenging our patents or patent applications covering our clinicalcandidates.

 

While budiodarone, tecarfarin and naronapride (ATI-7505) are allcovered in the United States by issued composition of matter patents,additional patent applications would be required to extend patent protectionbeyond 2020, 2025 and 2025, respectively (assuming the validity andenforceability of the current composition of matter patents). We cannotguarantee that any patents will be issued from our pending or future patentapplications, and any patents that issue from such pending or future patentapplications would be subject to the same risks described herein for currentlyissued patents.

 

Our research and development collaborators may have rights to publishdata and other information in which we have rights. In addition, we sometimesengage individuals or entities to conduct research that may be relevant to ourbusiness. The ability of these individuals or entities to publish or otherwisepublicly disclose data and other information generated during the course oftheir research is subject to certain contractual limitations. In most cases,these individuals or entities are at the least precluded from publiclydisclosing our confidential information and are only allowed to disclose otherdata or information generated during the course of the research after we havebeen afforded an opportunity to consider whether patent and/or otherproprietary protection should be sought. If we do not apply for patent protectionprior to such publication or if we cannot otherwise maintain theconfidentiality of our technology and other confidential information, then ourability to receive patent protection or protect our proprietary information maybe jeopardized.

 

***Failure to adequately protect ourtrade secrets and other intellectual property could substantially harm ourbusiness and results of operations.***

 

We also rely on trade secrets to protect our technology, especiallywhere we do not believe that patent protection is appropriate or obtainable.This is particularly true for our RetroMetabolic Drug Design technology.However, trade secrets are difficult to protect. Our employees, consultants,contractors, outside scientific collaborators and other advisors are requiredto sign confidential disclosure agreements but they may unintentionally orwillfully disclose our confidential information to competitors. Enforcing aclaim that a third party illegally obtained and is using our trade secrets isexpensive and time-consuming, and the outcome is unpredictable. Failure toobtain or maintain trade secret protection could adversely affect ourcompetitive business position.

 

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***Third-party claims of intellectualproperty infringement would require us to spend significant time and money andcould prevent us from developing or commercializing our products.***

 

Our commercial success depends in part on not infringing the patentsand proprietary rights of other parties and not breaching any licenses that wehave entered into with regard to our technologies and products. Because othersmay have filed, and in the future are likely to file, patent applicationscovering products or other technologies that are similar or identical to ours,patent applications or issued patents of others may have priority over ordominate our patent applications or issued patents or otherwise prevent us fromcommercializing our technologies. There are numerous issued and pendingapplications related to the original molecules and analogs from which ourproducts are engineered. If such pending patents issuing from such pendingapplications are determined to be valid and construed to cover our products,the development and commercialization of any or all could be negativelyaffected and even prevented. We do not believe that our activities infringe thepatents of others or that the patents of others inhibit our freedom to operate,but we cannot guarantee that we have identified all United States and foreignpatents and patent applications that pose a risk of infringement. We may beforced to litigate if an intellectual property dispute arises, and it ispossible that others may choose to challenge our position and that a judge orjury will disagree with our conclusions. We could incur substantial costs inlitigation if we are required to defend against patent suits brought by thirdparties. If we do not successfully defend an infringement action, are unable tohave infringed patents declared invalid, and do not obtain a license to thepatented technology, we may,

 

·                  incur substantial monetarydamages;

 

·                  encounter significant delaysin marketing our products; and

 

·                  be unable to conduct orparticipate in the manufacture, use or sale of our products or methods oftreatment.

 

Similarly, if we initiate suits to defend our patents, such litigationcould be costly and there is no assurance we would have the resources to defendour patents or that we would be successful in such processes. Any legal actionagainst our collaborators or us claiming damages and seeking to enjoincommercial activities relating to the affected products and processes could, inaddition to subjecting us to potential liability for damages, require ourcollaborators or us to obtain a license to continue to manufacture or marketthe affected products and processes. Licenses required under any of thesepatents may not be available on commercially acceptable terms, if at all.Failure to obtain such licenses could materially and adversely affect ourability to develop, commercialize and sell our product candidates. We believethat there may continue to be significant litigation in the biotechnology andpharmaceutical industry regarding patent and other intellectual propertyrights. If we become involved in litigation, it could consume a substantialportion of our management and financial resources and we may not prevail in anysuch litigation.

 

Furthermore, our commercial success will depend, in part, on ourability to continue to conduct research to identify additional productcandidates in current indications of interest or opportunities in otherindications. Some of these activities may involve the use of genes, geneproducts, screening technologies and other research tools that are covered bythird-party patents. In some instances, we may be required to obtain licensesto such third-party patents to conduct our research and development activities,including activities that may have already occurred. It is not known whetherany license required under any of these patents would be made available oncommercially acceptable terms, if at all. Failure to obtain such licenses couldmaterially and adversely affect our ability to maintain a pipeline of potentialproduct candidates and to bring new products to market. If we are required todefend against patent suits brought by third parties relating to third-partypatents that may be relevant to our research activities, or if we initiate suchsuits, we could incur substantial costs in litigation. Moreover, the results ofany such litigation are uncertain, and an adverse result from any legal actionin which we are involved could subject us to damages and/or prevent us fromconducting some or potentially all of our research and development activities.

 

***If third parties do not manufactureour product candidates in sufficient quantities or at an acceptable cost,clinical development and commercialization of our product candidates would bedelayed.***

 

We presently do not have sufficient quantities of our productcandidates to complete clinical trials of any of our lead product candidates.We do not currently own or operate manufacturing facilities, and we rely andexpect to continue to rely on a small number of third-party manufacturers andactive pharmaceutical ingredient formulators for the production of clinical andcommercial quantities of our product candidates. We do not have long-termagreements with any of these third parties, and our agreements with theseparties are generally terminable at will by either party at any time. If forany reason, these third parties are unable or unwilling to perform under ouragreements or enter into new agreements, we may not be able to locatealternative manufacturers or formulators or enter into favorable agreementswith them. Any inability to acquire sufficient quantities of our productcandidates in a timely manner from these third parties could delay clinicaltrials and prevent us from developing and commercializing our productcandidates in a cost-effective manner or on a timely basis.

 

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The starting materials for the production of budiodarone are providedby the following vendors: SCI Pharmtech, Inc., Lexen Inc., Panchim,Julich GmbH and Weylchem Inc. To date, Ricerca,Biosciences, LLC, ScinoPharm Ltd. and SCI Pharmtech have produced allof budiodarone’s active pharmaceutical ingredient. Historically, we have reliedon Ricerca, ScinoPharm and SCI Pharmtech as single-source suppliers for budiodarone’sactive pharmaceutical ingredients. In the event that Ricerca, Biosciences, LLC,ScinoPharm Ltd. or SCI Pharmtech is unable or unwilling to serve as thesupplier of budiodarone, we might not be able to manufacture budiodarone’sactive pharmaceutical ingredient. This could delay the development of, andimpair our ability to, commercialize budiodarone. To produce budiodarone drugproduct, drug substance is processed into 50 milligram or 200 milligram capsuleforms by Patheon Inc. of Mississauga, Ontario.

 

The starting materials for the production of tecarfarin are provided bySynquest Labs, Inc. and Chem Uetikon, GmbH. To date, the activepharmaceutical ingredient for tecarfarin has been produced by ChemShop BVof the Netherlands and Corum Inc. of Taiwan on an ongoing purchase orderbasis. Should ChemShop BV or Corum Inc. be unable or unwilling toserve as the supplier of tecarfarin, a delay in the development of tecarfarincould occur, impairing our ability to commercialize tecarfarin on our existingtimeline. Tecarfarin’s active pharmaceutical ingredient is processed into 1milligram, 2 milligram, 5 milligram or 10 milligram tablets by QS Pharmaof Boothwyn, PA.

 

The starting materials for the production of naronapride (ATI-7505) areprovided by the following vendors: SCI Pharmtech, Inc., Corum, Inc.and Lexen Inc. To produce naronapride drug products, drug substance isprocessed into 20 milligram or 40 milligram tablet form by PharmaceuticsInternational, Inc. of Hunt Valley, MD (PII). In the event that any ofthese vendors are unable or unwilling to produce sufficient quantities ofmaterial for the manufacture of naronapride, the development and/orcommercialization of naronapride could be delayed or impaired. A 500 kgquantity of naronapride active pharmaceutical ingredient (“API”) is currentlyin storage at PII. This drug supply is owned by Procter & Gamble andis being stored at our expense. We are currently in discussions with Procter &Gamble regarding the purchase by ARYx or a related third party of some, or all,of this naronapride API. Procter & Gamble may decide to dispose of anyof this existing naronapride API not purchased by us or a related third party.We believe this is sufficient supply to conduct the required Phase 3 programfor registration. However, Procter & Gamble may terminate thisarrangement at any time subsequent to the date they have agreed and dispose ofthe API material, or it may prove not to be adequate for the entirePhase 3 program.

 

The starting materials for the production of ATI-9242 are provided bythe following vendors: Corum Inc., Alfa Aesar, ApolloScientific Ltd., and SKECHEM. To date, the active pharmaceuticalingredient for ATI-9242 has been produced exclusively by Corum Inc. in Taiwan.In the event that Corum Inc. is unable or unwilling to serve as thesupplier of ATI-9242, we would not be able to manufacture ATI-9242’s activepharmaceutical ingredient. This could delay the development of, and impair ourability to, commercialize ATI-9242. To produce ATI-9242 drug product, drugsubstance is processed into 20 milligram capsule form by Xcelience LLC ofTampa, FL.

 

All of our current arrangements with third-party manufacturers andsuppliers for the production of our product candidates are on a purchase orderbasis. We currently do not have long-term supply contracts with any of thethird-party manufacturers and suppliers for our product candidates, and theyare not required to supply us with products for any specified periods, in anyspecified quantities or at any set price, except as may be specified in aparticular purchase order. We have no reason to believe that any of the currentmanufacturers and suppliers for our product candidates is the sole source forthe materials they supply us. However, if we were to lose one of these vendorsand were unable to obtain an alternative source on a timely basis or on termsacceptable to us, our clinical and production schedules could be delayed. Inaddition, to the extent that any of these vendors uses technology ormanufacturing processes that are proprietary, we may be unable to obtaincomparable materials from alternative sources.

 

***If we are required to obtainalternate third-party manufacturers, it could delay or prevent the clinicaldevelopment and commercialization of our product candidates.***

 

We may not be able to maintain or renew our existing or any otherthird-party manufacturing arrangements on acceptable terms, if at all. If weare unable to continue relationships with our current suppliers, or to do so atacceptable costs, or if these suppliers fail to meet our requirements for theseproduct candidates for any reason, we would be required to obtain alternativesuppliers. Any inability to obtain qualified alternative suppliers, includingan inability to obtain or delay in obtaining approval of an alternativesupplier from the FDA, would delay or prevent the clinical development andcommercialization of these product candidates.

 

Changes in manufacturing site, process or scale can trigger additionalregulatory requirements that could delay our ability to perform certain clinicaltrials or obtain product approval.

 

The manufacturing and formulation of each of our lead productcandidates that have been tested in humans to date has been performed byentities other than those that will likely manufacture the products for futureclinical trials or commercial use. There is a possibility that analysis offuture clinical trials will show that the results from our earlier clinicaltrials have not been replicated. The failure to replicate these earlierclinical trials would delay our clinical development timelines. New impurityprofiles that occur as a result of changing manufacturers may lead to delays inclinical trial testing and approvals.

 

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***Use of third-party manufacturers mayincrease the risk that we will not have adequate supplies of our productcandidates.***

 

Our current and anticipated future reliance on third-partymanufacturers will expose us and our future collaborative partners to risksthat could delay or prevent the initiation or completion of our clinicaltrials, the submission of applications for regulatory approvals, the approvalof our product by the FDA or the commercialization of our products, and mayresult in higher costs or lost product revenues. In particular, our contractmanufacturers could:

 

·                  encounter difficulties inachieving volume production, quality control and quality assurance or suffershortages of qualified personnel, which could result in their inability tomanufacture sufficient quantities of drugs to meet our clinical schedules or tocommercialize our product candidates;

 

·                  terminate or choose not torenew manufacturing agreements, based on their own business priorities, at atime that is costly or inconvenient for us;

 

·                  fail to establish and followFDA-mandated current good manufacturing practices, or cGMPs, which are requiredfor FDA approval of our product candidates, or fail to document their adherenceto cGMPs, either of which could lead to significant delays in the availabilityof material for clinical trials and delay or prevent marketing approval for ourproduct candidates; and

 

·                  breach or fail to perform asagreed under manufacturing agreements.

 

If we are not able to obtain adequate supplies of our productcandidates, it will be more difficult for us to develop our product candidatesand compete effectively. Our product candidates and any products that we maydevelop may compete with other product candidates and products for access tomanufacturing facilities.

 

In addition, Lexen, SCI Pharmtech, Scinopharm, Corum Inc. andChemShop BV are located outside of the United States. This may give riseto difficulties in importing our product candidates or their components intothe United States as a result of, among other things, FDA import inspections,incomplete or inaccurate import documentation, or defective packaging.

 

***If our preclinical trials do notproduce successful results or our clinical trials do not demonstrate safety andefficacy in humans, we will not be able to commercialize our productcandidates.***

 

To obtain the requisite regulatory approvals to market and sell any ofour product candidates, we must demonstrate, through extensive preclinical andclinical trials that the product candidate is safe and effective in humans. Todate, we have not completed all required clinical trials of any productcandidate. Preclinical and clinical testing is expensive, can take many yearsand has an uncertain outcome. A failure of one or more of our clinical trialscould occur at any stage of testing. In addition, success in preclinicaltesting and early clinical trials does not ensure that later clinical trialswill be successful, and interim results of a clinical trial do not necessarilypredict final results. We may experience numerous unforeseen events during, oras a result of, preclinical testing and the clinical trial process, which coulddelay or prevent our ability to commercialize our product candidates,including:

 

·                  regulators or institutionalreview boards may not authorize us to commence a clinical trial at aprospective trial site;

 

·                  our preclinical or clinicaltrials may produce negative or inconclusive results, which may require us toconduct additional preclinical or clinical testing or to abandon developmentprojects;

 

·                  we may suspend or terminateour clinical trials if the participating patients are being exposed to unacceptablehealth risks;

 

·                  regulators or institutionalreview boards may suspend or terminate clinical research for various reasons,including noncompliance with regulatory requirements;

 

·                  the effects of our productcandidates may not be the desired effects or may include undesirable sideeffects; and

 

·                  our preclinical or clinicaltrials may show that our product candidates are not superior to the originaldrugs on which our product candidates are modeled.

 

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For instance, our preclinical and clinical trials may indicate that ourproduct candidates cause unexpected drug-drug interactions and result inadverse events. For example, budiodarone’s preclinical trials contain resultsthat have led to our decision to monitor for such effect in the clinic and maycontinue to be monitored in the clinic in the future. Inhibition of testicularfunction was observed in one animal species as part of these trials. No sucheffect has been observed to date in the clinic and monitoring continues. Inpublished trials, a similar effect is thought to be correlated with theaccumulation of amiodarone in tissues. A possible renal effect was alsoobserved at high doses in our rat and dog toxicology trials for budiodarone.While we have and will continue to monitor patients for these effects, there isno assurance these effects will not occur in patients as part of our clinicaltrials for budiodarone, and have a resulting adverse effect on our ability toobtain requisite regulatory approval to market and sell budiodarone. Similarly,in the clinical testing of budiodarone in patients whose condition alsorequired treatment with warfarin, dose adjustments of warfarin were sometimesrequired. As is common to most clinical trials, the potential for drug-druginteractions will be monitored. As another example, due to the result of ourPhase 2/3 clinical trial of tecarfarin, additional clinical trials oftecarfarin will be necessary in order to demonstrate clinical superiority towarfarin. Even if we adequately demonstrate that tecarfarin is safe andeffective and obtain FDA approval, we may not be permitted to market it assuperior to warfarin. In a canine toxicology trial of naronapride (ATI-7505)performed by our former collaboration partner, P&G, six deaths occurred atdoses that were 10 and 20 times greater than doses currently being used inclinical trials. Our clinical trials to date have indicated only mild tomoderate side effects in humans. However, further observation is warranted.

 

Even when our product candidates do not cause any adverse effects,clinical trials of efficacy may show that our product candidates do not havesignificant effects on target symptoms or may be inconclusive. For example, inthe EmbraceAC trial, tecarfarin demonstrated efficacy essentially the same asin earlier Phase 2 trials but did not achieve the primary endpoint ofsuperiority over warfarin, as measured by time in therapeutic range.Naronapride (ATI-7505) was tested in two Phase 2 clinical trials in whichthe primary endpoints were not met in comparison to placebo. Although thesetrials did support naronapride’s efficacy against certain symptoms as secondaryendpoints, if future trials show that naronapride is not sufficientlyefficacious to justify its use as a therapy, our business and prospects may bematerially adversely affected. In addition, we may need to reformulate theATI-9242 drug product should we find in our on-going Phase 1 testing thatadequate blood levels are not achieved with our current formulation.

 

Unforeseen events could cause us to experience significant delays in,or the termination of, clinical trials. Any such events would increase ourcosts and could delay or prevent our ability to commercialize our productcandidates, which would adversely impact our financial results.

 

***Our product candidates will remainsubject to ongoing regulatory review even if they receive marketing approval.If we fail to comply with continuing regulations, we could lose these approvalsand the sale of our products could be suspended.***

 

Even if we receive regulatory approval to market a particular productcandidate, the approval could be conditioned on our conducting additionalcostly post-approval trials, implementing a Risk Evaluation and MitigationStrategy, or REMS, if the FDA determines that a REMS is necessary to ensure thebenefits of the drug outweigh the risks, or could limit the indicated usesincluded in our labeling. Moreover, the product may later cause adverse effectsthat limit or prevent its widespread use, force us to withdraw it from themarket or impede or delay our ability to obtain regulatory approvals inadditional countries. In addition, the manufacturer of the product and itsfacilities will continue to be subject to FDA review and periodic inspectionsto ensure adherence to applicable GMP regulations. After receiving marketingapproval, the manufacturing, labeling, packaging, adverse event reporting,storage, advertising, promotion and record keeping related to the product willremain subject to extensive regulatory requirements.

 

If we fail to comply with the regulatory requirements of the FDA andother applicable U.S. and foreign regulatory authorities or previously unknownproblems with our products, manufacturers or manufacturing processes arediscovered, we could be subject to administrative or judicially imposedsanctions, including:

 

·                  restrictions on theproducts, manufacturers or manufacturing processes;

 

·                  warning letters;

 

·                  civil or criminal penaltiesor fines;

 

·                  injunctions;

 

·                  product seizures, detentionsor import bans;

 

·                  voluntary or mandatoryproduct recalls and publicity requirements which could vary in foreignjurisdictions;

 

·                  suspension or withdrawal ofregulatory approvals;

 

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·                  total or partial suspensionof production; and

 

·                  refusal to approve pendingapplications for marketing approval of new drugs or supplements to approvedapplications.

 

***We are not currently pursuingadditional research candidates using our RetroMetabolic Drug Design technology.***

 

Because we have limited financial and managerial resources, we mustfocus on pursuing our strategic alternatives related to our later-stageprograms and are not pursuing product candidates for the opportunities that webelieve remain amenable to our RetroMetabolic Drug Design. We are not currentlypursuing additional research candidates using our Retrometabolic Drug Designtechnology. As a result, we may forego or delay pursuit of opportunities withother product candidates or other indications that later prove to have greatercommercial potential. Our resource allocation decisions may cause us to fail tocapitalize on viable commercial products or profitable market opportunities.During our recent restructuring, a significant portion of our research anddevelopment capability was dismantled. It would require significant time andeffort to reestablish these capabilities if discovering or developingearlier-stage programs becomes part of our strategic focus in the future.

 

***The commercial success of anyproducts that we may develop will depend upon the degree of market acceptanceamong physicians, patients, healthcare payors and the medical community.***

 

Any products that we may develop may not gain market acceptance amongphysicians, patients, healthcare payors and the medical community. If theseproducts do not achieve an adequate level of acceptance, we may not generatematerial product revenues and we may not become profitable. The degree ofmarket acceptance of any of our product candidates, if approved for commercialsale, will depend on a number of factors, including:

 

·                  demonstration of efficacyand safety in clinical trials;

 

·                  demonstration that we haveadequately addressed the specific safety problem of the original molecule;

 

·                  the prevalence and severityof any side effects;

 

·                  potential or perceivedadvantages over alternative treatments;

 

·                  perceptions about therelationship or similarity between our product candidates and the original drugupon which each RetroMetabolic Drug Design candidate was based;

 

·                  advantage over other drugsmay not be sufficiently great enough to obtain premium pricing;

 

·                  the timing of market entryrelative to competitive treatments;

 

·                  the ability to offer ourproduct candidates for sale at competitive prices;

 

·                  relative convenience andease of administration;

 

·                  the strength of marketingand distribution support;

 

·                  sufficient third-partycoverage or reimbursement; and

 

·                  the product labeling orproduct insert required by the FDA or regulatory authorities in othercountries.

 

***If we are unable to enter intoagreements with third parties to market and sell our product candidates, we maybe unable to generate product revenue.***

 

We do not have a sales and marketing organization and have noexperience in the sales, marketing and distribution of pharmaceutical products.It is our intention to use collaborative arrangements to gain access to largesales and marketing organizations in order to commercialize our productcandidates. If we do not enter into a collaborative agreement with partnerswhich give us access to a large sales and marketing organization, we may decideto engage contract sales organizations, pharmaceutical or other healthcarecompanies with an existing sales and marketing organization, and distributionsystem, to sell, market and distribute our products. If we enter intoarrangements with third parties to perform sales, marketing and distributionservices, our product revenues are likely to be 

 

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lowerthan if we market and sell any products that we develop ourselves. We may notbe able to establish these sales and distribution relationships on acceptableterms, or at all. If we are not able to partner with a third party, we willhave difficulty commercializing our product candidates, which would adverselyaffect our business and financial condition.

 

***Our ability to generate revenue fromany products that we may develop will depend on reimbursement and drug pricingpolicies and regulations.***

 

Many patients may be unable to pay for any products that we maydevelop. In the United States, many patients will rely on Medicare, Medicaid,private health insurers and other third-party payors to pay for their medicalneeds. Our ability to achieve acceptable levels of reimbursement for drugtreatments by governmental authorities, private health insurers and otherorganizations will have an effect on our ability to successfully commercialize,and attract collaborative partners to invest in the development of, our productcandidates. We cannot be sure that reimbursement in the United States, Europeor elsewhere will be available for any products that we may develop, and anyreimbursement that may become available may be decreased or eliminated in thefuture. Third- party payors increasingly are challenging prices charged formedical products and services, and many third-party payors may refuse toprovide reimbursement for particular drugs when an equivalent generic drug isavailable. Although we believe that the safety profile of any products that wemay develop will be sufficiently different from the original drugs from whichthey are modeled to be considered unique and not subject to substitution by ageneric of the original drug in the case of budiodarone and tecarfarin, it ispossible that a third- party payor may consider our product candidate and thegeneric original drug as equivalents and only offer to reimburse patients forthe generic drug. In the case of naronapride (ATI-7505), the original molecule,cisapride, was withdrawn from the market and no generic version exists, butthere are many competitive products which may limit the amount we can chargefor this product candidate. There are five atypical antipsychotics whichcurrently dominate an estimated $16.0 billion market for such drugs. Mostwill be generic competitors of ATI-9242 if it ever reaches the marketplace.While we have designed ATI-9242 to have the improved efficacy and safetyfeatures over the existing atypical antipsychotics, these desired features maynot be proven in clinical testing or payors may be unwilling to pay a higherprice for improved features when generic alternatives are available. Even if weshow improved safety with our product candidates, pricing of the existingoriginal drug may limit the amount we will be able to charge for each of ourproduct candidates. If reimbursement is not available or is available only atlimited levels, we may not be able to successfully commercialize our productcandidates, and may not be able to obtain a satisfactory financial return onproducts that we may develop.

 

The trend toward managed healthcare in the United States and thechanges in health insurance programs, as well as legislative proposals toreform healthcare or reduce government insurance programs, may result in lowerprices for pharmaceutical products, including any products that may be offeredby us. In addition, any future regulatory changes regarding the healthcareindustry or third-party coverage and reimbursement may affect demand for anyproducts that we may develop and could harm our sales and profitability.

 

***If our competitors are able todevelop and market products that are more effective, safer or less costly thanany products that we may develop, our commercial opportunity will be reduced oreliminated. ****

 

Thepharmaceutical industry is highly competitive, with a number of established,large pharmaceutical companies, as well as smaller companies. Many of thesecompanies have greater financial resources, marketing capabilities andexperience in obtaining regulatory approvals for product candidates than wecurrently do. There are many pharmaceutical companies, biotechnology companies,public and private universities, government agencies and research organizationsactively engaged in research and development of products which may target thesame markets as our product candidates. We expect any of the potential productswe develop to compete on the basis of, among other things, product efficacy andsafety, time to market, price, extent of adverse side effects experienced andconvenience of administration and drug delivery. One or more of our competitorsmay develop products based upon the principles underlying our proprietarytechnologies earlier than us, obtain approvals for such products from the FDAmore rapidly than us or develop alternative products or therapies that aresafer, more effective and/or more cost effective than any future productsdeveloped by us. We also expect to face competition in our efforts to identityappropriate collaborators or partners to help commercialize our productcandidates in our target commercial areas.

 

Naronapride(ATI-7505) has potential use in five indications: chronic constipation,functional dyspepsia, GERD, gastroparesis and IBS with constipation. Some ofthese indications may not be recognized by the FDA as sufficiently defined toenable regulatory approval of a drug for treatment. Naronapride is a prokineticagent which has been shown to increase motility in the upper and lowergastrointestinal tract, including the ability to improve gastric emptying andcolonic motility. Products which affect the gastrointestinal system’s motilitycould be useful in the treatment of each of these disorders. Other prokineticsare on the market which could be competitive to naronapride (ATI-7505).  Such prokinetics include erythromycin,metoclopramide, Tegaserod, which was withdrawn from the market due to cardiacsafety concerns, and velusetrag being developed by Theravance. Anotherpotentially competitive prokinetic compound, prucalopride, was recentlyapproved in Europe, with the potential for commercialization in the UnitedStates and Asia. Johnson & Johnson has rights to prucalopride in NorthAmerican and certain non-European countries. We 

 

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expectprucalopride to provide competition in markets around the world wherenaronapride might also be approved, should requisite regulatory approval beachieved.  Ironwood Pharmaceuticals andForest Laboratories are jointly developing linaclotide, a guanylate cyclase Cagonist, in North America for the treatment of chronic constipation andirritable bowel syndrome. They have completed Phase 3 trials in NorthAmerica with positive efficacy results. Ironwood has licensed development andcommercialization rights to linaclotide in both Europe and Asia, and we expectlinaclotide to provide competition in specific lower GI tract indications. Webelieve the most significant competition to naronapride for the treatment ofGERD is proton pump inhibitors and H2 blockers, which are currently on themarket in both prescription formulations and strengths as well as inover-the-counter forms. Many major pharmaceutical companies currently marketproton pump inhibitors and H2 blockers generating worldwide sales of over$17.0 billion in 2006. Naronapride is targeted at the approximately 20-25%of GERD patients who do not receive adequate relief from proton pumpinhibitors, which reduce the creation of acid in the stomach. Naronapride willface competition from the prokinetics as well as many inexpensive over-the-counterindications for the treatment of these gastrointestinal disorders.

 

Competitionfor tecarfarin for use as an oral anticoagulant will continue to come fromgeneric coumadin due to its pricing and the years of experience physicians andpatients have with the drug. Other oral anticoagulants are in developmentthroughout the pharmaceutical and biotechnology industry. Most of thesedevelopment programs fall into either the factor Xa or direct thrombininhibitor categories. We are aware that Johnson & Johnson incollaboration with Bayer AG has a factor Xa before the FDA for approval, andthat Bristol- Myers Squibb Company in collaboration with Pfizer, Inc., andMerck/Portola Pharmaceuticals, Inc. each have factor Xa programs in Phase 3testing. A direct thrombin inhibitor, dabigitran fromBoehringer-Ingelheim GmbH, was recently approved by the FDA based uponPhase 3 clinical trial results that demonstrated superiority to warfarin incertain measures.  Dabigatran, unlike thevitamin K antagonists, warfarin and tecarfarin, does not requiremonitoring.  Even though we believetecarfarin’s mechanism of action (VKOR inhibition as with warfarin) and broadlyavailable inexpensive monitoring methodology (INR) provide an advantage, these factorXa and direct thrombin inhibitor programs will likely provide significantcompetition in this market. In addition, there may be other compounds of whichwe are not aware that are at an earlier stage of development and may competewith our product candidates. If any of those compounds are successfullydeveloped and approved, they could compete directly with our productcandidates.

 

Webelieve generic amiodarone will continue to provide competition to budiodaronefor the treatment of atrial fibrillation, even though it is not labeled for usein atrial fibrillation in the United States. Amiodarone will continue to beused off-label in spite of its safety problems because of its generic pricing.In July 2009, Sanofi-Aventis was granted approval to commercialize in theUnited State the antiarrhythmic therapy Multaq® (dronedarone). Approval was also granted bythe European Union in November 2009. We believe Multaq® will providesubstantial competition to budiodarone in the treatment of atrial fibrillation.Other treatments for atrial fibrillation, such as sotalol, marketed by BayerHealthCare Pharmaceuticals, Inc., flecainide marketed by 3M Company andpropafenone, marketed by GlaxoSmithKline, do not have equivalent efficacy toamiodarone but will continue to compete in the atrial fibrillation marketplace.Cardiome Pharma Corporation’s oral product, vernakalant, for the treatment ofatrial fibrillation, was licensed to Merck in April 2009. Vernakalant isin Phase 3 testing and is hoped to have efficacy equal to or better thanflecainide or sotalol, but with reduced pro-arrhythmic effects. There are othercompanies developing devices or procedures to treat atrial fibrillation throughablation, including CryoCor, Inc. and CryoCath Technologies, Inc.

 

Competition for ATI-9242 will likely come from the five largest sellingatypical antipsychotics: Risperdal by Janssen Pharmaceutica, Seroquel byAstraZeneca Pharmaceuticals LP, Zyprexa by Eli Lilly and Company, Abilifyby Bristol-Myers Squibb/Otsuka America Pharmaceutical, Inc., and Geodon byPfizer Inc., which sold a collective $15.7 billion in 2007. It islikely that virtually all of these would be sold as generic versions by thetime ATI-9242 could come to market. Other antipsychotics are in developmentwhich may also be competitive to ATI-9242.

 

***If we fail to attract and keepsenior management and key scientific personnel, we may be unable tosuccessfully develop or commercialize our product candidates if we choose to doso.****

 

Our success depends on our ability to attract, retain and motivatehighly qualified management, clinical and scientific personnel and on ourability to develop and maintain important relationships with leadingclinicians. If we are not able to retain Dr. Goddard, our Chairman and ChiefExecutive Officer, Mr. Varian, our Chief Operating Officer and ChiefFinancial Officer, and Dr. Druzgala, our Senior Vice President and ChiefScientific Officer, we may not be able to successfully complete our ongoingeffort to explore strategic options or develop or commercialize our productcandidates, if we choose to do so. Our ability to retain and incentivize oursenior management and key scientific personnel may be impaired by the October 2009and February 2010 terminations of a substantial portion of our workforce,including Dr. Daniel Canafax, our former Vice President and ChiefDevelopment Officer, and this recent primary focus to explore strategic optionsto optimize the value of our assets. Competition for experienced scientists maylimit our ability to hire and retain highly qualified personnel on acceptableterms, if we choose to do so. In addition, none of our employees haveemployment commitments for any fixed period of time and could leave ouremployment at will. In June 2010, Peter Milner, our former President ofResearch and Development, resigned from the company. If we fail to retainqualified personnel, we may be unable to continue our ongoing strategicprocess.

 

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***Our workforce reductions in October 2009and February 2010 and any future workforce and expense reductions may havean adverse impact on our internal programs, our ability to retain key personneland may be distracting to management.***

 

In October 2009, our board of directors committed to arestructuring plan that resulted in a reduction in force affecting 17 employeesin order to improve operational efficiencies. In February 2010, our boardcommitted to a further reduction in force affecting 37 employees in order tofurther reduce operating expenses and conserve cash resources as we explorevarious strategic options. In light of our continued need for funding andexpense control, we may be required to implement further workforce and expensereductions in the future. Further workforce and expense reductions could resultin reduced progress on our internal programs. In addition, employees, whetheror not directly affected by a reduction, may seek future employment with ourbusiness partners or competitors. Although our employees are required to sign aconfidentiality agreement at the time of hire, the confidential nature ofcertain proprietary information may not be maintained in the course of any suchfuture employment. Further, we believe that our future success will depend inlarge part upon our ability to retain highly skilled personnel. We may havedifficulty retaining such personnel as a result of a perceived risk of futureworkforce and expense reductions. In addition, the implementation of therestructuring program may result in the diversion of efforts of our executivemanagement team and other key employees, which could adversely affect ourbusiness.

 

***While we are not currently planningto commercialize our product candidates using our own resources, we may need tohire additional employees in order to continue to develop or commercialize ourproduct candidates, if we choose to do so. Any inability to manage futuregrowth could harm our ability to develop or commercialize our productcandidates, increase our costs and adversely impact our ability to competeeffectively.***

 

In order to further develop or commercialize our product candidates, wewill need to expand the number of our managerial, operational, financial andother employees since our recent restructurings severely reduced ourdevelopment capabilities. Because the projected time frame for hiring theseadditional employees depends on access to additional financial resources and onthe development status of our product candidates and because of the numerousrisks and uncertainties associated with drug development and our existingcapital resources, we are unable to project if and when we will hire theseadditional employees. While to date we have not experienced difficulties inrecruiting, hiring and retaining qualified individuals, the competition forqualified personnel in the pharmaceutical and biotechnology field is intense.

 

Future growth will impose significant added responsibilities on membersof management, including the need to identify, recruit, maintain and integrateadditional employees. Our future financial performance and our ability tofurther develop and commercialize our product candidates and competeeffectively will depend, in part, on our ability to manage any future growtheffectively.

 

***If product liability lawsuits arebrought against us, we may incur substantial liabilities and may be required tolimit commercialization of any products that we may develop.***

 

We face an inherent risk of product liability exposure related to thetesting of our product candidates in human clinical trials and will face aneven greater risk if we commercially sell any products that we may develop. Ifwe cannot successfully defend ourselves against claims that our productcandidates or products that we may develop caused injuries, we will incursubstantial liabilities. Regardless of merit or eventual outcome, liabilityclaims may result in:

 

·                  decreased demand for anyproduct candidates or products that we may develop;

 

·                  injury to our reputation;

 

·                  withdrawal of clinical trialparticipants;

 

·                  costs to defend the relatedlitigation;

 

·                  increased demands onmanagement’s attention in defending the related litigation;

 

·                  substantial monetary awardsto clinical trial participants or patients;

 

·                  loss of revenue; and

 

·                  the inability tocommercialize any products that we may develop.

 

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We have product liability insurance that covers our clinical trials upto an aggregate $10.0 million annual limit. We intend to expand ourinsurance coverage to include the sale of commercial products if marketingapproval is obtained for any products that we may develop. Insurance coverageis increasingly expensive, and we may not be able to maintain insurancecoverage at a reasonable cost or obtain insurance coverage that will beadequate to satisfy any liability that may arise.

 

***If we use biological and hazardousmaterials in a manner that causes contamination, injury or violates laws, wemay be liable for damages.***

 

Our research and development activities involve the use of potentiallyharmful biological materials as well as hazardous materials, chemicals andvarious radioactive compounds. We cannot completely eliminate the risk ofaccidental contamination or injury from the use, storage, handling or disposalof these materials. In the event of contamination or injury, we could be heldliable for damages that result, and any liability could exceed our resources.We, the third parties that conduct clinical trials on our behalf and the thirdparties that manufacture our product candidates are subject to federal, stateand local laws and regulations governing the use, storage, handling anddisposal of these materials and waste products. The cost of compliance withthese laws and regulations could be significant. The failure to comply withthese laws and regulations could result in significant fines and work stoppages andmay harm our business.

 

Our principal facility is located in California’s Silicon Valley, in anarea with a long history of industrial activity and use of hazardoussubstances, including chlorinated solvents. Certain environmental laws,including the U.S. Comprehensive, Environmental Response, Compensation andLiability Act of 1980, impose strict, joint and several liabilities on currentoperators of real property for the cost of removal or remediation of hazardoussubstances. These laws often impose liability even if the owner or operator didnot know of, or was not responsible for, the release of such hazardoussubstances. As a result, while we have not been notified of any claim againstus, we are not aware of any such release, nor have we been held liable forcosts to address contamination at the property beneath our facility in the past,we cannot rule out the possibility that this may occur in the future. Wedo not carry specific insurance against such a claim.

 

***Failure to maintain effectiveinternal controls in accordance with Section 404 of the Sarbanes-Oxley Actof 2002 could have a material adverse effect on our business, stock price andability to raise additional capital.****

 

Section 404 of the Sarbanes-Oxley Act of 2002 requires management’sannual review and evaluation of our internal controls and, to the extentrequired, an attestation of the effectiveness of internal controls by ourindependent auditor. While the company believes that all material informationabout the company’s finances is known to management and that we are able tocontinue to provide reasonable assurance about the reliability of our financialreporting to stockholders including that the preparation of financialstatements for external purposes are in accordance with generally acceptedaccounting principles, due to the company’s recent restructuring, management maydetermine that we no longer have sufficient personnel or internal procedures toallow us to certify that we are in compliance with Section 404 of theSarbanes-Oxley Act as of December 31, 2010. Due to recent legislativechanges, we are no longer required to have an auditor attestation regarding ourcompliance in the first quarter of 2011. However, if management is unable tocertify as to the effectiveness of internal controls as of December 31,2010, then it is possible that we will receive an adverse opinion from ourauditor. Similarly, if we conclude at anytime that our internal controls are nolonger sufficient to provide reasonable assurance regarding the reliability ofour external financial reporting to stockholders, we may be required to make sucha disclosure to our stockholders. Either of these events could have a materialadverse effect on our business. We could lose investor confidence in theaccuracy and completeness of our financial reports, which could have an adverseeffect on our stock price and our ability to raise additional capital.

 

***Our principal facility is locatednear known earthquake fault zones, and the occurrence of an earthquake,extremist attack or other catastrophic disaster could cause damage to ourfacilities and equipment, which could require us to cease or curtailoperations.***

 

Our principal facility is located in California’s Silicon Valley nearknown earthquake fault zones and, therefore, is vulnerable to damage fromearthquakes. In October 1989, a major earthquake struck this area andcaused significant property damage and a number of fatalities. We are alsovulnerable to damage from other types of disasters, including power loss,attacks from extremist organizations, fire, floods and similar events. If anydisaster were to occur, our ability to operate our business could be seriouslyimpaired. In addition, the unique nature of our research activities and of muchof our equipment could make it difficult for us to recover from this type ofdisaster. We currently may not have adequate insurance to cover our lossesresulting from disasters or other similar significant business interruptions,and we do not currently plan to purchase additional insurance to cover suchlosses because of the cost of obtaining such coverage. Any significant lossesthat are not recoverable under our insurance policies could seriously impairour business and financial condition. Our current insurance does notspecifically cover property loss or business interruption due to earthquakedamage.

 

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**RisksRelated to Ownership of Our Common Stock**

 

***Our stock price may be extremelyvolatile, and your investment in our common stock could suffer a decline invalue.****

 

You should consider an investment in our common stock risky and investonly if you can withstand a significant loss and wide fluctuations in themarket value of your investment. Investors who purchase our common stock maynot be able to sell their shares at or above the purchase price. Securitiesmarket prices for securities of biopharmaceutical companies have been highlyvolatile. In addition, the volatility of biopharmaceutical company stocks oftendoes not correlate to the operating performance of the companies represented bysuch stocks. Some of the factors that may cause the market price of our commonstock to fluctuate include:

 

·      announcements regarding thesufficiency of our cash resources and the ongoing exploration of the strategicalternatives available to us;

 

·      adverse results or delays inour clinical trials;

 

·      the timing or delay ofachievement of our clinical, regulatory, partnering and other milestones, suchas the commencement of clinical development, the completion of a clinicaltrial, the receipt of regulatory approval or the establishment or terminationof a commercial partnership for one or more of our product candidates;

 

·      announcement of FDA approvalor non-approval of our product candidates or delays in the FDA review process;

 

·      actions taken by regulatoryagencies with respect to our product candidates, our clinical trials or oursales and marketing activities;

 

·      the commercial success ofany product approved by the FDA or its foreign counterparts;

 

·      regulatory developments inthe United States and foreign countries;

 

·      changes in the structure ofhealthcare payment systems;

 

·      any intellectual propertyinfringement lawsuit involving us;

 

·      announcements oftechnological innovations or new products by us or our competitors;

 

·      market conditions for thebiotechnology or pharmaceutical industries in general;

 

·      changes in financialestimates or recommendations by securities analysts;

 

·      sales of large blocks of ourcommon stock;

 

·      sales of our common stock byour executive officers, directors and significant stockholders;

 

·      direct sales of our commonstock through our Sales Agreement with MLV and Wm Smith or other financingarrangements;

 

·      Borrowing of funds under newor existing loan facilities;

 

·      restatements of ourfinancial results and/or material weaknesses in our internal controls; and

 

·      the loss of any of our keyscientific or management personnel.

 

The stock markets in general, and the markets for biotechnology stocksin particular, have experienced extreme volatility and price and volumefluctuations that have often been unrelated or disproportionate to theoperating performance of particular companies. These broad market and industryfactors may seriously harm the market price of our common stock, regardless ofour operating performance. In the past, class action litigation has often beeninstituted against companies whose securities have experienced periods ofvolatility in market price. Any such litigation brought against us could resultin substantial costs, which would hurt our financial condition and results ofoperations, divert management’s attention and resources, and possibly delay ourclinical trials or commercialization efforts.

 

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***Fluctuations in our operatingresults could cause our stock price to decline.***

 

The following factors are likely to result in fluctuations of ouroperating results from quarter to quarter and year to year:

 

·      fluctuations in our expensesbased on adjustments in light of our limited cash resources;

 

·      adverse results or delays inour clinical trials;

 

·      the timing or delay ofachievement of our clinical, regulatory, partnering and other milestones, suchas the commencement of clinical development, the completion of a clinicaltrial, the receipt of regulatory approval or the establishment or terminationof a commercial partnership for one or more of our product candidates;

 

·      announcement of FDA approvalor non-approval of our product candidates or delays in the FDA review process;

 

·      actions taken by regulatoryagencies with respect to our product candidates, our clinical trials or oursales and marketing activities;

 

·      the commercial success ofany product approved by the FDA or its foreign counterparts;

 

·      regulatory developments inthe United States and foreign countries;

 

·      changes in the structure ofhealthcare payment systems;

 

·      any intellectual propertyinfringement lawsuit involving us; and

 

·      announcements oftechnological innovations or new products by us or our competitors.

 

Because of these potential fluctuations in our operating results, aperiod-to-period comparison of our results of operations may not be a goodindication of our future performance. In any particular financial period theactual or anticipated fluctuations could be below the expectations ofsecurities analysts or investors and our stock price could decline.

 

***If we fail to regain compliance withthe listing requirements of The NASDAQ Global Market, our common stock may bedelisted and the price of our common stock and our ability to access thecapital markets could be negatively impacted.****

 

Our common stock is currently listed on The NASDAQ Global Market. Weannounced on April 9, 2010 that we had received a letter, dated April 5,2010, from the Listing Qualifications Department of The NASDAQ Stock Market(the “Staff”) notifying us that, for the last 30 consecutive business days, themarket value of our listed securities had been below the minimum $50.0 millionrequirement for continued inclusion on The NASDAQ Global Market pursuant toNASDAQ Listing Rules (the “Market Cap Requirement”). In accordance withNASDAQ Listing Rules, we were given 180 calendar days, or until October 4,2010, to regain compliance. On October 5, 2010, we received a secondletter from the Staff notifying us of its determination that we had failed toregain compliance with the Market Cap Requirement by October 4, 2010 andthat our common stock will be delisted from the NASDAQ Global Market on October 14,2010 unless we request an appeal of this determination. Subsequently, we didrequest such a hearing before a NASDAQ panel. Our securities will remain listedon The NASDAQ Global market pending a decision by the Panel following thehearing. There can be no assurance that the results of our hearing will besuccessful.

 

We announced on June 1, 2010 that we had received a letter, datedMay 25, 2010, from the Listing Qualifications Department of The NASDAQStock Market notifying us that, for the last 30 consecutive business days, thebid price of our common stock had closed below the minimum $1.00 per sharerequirement for continued inclusion on The NASDAQ Global Market pursuant toNASDAQ Listing Rules. In accordance with NASDAQ Listing Rules, we have beengiven 180 calendar days, or until November 22, 2010, to regain compliance.To regain compliance, the bid price for our common stock must close at $1.00 ormore for a minimum of 10 consecutive business days at any time prior toNovember 22, 2010. If we do not demonstrate compliance by November 22,2010, the NASDAQ Listing Qualifications Department will provide writtennotification to us that our common stock may be delisted. At that time, we mayeither apply for listing on The NASDAQ Capital Market, provided we meet thecontinued listing requirements of that market in accordance with NASDAQ ListingRules, or appeal the decision to the Panel. In the event of an 

 

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appeal,our securities would remain listed on The NASDAQ Global Market pending adecision by the Panel following a hearing. There can be no assurance that, ifwe do appeal a delisting determination to the Panel, that such appeal would besuccessful.

 

We announced on July 8, 2010 that we had received a letter, dated July 2,2010, from the Listing Qualifications Department of The NASDAQ Stock Marketnotifying us that, for the last 30 consecutive business days, the market valueof our publicly held shares has been below the minimum $15.0 millionrequirement for continued inclusion on The NASDAQ Global Market pursuant toNASDAQ Listing Rules.  In accordance withNASDAQ Listing Rules, we have been given 180 calendar days, or until December 28,2010, to regain compliance. To regain compliance, the market value of ourpublicly held shares must close at $15.0 million or more for a minimum of 10consecutive business days at any time prior to December 28, 2010.  If we do not demonstrate compliance by December 28,2010, the NASDAQ Listing Qualifications Department will provide writtennotification to us that our common stock may be delisted.  At that time, we may either apply for listingon The NASDAQ Capital Market, provided we meet the continued listing requirementsof that market in accordance with NASDAQ Listing Rules, or appeal the decisionto the Panel.  In the event of an appeal,our securities would remain listed on The NASDAQ Global Market pending adecision by the Panel following a hearing. There can be no assurance that, if we do appeal a delistingdetermination to the Panel, that such an appeal would be successful.

 

If we fail to regain compliance with the listing standards of TheNASDAQ Global Market, we may consider transferring to The NASDAQ Capital Market,provided we meet the transfer criteria, which is a lower tier market, or ourcommon stock may be delisted and traded on the over-the-counter bulletin boardnetwork. Moving our listing to The NASDAQ Capital Market could adversely affectthe liquidity of our common stock. If our common stock were to be delisted byNASDAQ, we could face significant material adverse consequences, including:

 

·      a limited availability ofmarket quotations for our common stock;

 

·      a reduced amount of news andanalyst coverage for us;

 

·      a decreased ability to issueadditional securities or obtain additional financing in the future;

 

·      reduced liquidity for ourstockholders;

 

·      potential loss of confidenceby collaboration partners and employees; and

 

·      loss of institutional investorinterest.

 

***Because a small number of existingstockholders own a large percentage of our voting stock, they may be able tocontrol our management and operations, acting in their best interests and notnecessarily those of other stockholders.****

 

Based on our outstanding shares as of September 30, 2010 (whichexcludes any shares of common stock issuable upon exercise of warrants andoptions outstanding on such date), our executive officers, directors andholders of 5% or more of our outstanding common stock beneficially ownedapproximately 31% of our common stock. As a result, these stockholders, actingtogether, may be able to significantly influence any matters requiring approvalby our stockholders, including the election of directors and the approval ofmergers or other business combination transactions. The interests of this groupof stockholders may not always coincide with our interests or the interests ofother stockholders. The significant concentration of stock ownership mayadversely affect the trading price of our common stock due to the perceptionthat conflicts of interest may exist or arise.

 

***Anti-takeover provisions in ourcharter documents and under Delaware law could make an acquisition of us, whichmay be beneficial to our stockholders, more difficult and may prevent attemptsby our stockholders to replace or remove our current management.***

 

Provisions in our certificate of incorporation and our bylaws may delayor prevent an acquisition of us, a change in our management or other changesthat stockholders may consider favorable. These provisions include:

 

·      a classified board ofdirectors;

 

·      a prohibition on actions byour stockholders by written consent;

 

·      the ability of our board ofdirectors to issue preferred stock without stockholder approval, which could beused to adopt a stockholders’ rights plan that would make it difficult for athird party to acquire us;

 

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·      notice requirements fornominations for election to the board of directors; and

 

·      limitations on the removalof directors.

 

Moreover, we are governed by the provisions of Section 203 of theDelaware General Corporation Law, which prohibits a person who owns in excessof 15% of our outstanding voting stock from merging or combining with us for aperiod of three years after the date of the transaction in which the personacquired in excess of 15% of our outstanding voting stock, unless the merger orcombination is approved in a prescribed manner.

 

***Future sales of our common stock inthe public market could cause our stock price to drop substantially.***

 

Sales of a substantial number of shares of our common stock in thepublic market, or the perception that these sales might occur, could depressthe market price of our common stock and could impair our ability to raisecapital through the sale of additional equity securities.

 

As of September 30, 2010, we had 33,461,975 shares of common stockoutstanding, which excludes any shares of common stock issuable upon exerciseof warrants and options outstanding as of such date. The shares outstanding arefreely tradable without restriction in the public market unless held by anaffiliate of ours. Shares held by our affiliates are eligible for sale in thepublic market either in accordance with an effective resale registrationstatement with the Securities and Exchange Commission or pursuant to the volumelimitations and manner of sale requirements under Rule 144. Any commonstock that is either subject to outstanding options or warrants or reserved forfuture issuance under our 2001 Equity Incentive Plan, 2007 Equity IncentivePlan, 2007 Non-Employee Directors’ Stock Option Plan and 2007 Employee StockPurchase Plan could also become eligible for sale in the public market to theextent permitted by the provisions of various vesting agreements, andRules 144 and 701 under the Securities Act. If these additional shares aresold, or if it is perceived that they will be sold, in the public market, thetrading price of our common stock could decline.

 

Certainof our affiliates have rights with respect to registration of a significantnumber of our shares of common stock under the Securities Act. If such holders,by exercising their registration rights, cause a large number of securities tobe sold in the public market, these sales could have an adverse effect on themarket price for our common stock and may impair our ability to raiseadditional capital. In addition, as of October 31, 2010, we have filedfour registration statements on Form S-8 under the Securities Act toregister up to an aggregate of 6,430,173 shares of our common stock forissuance under our stock option and employee stock purchase plans, and intendto file additional registration statements on Form S-8 to register theshares automatically added each year to the share reserves under these plans.

 

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

 

We issued and sold Notes in the principal amount of up to $4.0 millionand warrants to purchase an aggregate of 2,000,000 shares of our common stockin the two tranches of the Bridge Financing on August 13, 2010 and September 30,2010.

 

The Notes accrue interest at a continuously compounding rate of 12.0%per annum.  Unless earlier paid pursuantto the terms of the Bridge Financing or accelerated in connection with an eventof default, we will make interest only payments through December 31, 2010,followed by 24 equal monthly payments of principal and interest through January 1,2013.  In the event we sell any or all ofour assets or enter into certain strategic transactions, we may be required torepay the promissory notes at an earlier date under the terms of the BridgeFinancing. The warrants had a purchase price of $0.0125 per underlying share ofcommon stock and are exercisable for a term of five years from the date ofissuance at an exercise price of $0.50 per share.

 

The Notes and warrants wereoffered and sold in a private placement to certain accredited investors withoutregistration under the Securities Act of 1933, as amended, or state securitieslaws, in reliance on the exemptions provided by Section 4(2) of theSecurities Act of 1933, as amended, and Regulation D promulgated thereunder andin reliance on similar exemptions under applicable state laws. Accordingly, thepromissory notes and the warrants have not been registered under the SecuritiesAct of 1933, as amended, and until so registered, these securities may not beoffered or sold in the United States absent registration or availability of anapplicable exemption from registration. On October 12, 2010 we filed aregistration statement registering for resale the shares of common stockissuable upon the exercise of the warrants pursuant to the terms of theregistration rights agreement we entered into with the Bridge Investors.

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 4. (REMOVED AND RESERVED)**

 

None.

 

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**ITEM 5. OTHER INFORMATION**

 

Notapplicable.

 

**ITEM 6. EXHIBITS**

 

Alist of exhibits filed with this report or incorporated herein by reference isfound in the Exhibit Index immediately following the signaturepage of this report.

 

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**SIGNATURE**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

Dated:November 15, 2010

 

 
| ** ** | **ARYx  Therapeutics, Inc.** |
|------------|-----------------------------------|
|       |                              |
|       |                              |   |
|       | By:                               | /s/  John Varian |
|       |                              | John  Varian |
| * *   | * *                          | *Chief  Operating Officer and Chief Financial Officer* |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description of Document**                                                                                                                                                  |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                   |
| 3.2(1)              |       | Amended  and Restated Certificate of Incorporation.                                                                                                                                    |
|                |       |                                                                                                                                                                                   |
| 3.3(1)              |       | Bylaws.                                                                                                                                                                                |
|                |       |                                                                                                                                                                                   |
| 4.1                 |       | Reference  is made to Exhibit 3.2 and 3.3 above.                                                                                                                                  |
|                |       |                                                                                                                                                                                   |
| 4.2(1)              |       | Specimen  Common Stock Certificate.                                                                                                                                                    |
|                |       |                                                                                                                                                                                   |
| 4.3(1)              |       | Form of  Warrant to purchase shares of Series C preferred stock, issued  September 3, 2003.                                                                             |
|                |       |                                                                                                                                                                                   |
| 4.4(1)              |       | Form of  Warrant to purchase shares of Series C preferred stock, issued  December 23, 2002.                                                                             |
|                |       |                                                                                                                                                                                   |
| 4.5(1)              |       | Form of  Warrant to purchase shares of Series D preferred stock, issued  March 28, 2005.                                                                                |
|                |       |                                                                                                                                                                                   |
| 4.6(1)              |       | Amended  and Restated Investor Rights Agreement by and between the registrant and  certain of its security holders.                                                                    |
|                |       |                                                                                                                                                                                   |
| 4.7(1)              |       | Form of  Warrant to purchase shares of Series E preferred stock, issued  October 19, 2007.                                                                              |
|                |       |                                                                                                                                                                                   |
| 4.8(2)              |       | Form of  Warrant to purchase shares of common stock, issued October 17, 2008 to  Lighthouse.                                                                                 |
|                |       |                                                                                                                                                                                   |
| 4.9(3)              |       | Registration  Rights Agreement by and between the registrant and the investors identified  on the signature pages thereto, dated November 11, 2008.                          |
|                |       |                                                                                                                                                                                   |
| 4.10(3)             |       | Form of  Warrant to purchase shares of common stock, issued November 11, 2008 to  several purchasers.                                                                        |
|                |       |                                                                                                                                                                                   |
| 4.11(4)             |       | Form of  Warrant to purchase shares of common stock, issued December 31, 2008 to  Oxford Financial Corporation.                                                              |
|                |       |                                                                                                                                                                                   |
| 4.12(5)             |       | Registration  Rights Agreement by and between the registrant and Commerce Court Small Cap  Value Fund Ltd., dated October 6, 2009.                                                |
|                |       |                                                                                                                                                                                   |
| 4.13(6)             |       | Form of  Warrant to purchase shares of common stock, issued August 13, 2010 and  September 30, 2010 to several investors.                                               |
|                |       |                                                                                                                                                                                   |
| 10.1(67)            |       | Secured  Note and Warrant Purchase Agreement, dated August 13, 2010, by and among  the registrant and the investors identified on the signature  pages thereto.              |
|                |       |                                                                                                                                                                                   |
| 10.2(7)*            |       | Security  Agreement, dated August 13, 2010, by and among the registrant and the  investors identified on the signature pages thereto.                                        |
|                |       |                                                                                                                                                                                   |
| 10.3(7)             |       | Intellectual  Property Security Agreement, dated August 13, 2010, by and among the  registrant and the investors identified on the signature pages thereto.                  |
|                |       |                                                                                                                                                                                   |
| 10.4(7)             |       | Registration  Rights Agreement, dated August 13, 2010, by and among the registrant and  the investors identified on the signature pages thereto.                             |
|                |       |                                                                                                                                                                                   |
| 10.5(7)             |       | Amendment  No. 8 to Loan and Security Agreement, dated August 13, 2010, by and  between the registrant and Lighthouse Capital Partners V, L.P.                               |
|                |       |                                                                                                                                                                                   |
| 10.6(7)             |       | Intellectual  Property Security Agreement, dated August 13, 2010, by and between the  registrant and Lighthouse Capital Partners V, L.P.                                          |
|                |       |                                                                                                                                                                                   |
| 10.7(7)             |       | Intercreditor  Agreement, dated August 13, 2010, by and among Lighthouse Capital  Partners, the registrant and the other parties identified on the signature  pages thereto. |
|                |       |                                                                                                                                                                                   |
| 31.1                |       | Certification  of the Chief Executive Officer pursuant to Rule 13a-14(a) and  Rule 15d-14(a) of the Securities Exchange Act, as amended.                           |

 

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| 31.2   |   | Certification  of the Chief Financial Officer pursuant to Rule 13a-14(a) and  Rule 15d-14(a) of the Securities Exchange Act, as amended.                      |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                              |
| 32.1   |   | Certification  of the Chief Executive Officer and Chief Financial Officer pursuant to  18U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002. |

 

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*      Indicates managementcontract, compensatory plan or arrangement.

 

(1)   Previously filed as the likenumbered exhibit to registrant’s Registration Statement on Form S-1(No. 333-145813), initially filed with the Securities and ExchangeCommission on August 30, 2007, as amended, and incorporated by referenceherein.

 

(2)   Previously filed as thelike-numbered exhibit to registrant’s Current Report on Form 8-K (FileNo. 001-33782), filed with the SEC on October 23, 2008 andincorporated herein by reference.

 

(3)   Previously filed as thelike-numbered exhibit to registrant’s Current Report on Form 8-K (FileNo. 001-33782), filed with the SEC on November 12, 2008 andincorporated herein by reference.

 

(4)   Previously filed as the likenumbered exhibit to registrant’s Annual Report on Form 10-K (FileNo. 001-33782), filed with the SEC on March 27, 2009 and incorporateherein by reference.

 

(5)   Previously filed as thelike-numbered exhibit to registrant’s Current Report on Form 8-K (FileNo. 001-33782), filed with the SEC on October 8, 2009 andincorporated herein by reference.

 

(6)   Previously filed as Exhibit 4.1to registrant’s Current Report on Form 8-K (File No. 001-33782),filed with the SEC on August 16, 2010 and incorporated herein byreference.

 

(7)   Previously filed as thelike-numbered exhibit to registrant’s Current Report on Form 8-K (File No. 001-33782),filed with the SEC on August 16, 2010 and incorporated herein byreference.

 

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