Table ofContents

 

 

 

**UNITED STATES**

**SECURITIES AND 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 June 30, 2009.**                                                                                                                                   |
| ** ** | ** ** | ** **                                                                                                                                                                                |
| **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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**ARYx THERAPEUTICS, INC.**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                  | ** ** | **77-0456039**                      |
|---------------------------------------------------------------|------------|-------------------------------------|
| (State or Other Jurisdiction ofIncorporation or Organization) |       | (I.R.S. EmployerIdentification No.) |

 

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

(Address ofPrincipal Executive Offices including zip code)

 

**(510) 585-2200**

(Registrant’sTelephone Number, Including Area Code)

 

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

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submitand post such files).  Yes o  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of 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 |

 

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

 

As of July 31, 2009,the registrant had 27,448,530 shares of common stock outstanding.

 

 

 

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**ARYxTHERAPEUTICS, INC.**

 

**FORM 10-QFOR THE QUARTER ENDED JUNE 30, 2009**

 

**INDEX**

** **
| ** **                                                                                                       | ** **                                                                                  | **Page**   |
|------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|------------|
| **PART I — FINANCIAL INFORMATION**                                                                     | ** **                                                                                  |
| ** **                                                                                                       | ** **                                                                                  | ** ** |
| Item 1.                                                                                                          | Financial Statements                                                                        |       |
| Condensed Consolidated  Balance Sheets as of June 30, 2009 and December 31, 2008                       | 2                                                                                           |
| Condensed Consolidated  Statements of Operations for the three and six months ended June 30,  2009 and 2008 | 3                                                                                           |
| Condensed Consolidated  Statements of Cash Flow for the six months ended June 30, 2009 and 2008             | 4                                                                                           |
| Notes to Condensed Consolidated Financial Statements                                                             | 5                                                                                           |
| Item 2.                                                                                                          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 12         |
| Item 3.                                                                                                          | Quantitative  and Qualitative Disclosures About Market Risk                                 | 20         |
| Item 4T.                                                                                                         | Controls and  Procedures                                                                    | 20         |
|                                                                                                             |                                                                                        |       |
| **PART II  — OTHER INFORMATION**                                                                       | ** **                                                                                  |
| Item 1.                                                                                                          | Legal Proceedings                                                                           | 21         |
| Item 1A.                                                                                                         | Risk Factors                                                                                | 21         |
| Item 2.                                                                                                          | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 42         |
| Item 3.                                                                                                          | Defaults  Upon Senior Securities                                                            | 42         |
| Item 4.                                                                                                          | Submission  of Matters to a Vote of Security Holders                                        | 42         |
| Item 5.                                                                                                          | Other Information                                                                           | 42         |
| Item 6.                                                                                                          | Exhibits                                                                                    | 42         |
|                                                                                                             |                                                                                        |       |
| SIGNATURE                                                                                                        | 43                                                                                          |

 

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**PART I — FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS**

 

**ARYxTHERAPEUTICS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Inthousands)**

 
| ** **                                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                       | ** ** | **(unaudited)**   | ** ** | **(Note 1)**          | ** ** |
| **ASSETS**                                       |       |              |       |                  |       |
| Current  assets:                                 |       |              |       |                  |       |
| Cash  and cash equivalents                       |       | $                 | 11,933     |                  | $          | 35,999 |   |
| Marketable  securities                           |       | 10,306            |       | 8,588                 |       |
| Restricted  cash - current                       |       | 150               |       | 150                   |       |
| Prepaid  research and development expenses       |       | 270               |       | 381                   |       |
| Other  prepaid, receivable, and current assets   |       | 503               |       | 732                   |       |
| Total  current assets                            |       | 23,162            |       | 45,850                |       |
| Restricted  cash                                 |       | 1,203             |       | 1,203                 |       |
| Property  and equipment, net                     |       | 2,726             |       | 3,198                 |       |
| Other  assets                                    |       | 773               |       | 897                   |       |
| **Total assets**                                 |       | $                 | 27,864     |                  | $          | 51,148 |   |
|                                             |       |              |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**    |       |              |       |                  |       |
| Current  liabilities:                            |       |              |       |                  |       |
| Accounts  payable                                |       | $                 | 314        |                  | $          | 2,454 |   |
| Accrued  compensation                            |       | 640               |       | 494                   |       |
| Accrued  research and development expenses       |       | 1,014             |       | 3,832                 |       |
| Current  portion of notes payable                |       | 7,459             |       | 3,404                 |       |
| Other  accrued liabilities                       |       | 703               |       | 835                   |       |
| Total  current liabilities                       |       | 10,130            |       | 11,019                |       |
| Deferred  lease credit                           |       | 1,247             |       | 1,436                 |       |
| Notes  payable                                   |       | 7,127             |       | 11,278                |       |
| Commitments  and contingencies                   |       |              |       |                  |       |
| Stockholders’  equity:                      |       |              |       |                  |       |
| Common  stock                                    |       | 27                |       | 27                    |       |
| Additional  paid-in capital                      |       | 182,498           |       | 181,285               |       |
| Accumulated  other comprehensive income          |       | 7                 |       | 45                    |       |
| Accumulated  deficit                             |       | (173,172          | )          | (153,942              | )          |
| Total  stockholders’ equity                 |       | 9,360             |       | 27,415                |       |
| Total  liabilities and stockholders’ equity |       | $                 | 27,864     |                  | $          | 51,148 |   |

 

The accompanying notesare an integral part of these financial statements.

 

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**ARYxTHERAPEUTICS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Inthousands, except per share amounts)**

**(Unaudited)**

 
| ** **                                                                    | ** ** | **For the three months ended** | ** ** | **For the six months ended** | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                                                                    | ** ** | **June 30,**              | ** ** | **June 30,**            | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                                                    | ** ** | **2009**                       | ** ** | **2008**                     | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenue:                                                                      | ** ** | ** **                     | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Collaboration  services                                                       |       | $                              | —     |                         | $          | 164 |   | $ | — |   | $ | 232 |   |
| Technology  license fees                                                      |       | —                         |       | 974                          |       | — |   | 1,948 |   |
| Total  revenue                                                                |       | —                         |       | 1,138                        |       | — |   | 2,180 |   |
|                                                                          |       |                           |       |                         |       |   |   |   |   |
| Costs  and expenses:                                                          |       |                           |       |                         |       |   |   |   |   |
| Cost  of collaboration services                                               |       | —                         |       | 164                          |       | — |   | 232 |   |
| Research  and development                                                     |       | 6,271                          |       | 10,045                       |       | 13,060 |   | 17,645 |   |
| Selling,  general and administrative                                          |       | 2,622                          |       | 2,664                        |       | 5,225 |   | 5,596 |   |
| Total  costs and expenses                                                     |       | 8,893                          |       | 12,873                       |       | 18,285 |   | 23,473 |   |
| Loss  from operations                                                         |       | (8,893                         | )          | (11,735                      | )          | (18,285 | ) | (21,293 | ) |
|                                                                          |       |                           |       |                         |       |   |   |   |   |
| Interest  and other income, net                                               |       | 11                             |       | 308                          |       | 65 |   | 857 |   |
| Interest  expense                                                             |       | (496                           | )          | (469                         | )          | (996 | ) | (963 | ) |
| Other-than-temporary  loss on investments                                     |       | (14                            | )          | —                       |       | (14 | ) | — |   |
| Net  loss                                                                     |       | (9,392                         | )          | (11,896                      | )          | (19,230 | ) | (21,399 | ) |
|                                                                          |       |                           |       |                         |       |   |   |   |   |
| Basic  and diluted net loss per share                                         |       | $                              | (0.34      | )                            | $          | (0.67 | ) | $ | (0.70 | ) | $ | (1.21 | ) |
| Weighted  average shares used to compute basic and diluted net loss per share |       | 27,374                         |       | 17,641                       |       | 27,359 |   | 17,636 |   |

 

The accompanying notesare an integral part of these financial statements.

 

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**ARYxTHERAPEUTICS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **For the six months ended** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                   | ** ** | **June 30,**            | ** ** | **June 30,** | ** ** |
| ** **                                                                   | ** ** | **2009**                     | ** ** | **2008** | ** ** |
| **Cash flows from operating activities:**                                    | ** ** | ** **                   | ** ** | ** ** | ** ** |
| Net  loss                                                                    |       | $                            | (19,230    | ) | $ | (21,399 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |       |                         |       |   |   |
| Depreciation                                                                 |       | 549                          |       | 545 |   |
| Amortization  of premium on marketable securities                            |       | 87                           |       | 20 |   |
| Amortization  of warrants                                                    |       | 109                          |       | 214 |   |
| Impairment  losses                                                           |       | 26                           |       | — |   |
| Stock-based  compensation                                                    |       | 1,161                        |       | 1,137 |   |
| Change  in assets and liabilities:                                           |       |                         |       |   |   |
| Prepaid  research and development expenses                                   |       | 111                          |       | (739 | ) |
| Other  prepaid, receivable, and assets                                       |       | 229                          |       | 136 |   |
| Accounts  payable and other accrued liabilities                              |       | (2,461                       | )          | (1,309 | ) |
| Accrued  compensation                                                        |       | 146                          |       | (325 | ) |
| Accrued  research and development expenses                                   |       | (2,818                       | )          | 1,423 |   |
| Deferred  revenue                                                            |       | —                       |       | (1,953 | ) |
| Net  cash used in operating activities                                       |       | (22,091                      | )          | (22,250 | ) |
|                                                                         |       |                         |       |   |   |
| **Cash flows from investing activities:**                                    |       |                         |       |   |   |
| Purchases  of marketable securities                                          |       | (9,842                       | )          | (13,232 | ) |
| Proceeds  from sales of marketable securities                                |       | —                       |       | 3,475 |   |
| Proceeds  from maturities of marketable securities                           |       | 8,000                        |       | 4,390 |   |
| Increase  in restricted cash                                                 |       | —                       |       | (300 | ) |
| Purchases  of fixed assets                                                   |       | (89                          | )          | (556 | ) |
| Net  cash used in investing activities                                       |       | (1,931                       | )          | (6,223 | ) |
|                                                                         |       |                         |       |   |   |
| **Cash flows from financing activities:**                                    |       |                         |       |   |   |
| Proceeds  from exercise of stock options and issuance of common stock        |       | 144                          |       | 44 |   |
| Offering  cost in connection with placement of equity                        |       | (92                          | )          | — |   |
| Proceeds  from issuance of notes payable                                     |       | —                       |       | 9,000 |   |
| Principal  payments on notes payable                                         |       | (96                          | )          | (1,511 | ) |
| Net  cash (used in) provided by financing activities                         |       | (44                          | )          | 7,533 |   |
|                                                                         |       |                         |       |   |   |
| **Net decrease in cash and cash equivalents**                                |       | (24,066                      | )          | (20,940 | ) |
| Cash  and cash equivalents at beginning of period                            |       | 35,999                       |       | 55,476 |   |
| **Cash and cash equivalents at end of period**                               |       | $                            | 11,933     |   | $ | 34,536 |   |

 

The accompanying notesare an integral part of these financial statements.

 

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**ARYxTHERAPEUTICS, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

In this 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**

 

***TheCompany***

 

ARYx is abiopharmaceutical company focused on developing a portfolio of internallydiscovered product candidates designed to eliminate known safety issuesassociated with well-established, commercially successful drugs. We use ourRetroMetabolic Drug Design technology to design structurally unique moleculesthat retain the efficacy of these original drugs but are metabolized through apotentially safer pathway to avoid specific adverse side effects associatedwith these compounds. Our product candidate portfolio includes: an oralantiarrhythmic agent, budiodarone (ATI-2042), designed to have the efficacy ofamiodarone, in Phase 2b clinical development for the treatment of atrialfibrillation, a form of irregular heartbeat; an oral anticoagulant, tecarfarin(ATI-5923), designed to have the same therapeutic benefits as warfarin, inPhase 2/3 clinical development for the treatment of patients who are atrisk for the formation of dangerous blood clots; an oral prokinetic agent,ATI-7505, designed to have the same therapeutic benefits as cisapride, inPhase 2b clinical development for the treatment of chronic constipation,gastroparesis, functional dyspepsia, irritable bowel syndrome withconstipation, and gastroesophageal reflux disease; and, a novel,next-generation atypical antipsychotic agent, ATI-9242, currently inPhase 1 clinical testing for the treatment of schizophrenia and otherpsychiatric disorders. Additionally, we have several product candidates inpreclinical development.

 

We wereincorporated in the State of California on February 28, 1997 andreincorporated in the State of Delaware on August 29, 2007. We maintain awholly-owned subsidiary, ARYx Therapeutics Limited, with registered offices inthe United Kingdom, which has had no operations since its inception in September 2004and was established to serve as a legal entity in support of our clinical trialactivities conducted in Europe. We operate in a single business segment withregard to the development of human pharmaceutical products.

 

***Basisof Presentation***

 

The accompanyingunaudited condensed consolidated financial statements include the accounts ofour wholly-owned subsidiary, ARYx Therapeutics, Ltd. All intercompanyaccounts and transactions have been eliminated. These unaudited condensedconsolidated financial statements have been prepared in accordance with U.S.generally accepted accounting principles, or U.S. GAAP, for interim financialinformation on the same basis as the annual financial statements and withinstructions to Form 10-Q and Rule 10-01 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby generally accepted accounting principles for complete financial statements.These interim financial statements include all adjustments (consisting only ofnormal recurring adjustments) that management believes are necessary for thefair presentation of the balances and results for the periods presented.Interim financial results are not necessarily indicative of results to beexpected for the full fiscal year or any future interim period.

 

The balance sheet data atDecember 31, 2008 has been derived from our audited consolidated financialstatements for the year ended December 31, 2008, contained in our AnnualReport on Form 10-K. The unaudited condensed consolidated financialstatements and related disclosures contained in this report have been preparedwith the presumption that users of the interim financial statements have reador have access to our audited financial statements for the preceding year.Accordingly, these interim financial statements should be read in conjunctionwith our audited financial statements and notes thereto for the year ended December 31,2008, contained in our Annual Report on Form 10-K.

 

We have evaluatedsubsequent events for recognition or disclosure through August 13, 2009,the date on which the accompanying unaudited condensed consolidated financialstatements being presented were issued as part of this Quarterly Report on Form 10-Q,and not beyond that date.

 

***Need to Raise Additional Capital***

 

As of June 30, 2009,we had $22.6 million in cash, cash equivalents and marketable securities.While our cash resources as of June 30, 2009 are less than the amountneeded for us to maintain our current operations for the next 12 months, webelieve that our cash, cash equivalents and marketable securities on hand willbe sufficient to fund our operations through the end of the first quarter of2010. Since our inception, we have incurred significant net operating lossesand, as of June 30, 2009, we had an accumulated deficit of $173.2 million.We have generated no revenue from product sales to date. We have funded ouroperations principally from the sale of our convertible preferred and commonstock, through collaboration agreements and debt financing.

 

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Our level of capitalresources as of June 30, 2009 could raise doubt about our ability tocontinue to fund our operations at current levels and meet our obligations asthey become due. Our ability to continue operations is dependent upon ourability to obtain substantial additional capital to continue our research anddevelopment programs and to bring any potential future products to market. Inorder to satisfy our projected cash needs for at least the next 12 months, weare considering various options that may be available to us, including enteringinto collaborative arrangements for one or more of our product candidates,public or private equity financings, debt financing or a combination of theaforementioned. However, there is no assurance that we will be able to raiseadditional capital on terms acceptable to us or at all. Furthermore, anyadditional equity financings may be dilutive to our stockholders and debtfinancing, if available to us on acceptable terms or at all, may involvecovenants that place substantial restrictions on our business. If we fail toraise sufficient capital as and when needed, we have developed contingencyplans that may require us to delay, reduce the scope of, or eliminate one ormore of our research and development programs, partner one or more of ourproduct candidates at an earlier stage of development than we might otherwisechoose, or to reduce personnel and related costs and other discretionary expendituresthat are within our control. Even assuming we successfully raise additionalcapital, there can be no assurance that we will achieve positive cash flow inthe foreseeable future, or at all.

 

The accompanyingcondensed consolidated financial statements have been prepared assuming we willcontinue to operate as a business, which contemplates the realization of assetsand the settlement of liabilities in the normal course of business for theforeseeable future. Our condensed consolidated financial statements do notinclude any adjustments to reflect the possible future effects on therecoverability and classification of assets or the amounts and classificationof liabilities that may result from uncertainty related to our ability tocontinue to operate as a business, which may be necessary should we reach apoint when we are unable to continue with our operations.

 

***Useof Estimates***

 

Thepreparation of financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make judgments, assumptions andestimates that affect the reported amounts in the consolidated financialstatements and accompanying notes. On an ongoing basis, we evaluate ourcritical accounting policies and estimates, including those related to clinicaltrial accruals and stock-based compensation. Management bases its estimates onhistorical experience and on assumptions believed to be reasonable under thecircumstances. Actual results could differ from those estimates.

 

***FairValue of Financial Instruments***

 

Our financial instruments consist principally of cash and cashequivalents, marketable securities, restricted cash, and certain other assetssuch as our long-term marketable securities holding of a single auction rateinstrument, accounts payable, accrued liabilities, and current and non-currentnotes payable. The fair value of our financial instruments reflects theestimated amounts that would be received upon the sale of an asset or thetransfer of a liability in an orderly transaction between market participantsat the measurement date. The fair value estimates presented throughout thisreport reflect the information available to us or estimates we used as of June 30,2009 and December 31, 2008.

 

Cash, cash equivalents and restricted cash are stated at cost, whichapproximates fair value. We consider all highly liquid investments purchasedwith an original maturity of three months or less to be cash equivalents.

 

Marketable securities are classified as available-for-sale and arecarried at their fair value at the balance sheet date (See Note 2—FairValue Measurement). Our marketable securities portfolio may include U.S.government obligations, government agency securities, corporate bonds,certificates of deposit, commercial paper, and auction rate securities withoriginal maturities beyond three months.

 

Accounts payable, accrued liabilities and the current portion of notespayable are carried at cost and amortized cost, respectively, that approximatefair value due to their expected short maturities. Based on the borrowing ratesavailable to us for loans with similar terms and average maturities, we employa discounted cash flow model using our estimate of risk premiums andcorresponding yields to maturity to determine the fair value of our non-currentportion of notes payable. The fair value was estimated to be $6.0 millionand $9.3 million as of June 30, 2009 and December 31, 2008,respectively, assuming transfer in an orderly market transaction. The carryingamount of our non-current portion of notes payable was stated on the face ofour consolidated balance sheet at amortized cost for all periods presented.

 

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***ComprehensiveLoss***

 

Comprehensive loss is comprised of net loss and other comprehensiveincome (loss). The only component of our other comprehensive income (loss) isthe unrealized gains and losses on our marketable securities. Comprehensiveloss for the three months ended June 30, 2009 and 2008 was$9.4 million and $12.0 million, respectively, and for the six monthsended June 30, 2009 and 2008 was $19.3 million and $21.5 million,respectively.

 

***NetLoss 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 antidilutive effect.

 

The following table presents the calculation of basic and diluted netloss per share:

 
| ** **                                                                      | ** ** | **Three Months Ended  June 30,**       | ** ** | **Six Months Ended********June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                      | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                      | ** ** | **(in thousands, except per share amount)** | ** ** |
| *Numerator:*                                                                    |       |                                        |       |                                      |       |   |   |   |   |
| Net loss                                                                        |       | $                                           | (9,392     | )                                         | $          | (11,896 | ) | $ | (19,230 | ) | $ | (21,399 | ) |
| *Denominator:*                                                                  |       |                                        |       |                                      |       |   |   |   |   |
| Weighted average common shares outstanding                                      |       | 27,386                                      |       | 17,668                                    |       | 27,372 |   | 17,664 |   |
| Less: Weighted average unvested restricted common  shares                       |       | (12                                         | )          | (27                                       | )          | (13 | ) | (28 | ) |
| Weighted average shares used in computing basic  and diluted net loss per share |       | 27,374                                      |       | 17,641                                    |       | 27,359 |   | 17,636 |   |
| Basic and diluted net loss per share                                            |       | $                                           | (0.34      | )                                         | $          | (0.67 | ) | $ | (0.70 | ) | $ | (1.21 | ) |

 

***IncomeTaxes***

 

We utilize the liability method of accounting forincome taxes. Under this method, deferred tax assets and liabilities aredetermined based on differences between financial reporting bases and the taxbases of assets and liabilities and are measured using the enacted tax ratesand laws that will be in effect when the differences are expected to reverse.Based on known factors, our management cannot currently conclude that it willbe more likely than not that deferred tax assets will be utilized. Accordingly,deferred tax assets have been fully offset by a valuation allowance.

 

Weelect to classify interest and penalties related to unrecognized tax benefitsas part of our income tax provision, although there have been no such interestor penalties recognized to-date.

 

***RecentAccounting Pronouncements***

 

InApril 2009, the Financial Accounting Standard Board, or FASB, issued threefinal Staff Positions, or FSPs, intended to provide additional applicationguidance and enhance disclosures regarding fair value measurements andimpairments of securities. FSP FAS 157-4, *Determining Fair ValueWhen the Volume and Level of Activity for the Asset or Liability Have SignificantlyDecreased and Identifying Transactions That Are Not Orderly*,provides guidelines for making fair value measurements more consistent with theprinciples presented in FASB Statement No. 157, *Fair ValueMeasurements*, or SFAS 157. It reaffirms the objective of fair valuemeasurement, which is to reflect how much an asset would be sold for in anorderly transaction (as opposed to a distressed or forced transaction) at thedate of the financial statements under current market conditions. FSP FAS 107-1and APB 28-1, *Interim Disclosures About Fair Value ofFinancial Instruments*, relates to fair value disclosures for anyfinancial instruments that are not currently reflected on the balance sheet atfair value. Prior to issuing this FSP, fair values for these assets andliabilities were only disclosed once a year. The FSP now requires thesedisclosures on a quarterly basis to provide qualitative and quantitativeinformation about fair value estimates for all those financial instruments notmeasured on the balance sheet at fair value. FSP FAS 115-2 and FAS 124-2, *Recognition and Presentation of Other-Than-Temporary Impairments*,provides additional guidance designed to bring greater consistency to thetiming of impairment recognition, and provide greater clarity to investorsabout the credit and 

 

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non-credit components ofimpaired debt securities that are not expected to be sold. This FSP alsorequires increased and more timely disclosures regarding expected cash flows,credit losses, and aging of securities with unrealized losses. The FSPs areeffective for interim and annual periods ending after June 15, 2009. Theadoption of the above FSPs did not have a material impact on either ourconsolidated financial position or results of operations.

 

In May 2009, the FASB issued Statement of Financial AccountingStandards No. 165, *Subsequent Events*,or SFAS 165. SFAS 165 is effective on a prospective basis for interim andannual financial periods ending after June 15, 2009. SFAS 165 providesauthoritative guidance largely similar to the current guidance in the auditingliterature with some exceptions that are not intended to result in significantchanges in practice. The modifications to the subsequent events guidance inexisting auditing literature are: (i) to name the two types of subsequentevents either as recognized subsequent events (currently known as Type Isubsequent events) or non-recognized subsequent events (currently known as TypeII subsequent events); (ii) to modify the definition of subsequent eventsto refer to events or transactions that occur after the balance sheet date butbefore the financial statements are issued (for public entities); and (iii) torequire entities to disclose the date through which an entity has evaluatedsubsequent events and the basis for that date. Accordingly, we have adopted SFAS 165 for the interimperiod ended June 30, 2009 and evaluated subsequent events for recognitionor disclosure through August 13, 2009, the date on which the accompanyingunaudited condensed consolidated financial statements being presented wereissued as part of this Quarterly Report on Form 10-Q, and not beyond thatdate.

 

In June 2009,the FASB issued Statement of Financial Accounting Standards No. 168, *The* *FASBAccounting Standards Codification andthe Hierarchy of Generally Accepted Accounting Principles — A Replacement of* *FASBStatement No. 162*, or SFAS 168. The FASB Accounting StandardsCodification, or Codification, will become the source of authoritative U.S.GAAP recognized by the FASB applicable to non-governmental entities. Rules andinterpretive releases of the SEC under authority of federal securities laws arealso sources of authoritative U.S. GAAP for SEC registrants. On the effectivedate of this Statement, the Codification will supersede all then-existingnon-SEC accounting and reporting standards. All other non-grandfathered non-SECaccounting literature not included in the Codification will no longer beauthoritative. SFAS 168 will be effective for us for the nine-month periodending September 30, 2009 and the adoption is not expected to have amaterial effect on either our consolidated financial position or results ofoperations.

 

**2. Fair Value Measurement**

 

Thefollowing tables summarize the fair value of our financial assets as of June 30,2009 and December 31, 2008 that were recorded at fair value on a recurringbasis consistent withthe fair value hierarchy.

 
| ** **                                   | ** ** | **June 30, 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)**     | ** ** |
| Cash and cash equivalents                    |       | $                      | 11,933     |   | $ | 11,330 |   | $ | 603 |   | $ | — |   |
| Marketable securities                        |       | 10,306                 |       | — |   | 10,306 |   | — |   |
| Restricted cash                              |       | 150                    |       | 150 |   | — |   | — |   |
| Total fair value of current financial assets |       | 22,389                 |       | 11,480 |   | 10,909 |   | — |   |
| Restricted cash—non-current             |       | 1,203                  |       | 1,203 |   | — |   | — |   |
| Auction rate securities:                     |       |                   |       |   |   |   |   |   |   |
| Balance as of December 31, 2008         |       | 367                    |       | — |   | — |   | 367 |   |
| Other-than-temporary loss on investments     |       | (14                    | )          | — |   | — |   | (14 | ) |
| Balance as of June 30, 2009             |       | 353                    |       | — |   | — |   | 353 |   |
| Total fair value of financial assets         |       | $                      | 23,945     |   | $ | 12,683 |   | $ | 10,909 |   | $ | 353 |   |

 
| ** **                                   | ** ** | **December 31, 2008** | ** ** |
|----------------------------------------------|------------|----------------------------|------------|
| ** **                                   | ** ** | **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)**         | ** ** |
| Cash and cash equivalents                    |       | $                          | 35,999     |   | $ | 33,549 |   | $ | 2,450 |   | $ | — |   |
| Marketable securities                        |       | 8,588                      |       | — |   | 8,588 |   | — |   |
| Restricted cash                              |       | 150                        |       | 150 |   | — |   | — |   |
| Total fair value of current financial assets |       | 44,737                     |       | 33,699 |   | 11,038 |   | — |   |
| Restricted cash—non-current             |       | 1,203                      |       | 1,203 |   | — |   | — |   |
| Auction rate securities                      |       | 367                        |       | — |   | — |   | 367 |   |
| Total fair value of financial assets         |       | $                          | 46,307     |   | $ | 34,902 |   | $ | 11,038 |   | $ | 367 |   |

 

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Our financial assets valued using Level 1 inputs consist primarily ofcash, money market funds, and certificate of deposit at a financialinstitution.  Our financial assets valuedusing Level 2 inputs consist primarily of U.S. government agencies debtinstruments, commercial paper, and corporate debt securities. The fair value ofthese instruments was determined by our institutional portfolio managers whosevaluations were based upon market-corroborated inputs such as broker/dealerquotes, reported trades, bids and offers that we believe are reasonable. Thefair value of our remaining auction rate security was measured using Level 3inputs as determined by a discounted cash flow model that considers expectedcash flows from the auction rate instrument including expected interestpayments, market yields for similarly rated instruments, our estimates of timeto liquidity for the security and a marketability discount.

 

As of June 30, 2009, the fair value of our remaining auction rateinstrument was $353,000, net of an estimated $147,000 loss representing a 29.4%reduction in the carrying value for this instrument. We revisited ourassumptions used in the discounted cash flow model as of June 30, 2009 andrecorded an additional $14,000 loss on marketable securities for the three andsix months ended June 30, 2009 in our statement of operations. We continueto classify this auction rate instrument as an other non-current asset on thebalance sheet as we do not expect that the instrument will likely become liquidin the next 12 months.

 

Marketable securities held at June 30, 2009 and December 31,2008 are summarized below:

 
| ** **                                           | ** ** | **June 30, 2009** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|
| ** **                                           | ** ** | **Amortized  Cost**    | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Unrealized********Other-than-  temporary  Impairment** | ** ** | **Fair Value** | ** ** |
| ** **                                           | ** ** | **(in thousands)**     | ** ** |
| **Available-for-sale marketable securities:**        |       |                   |       |   |   |   |   |   |   |   |   |
| U.S. government agencies debt                        |       | $                      | 5,980      |   | $ | 4 |   | $ | — |   | $ | — |   | $ | 5,984 |   |
| Commercial paper                                     |       | 1,998                  |       | 1 |   | — |   | — |   | 1,999 |   |
| Corporate debt securities                            |       | 2,319                  |       | 4 |   | — |   | — |   | 2,323 |   |
| Auction rate securities                              |       | 353                    |       | — |   | — |   | — |   | 353 |   |
| Total marketable securities                          |       | $                      | 10,650     |   | $ | 9 |   | $ | — |   | $ | — |   | $ | 10,659 |   |
| **Maturing:**                                        |       |                   |       |   |   |   |   |   |   |   |   |
| Within 1 year                                   |       | $                      | 8,790      |   |   |   |   |   |   |   | $ | 8,796 |   |
| Between 1 and 2 years                           |       | 1,507                  |       |   |   |   |   |   |   | 1,510 |   |
| Auction rate securities maturing beyond  1 year |       | 353                    |       |   |   |   |   |   |   | 353 |   |
|                                                 |       | $                      | 10,650     |   |   |   |   |   |   |   | $ | 10,659 |   |

 
| ** **                                           | ** ** | **December 31, 2008** | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|
| ** **                                           | ** ** | **Amortized  Cost**        | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Unrealized********Other-than-temporary Impairment** | ** ** | **Fair Value** | ** ** |
| ** **                                           | ** ** | **(in thousands)**         | ** ** |
| **Available-for-sale marketable  securities:**       |       |                       |       |   |   |   |   |   |   |   |   |
| U.S. government agencies debt                        |       | $                          | 6,010      |   | $ | 31 |   | $ | — |   | $ | — |   | $ | 6,041 |   |
| Commercial paper                                     |       | 997                        |       | 2 |   | — |   | — |   | 999 |   |
| Corporate debt securities                            |       | 1,538                      |       | 10 |   | — |   | — |   | 1,548 |   |
| Auction rate securities                              |       | 367                        |       | — |   | — |   | — |   | 367 |   |
| Total marketable securities                          |       | $                          | 8,912      |   | $ | 43 |   | $ | — |   | $ | — |   | $ | 8,955 |   |
| **Maturing:**                                        |       |                       |       |   |   |   |   |   |   |   |   |
| Within 1 year                                   |       | $                          | 7,007      |   |   |   |   |   |   |   | $ | 7,040 |   |
| Between 1 and 2 years                           |       | 1,538                      |       |   |   |   |   |   |   | 1,548 |   |
| Auction rate securities maturing beyond  1 year |       | 367                        |       |   |   |   |   |   |   | 367 |   |
|                                                 |       | $                          | 8,912      |   |   |   |   |   |   |   | $ | 8,955 |   |

 

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**3.  Revenue Recognition**

 

We generated no revenue for the three and six months ended June 30,2009. We recognized $1.1 million and $2.2 million for the three and sixmonths ended June 30, 2008, respectively, as license fees revenue and$164,000 and $232,000 for the three and six months ended June 30, 2008,respectively, as collaboration service revenue in connection with our priorcollaboration agreement with Procter & Gamble Pharmaceuticals, Inc.,or P&G. Effective with P&G’s notice of termination on July 2,2008, we no longer provide any support services to P&G for the developmentof ATI-7505 and therefore those services are no longer a source of revenue forus. In accounting for our prior collaboration agreement with P&G, we haveconsistently reported activities between third parties and us on a gross basisand therefore the adoption of EITF Issue No. 07-1, *Accountingfor Collaborative Arrangements*, effective for interim periods endingafter March 15, 2009, did not have a material impact on our consolidatedfinancial statements.

 

**4.  Debt Financing**

 

As of June 30, 2009, wehave loan commitments outstanding with Lighthouse Capital Partners V, L.P., orLighthouse, General Electric Commercial Finance, or GE, and Oxford FinanceCorporation, or Oxford.  The totalprincipal amount borrowed under the Lighthouse agreements was $19.0 million andthe total unpaid principal balance outstanding as of June 30, 2009 was$12.2 million. We recorded interest expense related to the Lighthouse loanagreement, including amortization of expense related to the terminal paymentand the warrants issued under the agreement, of $461,000 and $446,000 for thethree months ended June 30, 2009 and 2008, respectively, and $921,000 and$902,000 for the six months ended June 30, 2009 and 2008, respectively.The total principal amount borrowed under the GE agreements was $1.9 millionand the total unpaid principal balance outstanding as of June 30, 2009 was$177,000. We recorded interest expense related to the GE loan agreements of$6,000 and $22,000 for the three months ended June 30, 2009 and 2008,respectively, and $15,000 and $61,000 for the six months ended June 30,2009 and 2008, respectively.  The totalprincipal amount borrowed under the Oxford loan agreement was $1.0 million andthe total unpaid principal balance outstanding as of June 30, 2009 was$856,000. We recorded interest expense related to the Oxford loan agreement,including amortization of expense related to the terminal payment and thewarrant issued under the agreement, of $29,000 and zero for the three monthsended June 30, 2009 and 2008, respectively, and $60,000 and zero forthe six months ended June 30, 2009 and 2008, respectively.

 

**5.  Warrants**

 

We issue freestanding warrants from time to time pursuant to variouscontractual arrangements. As of June 30, 2009, the following warrants topurchase 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)        |       | 3/28/2005      |       | Debt  financing              |       | Common  Stock           |       | 100,704    |       | $                                | 9.93       |            | (1         | ) |
| Lighthouse(2)        |       | 10/19/2007     |       | Debt  financing              |       | Common  Stock           |       | 83,332     |       | $                                | 10.80      |            | (2         | ) |
| Lighthouse(3)        |       | 10/17/2008     |       | Debt  restructure            |       | Common  Stock           |       | 158,770    |       | $                                | 3.975      |            | (3         | ) |
| Various investors(4) |       | (4             | )          | Private  placement of equity |       | Common  Stock           |       | 2,894,864  |       | $                                | 2.64       |            | 11/14/2013 |   |
| Oxford(5)            |       | 12/31/2008     |       | Equipment  financing         |       | Common  Stock           |       | 8,547      |       | $                                | 2.34       |            | 12/31/2013 |   |
|                 |       |           |       |                         |       |                    |       | 3,251,828  |       |                             |       |            |       |

 

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(1)                                  Exercisable, inwhole or in part, 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) November 7, 2009 or (ii) theeffective date of a merger, as defined in the 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 on October 19,2014, or (ii) the effective date of a merger, as defined in the agreement.

(3)                                  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 on October 17,2013, or (ii) the effective date of a merger, as defined in the agreement.

(4)                                  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; exercisable, in whole or in part, at anytime at theoption of the holder for a term of five years from November 14, 2008.

 

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(5)                                  Exercisable, inwhole or in part, at anytime at the option of the holder for a term of fiveyears from the date of issuance or deemed to have been automatically exercisedin full immediately prior to the expiration of the warrant if the fair marketvalue of one share of our common stock is greater than the exercise price ofthe warrant on such date.

 

In June 2008, the FASB ratified EITF Issue No. 07-5, *Determining Whether an Instrument (or Embedded Feature) is Indexed toan Entity’s Own Stock*, or EITF 07-5. EITF 07-5 provides guidance onhow to determine if certain instruments (or embedded features) are consideredindexed to our own stock. EITF 07-5 requires companies to use a two-stepapproach to evaluate an instrument’s contingent exercise provisions andsettlement provisions in determining whether the instrument is considered to beindexed to its own stock and thus exempt from the application of SFAS No. 133,*Accounting for Derivative Instruments and HedgingActivities*. Although EITF 07-5 is effective for fiscal years beginningafter December 15, 2008, any outstanding instrument at the date ofadoption requires retrospective application of the accounting through acumulative effect adjustment to retained earnings upon adoption. The adoptionof EITF 07-5 did not have a material impact on our consolidated financialposition or results of operations.

 

The fair value of our capitalized warrants issued in connection withthe placement of our long-term debt was amortized to interest expense asfollows:

 
| ** **                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended********June 30,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                         | ** ** | **2009**                              | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                         | ** ** | **(in thousands)**                    | ** ** |
| Lighthouse—Warrant 1          |       | $                                     | 13         |                                      | $          | 23 |   | $ | 27 |   | $ | 47 |   |
| Lighthouse—Warrant 2          |       | 13                                    |       | 16                                        |       | 26 |   | 167 |   |
| Lighthouse—Warrant 3          |       | 27                                    |       | —                                    |       | 54 |   | — |   |
| Oxford                             |       | 1                                     |       | —                                    |       | 2 |   | — |   |
| Total warrant amortization expense |       | $                                     | 54         |                                      | $          | 39 |   | $ | 109 |   | $ | 214 |   |

 

**6. ****Stock-Based Compensation**

 

The components of ourstock-based compensation expense recognized for the three and six months ended June 30,2009 and 2008 were as follows:

 
| ** **                              | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended********June 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | **2009**                              | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                              | ** ** | **(in thousands)**                    | ** ** |
| *Research and development:*             |       |                                  |       |                                      |       |   |   |   |   |
| Officer compensation                    |       | $                                     | 76         |                                      | $          | 84 |   | $ | 144 |   | $ | 160 |   |
| Employee and consultant compensation    |       | 163                                   |       | 161                                       |       | 314 |   | 332 |   |
| *Selling, general and  administrative:* |       |                                  |       |                                      |       |   |   |   |   |
| Director and officer compensation       |       | 355                                   |       | 279                                       |       | 626 |   | 555 |   |
| Employee and consultant compensation    |       | 39                                    |       | 48                                        |       | 77 |   | 90 |   |
| Total stock-based compensation expense  |       | $                                     | 633        |                                      | $          | 572 |   | $ | 1,161 |   | $ | 1,137 |   |

 

Weissued an aggregate 36,144 shares of our common stock upon the exercise ofstock options and 24,128 shares of our common stock upon the conclusion of theinitial offering period under our 2007 Employee Stock Purchase Plan during thesix months ended June 30, 2009.

 

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**ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*Thefollowing discussion of our financial condition and the results of operationsshould be read in conjunction with the condensed consolidated financialstatements and notes to condensed consolidated financial statements includedelsewhere in this quarterly report on Form 10-Q. This discussion containsforward looking statements that involve risks and uncertainties. When reviewingthe discussion below, you should keep in mind the substantial risks anduncertainties that characterize our business. In particular, we encourage youto review the risks and uncertainties described in Part II - Item 1A.“RISK FACTORS” elsewhere in this report. These risks and uncertainties couldcause actual results to differ materially from those projected inforward-looking statements contained in this report or implied by past resultsand trends. Forward-looking statements are statements that attempt to forecastor anticipate future developments in our business; we encourage you to reviewthe examples of our forward-looking statements under the heading “CautionaryNote Regarding Forward-Looking Statements” that appears at the end of thisdiscussion. These statements, like all statements in this report, speak only asof their date (unless another date is indicated), and we undertake noobligation to update or revise these statements in light of futuredevelopments.*

 

**Overview**

 

ARYx Therapeutics, Inc.,or ARYx, is 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 antiarrhythmic agent, budiodarone (ATI-2042), designed to have theefficacy of amiodarone, in Phase 2b clinical development for the treatmentof atrial fibrillation, a form of irregular heartbeat; an oral anticoagulant,tecarfarin (ATI-5923), designed to have the same therapeutic benefits aswarfarin, in Phase 2/3 clinical development for the treatment of patientswho are at risk for the formation of dangerous blood clots; an oral prokineticagent, ATI-7505, designed to have the same therapeutic benefits as cisapride,in Phase 2b clinical development for the treatment of chronicconstipation, gastroparesis, functional dyspepsia, irritable bowel syndromewith constipation, and gastroesophageal reflux disease; and, a novel,next-generation atypical antipsychotic agent, ATI-9242, currently inPhase 1 clinical testing for the treatment of schizophrenia and otherpsychiatric disorders. Additionally, we have several product candidates inpreclinical development. Each of our product candidates is an orally available,patentable new chemical entity designed to address similar indications as thoseof the original drug upon which each is based. Our product candidates targetwhat we believe to be multi-billion dollar market opportunities.

 

We wereincorporated in the State of California on February 28, 1997 andreincorporated in the State of Delaware on August 29, 2007. We maintain awholly-owned subsidiary, ARYx Therapeutics Limited, with registered offices inthe United Kingdom, which has had no operations since its inception in September 2004and was established to serve as a legal entity in support of our clinical trialactivities conducted in Europe. We operate in a single business segment withregard to the development of human pharmaceutical products.

 

Since our inception, we have incurred significant net losses, and weexpect to continue to incur net losses for the next several years as we developour own product candidates, potentially acquire or in-license additionalproducts or product candidates, conduct clinical trials, manufacture materialsfor use in non-clinical studies and clinical trials, expand our research anddevelopment activities, seek regulatory approvals and engage incommercialization preparation activities. It is very expensive to gain approvalof and launch a pharmaceutical product. Many expenses are incurred beforerevenue is received. We are unable to predict the extent of any future lossesor when we will become profitable, if at all.

 

Weare engineering potentially safer oral product candidates that retain theefficacy of commercially successful drugs for well-established chronic markets.We have established proof of concept with our three leading product candidates,budiodarone, tecarfarin, and ATI-7505. The following is a summary of ourproduct candidates that are currently in clinical development:

 

***Budiodarone***

 

Budiodarone is an oralantiarrhythmic agent in Phase 2 clinical development for the treatment ofpatients with atrial fibrillation. Budiodarone was designed to have theefficacy of amiodarone, a drug that has been used for many years, despite itsadverse side effects, because physicians consider it to be the most effectivedrug for treating patients with atrial fibrillation. Amiodarone accumulates inmany different organs and can only be metabolized by CYP450, potentiallyleading to serious side effects that are not immediately reversible uponwithdrawal of the drug. Since budiodarone is predominantly metabolized throughthe esterase pathway, it should avoid accumulation in organs and have fewerdrug-drug interactions. We 

 

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have completed a Phase 2 pilot study (CLN-208)with budiodarone involving six atrial fibrillation patients with implantedrecordable pacemakers who did not respond to previous drug therapy. This pilotstudy suggested that the effect of budiodarone improved as the dose increased.Based upon the results of this pilot study, we conducted an additionalPhase 2b clinical trial to further demonstrate the efficacy of budiodaronein patients with atrial fibrillation. The clinical trial, which enrolled 72patients, was a multi-centered, randomized, double blind, placebo-controlledstudy of the efficacy and safety of budiodarone in patients with paroxysmalatrial fibrillation, or PAF. All patients entering this study had previouslyimplanted permanent pacemakers with appropriate diagnostic and recordingcapabilities. In December 2008, we announced successful top-line efficacyresults from this Phase 2b clinical trial. By achieving statisticalsignificance at the two highest doses of the three tested, the resultsessentially mirrored the findings of the earlier Phase 2 pilot study alsoconducted in paroxysmal atrial fibrillation patients. The Phase 2b studyalso demonstrated that patients in the study quickly returned to theirpre-treatment level of atrial fibrillation once the treatment ended. We have alsoannounced the complete safety results from this Phase 2b clinical trialwhich indicate that budiodarone is generally safe and well-tolerated, andappears to avoid the tissue accumulation evident with amiodarone. We areactively seeking a large pharmaceutical company partner for the fulldevelopment and eventual commercialization of budiodarone, in the event weobtain requisite regulatory approval.

 

***Tecarfarin***

 

Tecarfarinis an oral anticoagulant 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 CYP 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. Therate of anticoagulation for both warfarin and tecarfarin is measured by thestandard assay known as International Normalized Ratio, or INR.

 

Wehave treated over 400 patients with tecarfarin measuring the drug’s ability tomaintain those patients within the target therapeutic range of INR of 2 to 3(2.5 to 3.5 for heart valve patients). Two of the clinical trials performedwere Phase 2 studies (CLN-504 and CLN-509) and the third was the recentlycompleted Phase 2/3 trial, EmbraceAC (CLN-505). The tecarfarin efficacy resultsin each were nearly identical, appearing to demonstrate tecarfarin’s ability tomaintain patients’ INR within the target therapeutic range during a consistentpercentage of the time treated: 71.5% (CLN-504); 73.9% (CLN-509); and 74%(EmbraceAC). Statistical significance was achieved in CLN-504 when comparingthe tecarfarin response to the same patients’ historical experience withwarfarin: 71.5% time within therapeutic range versus 59.3% time withintherapeutic range, respectively (p= 0.0009). However, statistical significancewas not achieved at the primary endpoint in the 607-patient EmbraceAC clinicaltrial, directly measuring the ability of tecarfarin to maintain patients withinthe target therapeutic range of INR as compared to warfarin patients. Theendpoint was missed due to the virtually unprecedented time within therapeuticrange in the warfarin-treated patients of 73.2% (p=0.506). We believe thewarfarin outcome resulted from the intense monitoring and dose control providedby the study’s central dosing methodology, executed in accord with ouragreement on the study design with the U.S. Food and Drug Administration, orFDA. A second Phase 3 study must be conducted, again directly comparingtecarfarin to warfarin but in a “real-world” setting in which all monitoringand dosing decisions will be made at the study sites. This will be similar tohow tecarfarin was dosed in CLN-504 and how warfarin is typically dosed andtitrated in clinical practice. Similar studies conducted in the past withwarfarin have typically shown a time in therapeutic range of 56% to 66%,considerably less than was seen in the EmbraceAC study which was highlycontrolled. Subsequent additional analyses of the data generated in theEmbraceAC trial, looking at specific subpopulations in the study, support ourbelief that a real-world study would demonstrate the importance of warfarin’sdependence on CYP450 metabolism versus tecarfarin’s avoidance of that metabolicpathway in maintaining patients within the target therapeutic range of INR. Inprevious discussions, the FDA indicated that the ability to maintain patientswithin the targeted INR will likely be an acceptable surrogate and primaryendpoint for tecarfarin’s clinical development. Using INR maintenance as asurrogate and primary endpoint should reduce both the size of and time tocomplete our planned clinical trials for tecarfarin compared to clinical trialsmeasuring survival rates or other outcomes. Based upon our earlier discussionswith the FDA, we believe the completed EmbraceAC clinical trial may qualify asa registration study. We are continuing to actively seek a pharmaceuticalcompany partner for the full development and eventual commercialization oftecarfarin, in the event we obtain requisite regulatory approval. Thispotential partner will be responsible for conducting the required second Phase3 study.

 

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***ATI-7505***

 

ATI-7505is an oral prokinetic drug that speeds up the motion of contents through thegut, which has successfully completed a series of Phase 2 clinical trialsfor the treatment of multiple gastrointestinal disorders including gastroesophagealreflux disease, or GERD, functional dyspepsia and chronic idiopathicconstipation. ATI-7505 was designed to have the same therapeutic benefits ascisapride, a drug marketed by Johnson & Johnson as Propulsid in theUnited States. Launched in 1993, cisapride was withdrawn from the market in2000 due to serious cardiovascular side effects. These side effects occurred asblood levels of the drug rose significantly when CYP450 clearance was inhibitedbecause of the presence of other drugs cleared by the same metabolic pathway.We designed ATI-7505 to be metabolized through the esterase pathway,eliminating metabolism through CYP450 as well as the off-target cardiovasculareffects. More than 900 subjects have been treated with ATI-7505 as part of ourclinical trial program, which includes four Phase 2 trials to date. In June 2006,we entered into a collaboration agreement with Procter & GamblePharmaceuticals, Inc., or P&G, to develop and commercialize ATI-7505.On July 2, 2008, we received notice from P&G that it elected toexercise its option to terminate the collaboration agreement effective July 2,2008. P&G subsequently announced that it is exiting pharmaceutical drugdevelopment. Upon termination of the collaboration agreement by P&G, allrights to ATI-7505 reverted to ARYx. Also on July 2, 2008, we announcedthe overall successful results of a Thorough QT study, or TQT study, onATI-7505, which we believe supports the agent’s favorable cardiac safetyprofile. In March 2009, we received written confirmation from the FDA thatbased on the FDA’s review of results from our TQT study of ATI-7505, the FDAconcurs with our interpretation of the results that the findings were negative,meaning ATI-7505 does not significantly increase the QT interval at the proposedtherapeutic or supratherapeutic doses. Since the QT interval is an importantmeasure of cardiac safety, this result supports our belief that ATI-7505 doesnot lead to cardiac liabilities. On August 22, 2008, we announced theresults of a Phase 2b clinical trial testing the safety and efficacy ofATI-7505 in patients with chronic idiopathic constipation. The clinical trial,conducted by P&G, was designed to enroll 400 patients evaluating four dosesof the agent compared to placebo. As a result of the termination of thecollaboration between ARYx and P&G, the study was terminated early afteronly 214 patients had been enrolled. In spite of the early termination of thestudy, ATI-7505 achieved statistical significance at the study’s primaryendpoint in the 80 milligram twice daily dose. In addition, all doses testeddemonstrated a clinically meaningful and desired increase in spontaneous bowelmovements over baseline compared to placebo after one week of treatment. We arenow actively seeking a new pharmaceutical company partner to complete thedevelopment and eventually commercialize ATI-7505, in the event we obtainrequisite regulatory approval.

 

***ATI-9242***

 

ATI-9242 is a novelantipsychotic agent in Phase 1 clinical development for the treatment ofschizophrenia and other psychiatric disorders. ATI-9242’s receptor profile istargeted at the treatment of both the positive and the negative symptoms ofschizophrenia as well as the improvement of cognitive function. To date,preclinical work has supported this profile. ATI-9242 is designed to avoidcertain drug-drug interactions by avoiding CYP450 enzymes for metabolism andreduce certain metabolic problems associated with this class of therapy,including weight gain and type 2 diabetes. The Phase 1 single-dose clinicaltrial, testing the safety and tolerability of ATI-9242, is underway and isexpected to be completed as financial resources allow.

 

***Research and Development Expense***

 

Our research and development, or R&D, expense consists of expensesincurred in identifying, testing and developing our product candidates. Theseexpenses consist primarily of fees paid to contract research organizations andother third parties to assist us in managing, monitoring and analyzing ourclinical trials, clinical trial costs paid to sites and investigators’ fees,costs of non-clinical studies including toxicity studies in animals, costs ofcontract manufacturing services, costs of materials used in clinical trials andnon-clinical studies, laboratory related expenses, R&D support costsincluding certain regulatory, quality assurance, project management andadministration, allocated expenses such as facilities and informationtechnology that are used to support our research and development activities andrelated personnel expenses, including stock-based compensation. R&D costsare expensed as incurred.

 

Clinical trial costs are a significant component of our R&Dexpense. Currently, we conduct our clinical trials primarily throughcoordination with contract research organizations and other third-party serviceproviders. We recognize research and development expense for these activitiesbased upon a variety of factors, including actual and estimated patientenrollment, clinical site initiation activities, direct pass-through costs andother activity-based factors.

 

The following table summarizes our R&D expense for the three andsix months ended June 30, 2009 and 2008:

 

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| ** **                                                          | ** ** | **Three Months Ended********June 30,** | ** ** | **Six Months Ended********June 30,** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                          | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                          | ** ** | **(in thousands)**                          | ** ** |
| Direct R&D expense by product candidate:                        |       |                                        |       |                                      |       |   |   |   |   |
| Budiodarone                                                         |       | $                                           | 69         |                                      | $          | 1,389 |   | $ | 707 |   | $ | 3,338 |   |
| Tecarfarin                                                          |       | 2,665                                       |       | 4,494                                     |       | 5,491 |   | 6,081 |   |
| ATI-7505                                                            |       | 64                                          |       | 546                                       |       | 116 |   | 1,092 |   |
| ATI-9242                                                            |       | 51                                          |       | 57                                        |       | (56 | ) | 133 |   |
| Other research programs                                             |       | 56                                          |       | 394                                       |       | 100 |   | 648 |   |
| Total direct R&D expense                                        |       | 2,905                                       |       | 6,880                                     |       | 6,358 |   | 11,292 |   |
| R&D personnel, administrative and other  expense                |       | 3,366                                       |       | 3,178                                     |       | 6,702 |   | 6,392 |   |
| Less: R&D portion of the cost of collaboration  service revenue |       | —                                      |       | (13                                       | )          | — |   | (39 | ) |
| Total R&D expense                                               |       | 6,271                                       |       | $                                         | 10,045     |   | $ | 13,060 |   | $ | 17,645 |   |
|                                                                     |            |                                             |            |                                           |            |  |  |  |  |  |  |  |  |

 

From our inception through June 30, 2009, we estimate thatapproximately $25.0 million was incurred for our budiodarone product candidate,approximately $38.3 million of expense was incurred for our tecarfarin productcandidate, approximately $22.6 million was incurred for our ATI-7505 productcandidate, approximately $5.0 million was incurred for our ATI-9242 product candidate,and approximately $64.7 million was incurred for costs related to our R&Dpersonnel, 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 “R&D personnel, administrative and other expense” in the above table.The portion of our R&D expense that is identified as cost of collaborationservice revenue is included within a separate category of expense in ourcondensed consolidated financial statements and is subtracted from totalexpenses in the above table to derive total research and development expense asreported in our condensed consolidated financial statements.

 

At this time, due to the risks inherent in the clinical trial processand given the various stages of development of our product candidates, we areunable to estimate with any certainty the costs we will incur in the continueddevelopment of our product candidates. Clinical development timelines, theprobability of success and development costs can differ materially fromexpectations. While we are currently focused on advancing each of our productcandidates, our future research and development expense will depend on theclinical success of each product candidate, as well as ongoing assessments asto each product candidate’s commercial potential. In addition, we cannotforecast with any degree of certainty which product candidates will be subjectto future collaborations, when such arrangements will be secured, if at all,and to what degree such arrangements would affect our development plans and capitalrequirements.

 

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 a timelymanner, it could have a material effect on our operations, financial positionand liquidity. In addition, any failure by us or our partners to obtain, or anydelay in obtaining, regulatory approvals for our product candidates could havea material adverse effect on our results of operations. A further discussion ofthe risks and uncertainties associated with completing our programs onschedule, or at all, and certain consequences of failing to do so are discussedin Part II—Item 1A. “Risk Factors” section of this report.

 

**CriticalAccounting Policies and Significant Estimates**

 

We have prepared ourconsolidated financial statements in accordance with U.S. generally acceptedaccounting principles. Accordingly, we have had to make estimates, assumptionsand judgments that affect the amounts reported in our consolidated financialstatements. These estimates, assumptions and judgments about future events andtheir effects on our results cannot be determined with certainty, and are madebased upon our historical experience and on other assumptions that are believedto be reasonable under the circumstances. These estimates may change as newevents occur or additional information is obtained, and we may periodically befaced with uncertainties, the outcomes of which are not within our control andmay not be known for a prolonged period of time.

 

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Our critical accountingpolicies are more fully described in Note 1 of the audited consolidatedfinancial statements for the year ended December 31, 2008, which areincluded in our annual report on Form 10-K filed with the Securities andExchange Commission. There have been no material changes in our criticalaccounting policies and significant estimates during the three and six monthsended June 30, 2009.

 

**Results of Operations**

 

***Comparison of Threeand Six Months Ended June 30, 2009 and 2008***

 

***Revenue***

 
| ** **                    | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------|--------------|------------------------------|------------|------------|------------|-------------------|------------|----------------------|------------|------------|------------|------------|------------|
| ** **                    | ** **   | **June 30,**            | ** ** | **Change** | ** ** | **June 30,** | ** ** | **Change**           | ** ** |
| ** **                    | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**             | ** ** | **%**                | ** ** | **2009**   | ** ** | **2008**   | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***                  | *** *** | **(In thousands, except %)** | ** ** |
| Collaboration service revenue |         | $                            | —     |       | $          | 164               |       | $                    | (164       | )          | (100       | )%         | $          | — |   | $ | 232 |   | $ | (232 | ) | (100 | )% |
| Technology license fees       |         | —                       |       | 974        |       | (974              | )          | (100                 | )%         | —     |       | 1,948      |       | (1,948 | ) | (100 | )% |
| Total revenue                 |         | $                            | —     |       | $          | 1,138             |       | $                    | (1,138     | )          | (100       | )%         | $          | — |   | $ | 2,180 |   | $ | (2,180 | ) | (100 | )% |

 

Wegenerated no revenue for the three and six months ended June 30, 2009.Revenue for the three months ended June 30, 2009, as compared to the sameperiod in 2008, decreased by $1.1 million. Revenue for the sixmonths ended June 30, 2009, as compared to the same period in 2008,decreased by $2.2 million.  Our only source of revenue in 2008 was inconnection with our prior collaboration agreement with P&G for thelicensing of our ATI-7505 product candidate and for providing pharmaceuticaldevelopment and other services to P&G. The decrease in revenue was due tothe termination ofthe collaboration agreement with P&G in July 2008.

 

***Cost of CollaborationService Revenue***

*** ***
| ** **                            | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------|--------------|------------------------------|------------|------------|------------|-------------------|------------|----------------------|------------|------------|------------|------------|------------|
| ** **                            | ** **   | **June 30,**            | ** ** | **Change** | ** ** | **June 30,** | ** ** | **Change**           | ** ** |
| ** **                            | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**             | ** ** | **%**                | ** ** | **2009**   | ** ** | **2008**   | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***                          | *** *** | **(In thousands, except %)** | ** ** |
| Cost of collaboration service revenue |         | $                            | —     |       | $          | 164               |       | $                    | (164       | )          | (100       | )%         | $          | — |   | $ | 232 |   | $ | (232 | ) | (100 | )% |
|                                       |              |                              |            |            |            |                   |            |                      |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Weincurred costs for certain services provided in connection with our priorcollaboration agreement with P&G, including costs for pharmaceuticaldevelopment, patent filing and maintenance and other activities related to theATI-7505 product candidate. We did not generate any collaboration servicerevenue nor associated cost for the three and six months ended June 30,2009. The $164,000and $232,000 decreases in cost of revenue for the three and six months ended June 30,2009, respectively, ascompared to the same periods in 2008, were the result of the termination of thecollaboration agreement with P&G in July 2008.

 

***Research andDevelopment Expense***

 
| ** **                       | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|--------------|------------------------------|------------|------------|------------|-------------------|------------|----------------------|------------|------------|------------|------------|------------|
| ** **                       | ** **   | **June 30,**            | ** ** | **Change** | ** ** | **June 30,** | ** ** | **Change**           | ** ** |
| ** **                       | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**             | ** ** | **%**                | ** ** | **2009**   | ** ** | **2008**   | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***                     | *** *** | **(In thousands, except %)** | ** ** |
| Research and development expense |         | $                            | 6,271      |       | $          | 10,045            |       | $                    | (3,774     | )          | (38        | )%         | $          | 13,060 |   | $ | 17,645 |   | $ | (4,585 | ) | (26 | )% |
|                                  |              |                              |            |            |            |                   |            |                      |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

For the three monthsended June 30, 2009, as compared to the same period in 2008, our researchand development expense decreased by $3.8 million, or 38%. The decrease wasprimarily due to:

 

·                  a $1.3 million reduction in expendituresas a result of the substantive completion of ourbudiodarone Phase 2b clinical study in December 2008;

 

·                  a $1.2 million reduction in drugmanufacturing cost and a $450,000 reduction in non-clinical studiesexpenditures associated with our tecarfarin development program;

 

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·                  a $500,000 reduction in expendituresrelated to the substantial completion of a ATI-9242 Phase 1 clinical study;

 

·                  a $300,000 reduction in expendituresrelated to our other research programs.

 

For the six monthsended June 30, 2009, as compared to the same period in 2008, our researchand development expense decreased by $4.6 million, or 26%. The decrease wasprimarily due to:

 

·                  a $2.6 million reduction in expendituresas a result of the substantive completion of ourbudiodarone Phase 2b clinical study in December 2008;

 

·                  a $2.2 million reduction in drugmanufacturing and non-clinical studies expenditures associated with ourtecarfarin development program;

 

·              a $1.1 million reduction in clinicaltrial expenditures as a result of the completion of a pilot clinical study ontecarfarin, partially offset by a $2.6 million increase in clinical trialexpenditures related to the double-blinded, placebo-controlled tecarfarinPhase 2/3 clinical trial;and

 

·                  a $1.2 million reduction in expendituresrelated to the completion of five cohorts of patient studiesin a ATI-9242 Phase** **1 clinical study.

 

***Selling, General andAdministrative Expense***

*** ***
| ** **                                  | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------|--------------|------------------------------|------------|------------|------------|-------------------|------------|----------------------|------------|------------|------------|------------|------------|
| ** **                                  | ** **   | **June 30,**            | ** ** | **Change** | ** ** | **June 30,** | ** ** | **Change**           | ** ** |
| ** **                                  | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**             | ** ** | **%**                | ** ** | **2009**   | ** ** | **2008**   | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***                                | *** *** | **(In thousands, except %)** | ** ** |
| Selling, general and administrative expense |         | $                            | 2,622      |       | $          | 2,664             |       | $                    | (42        | )          | (2         | )%         | $          | 5,225 |   | $ | 5,596 |   | $ | (371 | ) | (7 | )% |
|                                             |              |                              |            |            |            |                   |            |                      |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

The lower selling,general and administrative expense for the three and six months ended June 30,2009 as compared to the same periods in 2008 was primarily due to a reductionin legal expenses in connection with the initiation of our Phase 2/3 clinicaltrial on tecarfarin, lower international patent filing costs, and arestructuring of executive bonuses to a contingent milestone basis.

 

***Interest and Other Income, Net***

*** ***
| ** **                     | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|--------------|------------------------------|------------|------------|------------|-------------------|------------|----------------------|------------|------------|------------|------------|------------|
| ** **                     | ** **   | **June 30,**            | ** ** | **Change** | ** ** | **June 30,** | ** ** | **Change**           | ** ** |
| ** **                     | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**             | ** ** | **%**                | ** ** | **2009**   | ** ** | **2008**   | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***                   | *** *** | **(In thousands, except %)** | ** ** |
| Interest and other income, net |         | $                            | 11         |       | $          | 308               |       | $                    | (297       | )          | (96        | )%         | $          | 65 |   | $ | 857 |   | $ | (792 | ) | (92 | )% |
|                                |              |                              |            |            |            |                   |            |                      |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Interest and other income, net of otherexpenses, consist primarily of interest income from our investments inmarketable securities reduced by certain expenses such as state franchise tax.Lower interest income for the three and six months ended June 30, 2009 ascompared to the same periods in 2008 was attributable to lower prevailing short-terminterest rates and a lower cash balance in our investment portfolio.

 

***Interest Expense***

*** ***
| ** **       | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------|--------------|------------------------------|------------|------------|------------|-------------------|------------|----------------------|------------|------------|------------|------------|------------|
| ** **       | ** **   | **June 30,**            | ** ** | **Change** | ** ** | **June 30,** | ** ** | **Change**           | ** ** |
| ** **       | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**             | ** ** | **%**                | ** ** | **2009**   | ** ** | **2008**   | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***     | *** *** | **(In thousands, except %)** | ** ** |
| Interest expense |         | $                            | 496        |       | $          | 469               |       | $                    | 27         |       | 6          | %          | $          | 996 |   | $ | 963 |   | $ | 33 |   | 4 | % |
|                  |              |                              |            |            |            |                   |            |                      |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

The increase in interest expense for the threeand six months ended June 30, 2009 as compared to the same periods in 2008was primarily due to additional equipment financing provided to us by OxfordFinance Corporation in December 2008.

 

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***Other-Than-Temporary ImpairmentLoss***

*** ***
| ** **                           | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------|--------------|------------------------------|------------|------------|------------|-------------------|------------|----------------------|------------|------------|------------|------------|------------|
| ** **                           | ** **   | **June 30,**            | ** ** | **Change** | ** ** | **June 30,** | ** ** | **Change**           | ** ** |
| ** **                           | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**             | ** ** | **%**                | ** ** | **2009**   | ** ** | **2008**   | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***                         | *** *** | **(In thousands, except %)** | ** ** |
| Other-than-temporary impairment loss |         | $                            | 14         |       | $          | —            |       | $                    | 14         |       | N/A        |       | $          | 14 |   | $ | — |   | $ | 14 |   | N/A |   |
|                                      |              |                              |            |            |            |                   |            |                      |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

For the three and six months ended June 30, 2009, we recorded anadditional $14,000 impairment loss due to an estimated decline in fair value ofour remaining auction rate security that we determined to be other thantemporary. As of June 30, 2009, the carrying value of this instrument was$353,000.

 

**Liquidityand Capital Resources**

 
| ** **                  | ** **   | **Six Months Ended** | ** **   |
|-----------------------------|--------------|----------------------|--------------|
| ** **                  | ** **   | **June 30,**    | ** **   |
| ** **                  | ** **   | **2009**             | ** **   | **2008** | ** ** |
| *** ***                | *** *** | **(In thousands)**   | *** *** |
| Cash (used in) provided by: |         |                 |         |   |   |
| Operating activities        |         | $                    | (22,091      | ) | $ | (22,250 | ) |
| Investing activities        |         | (1,931               | )            | (6,223 | ) |
| Financing activities        |         | (44                  | )            | 7,533 |   |
| Total cash (used) provided  |         | $                    | (24,066      | ) | $ | (20,940 | ) |

 

As of June 30,2009, we had $22.6 million in cash, cash equivalents and marketablesecurities. While our cash resources as of June 30, 2009 are less than theamount needed for us to maintain our current operations for the next 12 months,we believe that our cash, cash equivalents and marketable securities on handwill be sufficient to fund our operations through the end of the first quarterof 2010. Since our inception, we have incurred significant net operating lossesand, as of June 30, 2009, we had an accumulated deficit of $173.2 million.Our ability to continue operations is dependent upon our ability to obtainsubstantial additional capital to continue our R&D programs and to bringany potential future products to market. In order to satisfy our projected cashneeds for at least the next 12 months, we are considering various options thatmay be available to us, including entering into collaborative arrangements forone or more of our product candidates, public or private equity financings,debt financing or a combination of the aforementioned. However, there is noassurance that we will be able to raise additional capital on terms acceptableto us or at all. Furthermore, any additional equity financings may be dilutiveto stockholders and debt financing, if available, may involve covenants thatplace substantial restrictions on our business. If we fail to raise sufficientcapital as and when needed, we have developed contingency plans that mayrequire us to delay, reduce the scope of, or eliminate one or more of ourR&D programs, partner one or more of our product candidates at an earlierstage of development than we might otherwise choose, or to reduce personnel andrelated costs and other discretionary expenditures that are within our control.

 

Due to adverse developments in global financial markets, we haveexperienced reduced liquidity with respect to our investment in a singleauction rate instrument. If the need arose to liquidate this security beforematurity, we may experience realized losses upon liquidation. Due to the shortduration of all instruments held within our investment portfolio with theexception of one auction rate instrument, we believe that we have the abilityto hold all but one of these securities to maturity when they are expected to beredeemed at par value.

 

Net cash used in operating activities was $22.1 million and $22.3million for the six months ended June 30, 2009 and 2008, respectively. Netcash used in each of these periods was primarily used towards the funding ofour operating costs and expenses in connection with the conduct of ourresearch, development and administrative activities.

 

Cash used ininvesting activities primarily consists of purchases, sales and maturities ofmarketable securities, as well as changes in restricted cash balances andpurchases of property and equipment. Cash used in investing activities duringthe six months ended June 30, 2009 decreased, as compared to the sameperiod in 2008, primarily due to lower net purchases of marketable securities.Net purchases of marketable securities were $1.8 million for the six monthsended June 30, 2009, compared to $5.4 million for the same period in 2008. Purchases ofproperty and equipment were $89,000 for the six months ended June 30,2009, compared to $556,000 for the same period in 2008. Cash used in investingactivities for the six months ended June 30, 2008 also included a $300,000increase in restricted cash.

 

Net cash used in financing activities was $44,000 for the six monthsended June 30, 2009, and net cash provided by financing activities was$7.5 million for the six months ended June 30, 2008. Net cash used infinancing activities for the six months ended June 30, 2009 primarilyconsisted of principal payments on our long-term debt offset by proceeds fromemployee purchases of our common stock pursuant to an offering under our 2007Employee Stock Purchase Plan.  Net cashprovided by financing activities for the six months ended June 30, 2008was primarily due to the utilization of the $9.0 million loan facilityextended to us by Lighthouse Capital Partners, net of $1.5 million principalpayments on our long-term debt.

 

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As of June 30, 2009, we have loan commitments outstanding withLighthouse Capital Partners V, L.P., or Lighthouse, General Electric CommercialFinance, or GE, and Oxford Finance Corporation, or Oxford.  The total principal amount borrowed under theLighthouse agreements was $19.0 million and the total unpaid principal balanceoutstanding as of June 30, 2009 was $12.2 million. We recorded interestexpense related to the Lighthouse loan agreement, including amortization ofexpense related to the terminal payment and the warrants issued under theagreement, of $461,000 and $446,000 for the three months ended June 30,2009 and 2008, respectively, and $921,000 and $902,000 for the six months endedJune 30, 2009 and 2008, respectively. The total principal amount borrowedunder the GE agreements was $1.9 million and the total unpaid principal balanceoutstanding as of June 30, 2009 was $177,000. We recorded interest expenserelated to the GE loan agreements of $6,000 and $22,000 for the three monthsended June 30, 2009 and 2008, respectively, and $15,000 and $61,000 forthe six months ended June 30, 2009 and 2008, respectively.  The total principal amount borrowed under theOxford loan agreement was $1.0 million and the total unpaid principal balanceoutstanding as of June 30, 2009 was $856,000. We recorded interest expenserelated to the Oxford loan agreement, including amortization of expense relatedto the terminal payment and the warrant issued under the agreement, of $29,000and zero for the three months ended June 30, 2009 and 2008, respectively,and $60,000 and zero for the six months ended June 30, 2009 and 2008,respectively.

 

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

 

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

 

·                  the scope, rate of progress,results and cost of our preclinical testing, clinical trials and other researchand development activities;

 

·                  the cost, timing andoutcomes of regulatory approvals;

 

·                  the number andcharacteristics of product candidates that we pursue;

 

·                  the cost and timing ofestablishing sales, marketing and distribution capabilities;

 

·                  the cost of establishingclinical and commercial supplies of our product candidates and any productsthat we may develop;

 

·                  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.

 

In order to provide for our long-term objective of productcommercialization and continued investment in our R&D pipeline, we willneed to raise additional funds to support our operations, and such funding maynot be available to us on acceptable terms, or at all. If we are unable toraise additional funds when needed, we may not be able to continue developmentof our product candidates or we could be required to delay, scale back oreliminate some or all of our R&D programs. We may seek to raise any necessaryadditional funds through public or private equity, debt financings,collaborative arrangements with corporate partners or other sources. If weraise additional funds through the issuance of debt securities, thesesecurities could have rights that are senior to the holders of our common stockand could contain covenants that restrict our operations. If we raiseadditional funds by issuing equity securities, dilution to our existingstockholders may result. In addition, if we raise additional funds through thesale of equity securities, new investors could have rights superior to ourexisting stockholders. To the extent that we raise additional capital throughlicensing arrangements or arrangements with collaborative partners, we may berequired to relinquish, on terms that are not favorable to us, rights to someof our technologies or product candidates that we would otherwise seek todevelop or commercialize ourselves for a higher profit margin. The terms offuture financings may restrict our ability to raise additional capital, whichcould delay or prevent the further development of our product candidates orcommercialization of our products. Our failure to raise capital when needed mayharm our business and operating results.

 

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**ContractualObligations**

 

There were no material changes to our contractual obligations from thosedisclosed in our annual report on Form 10-K for the year ended December 31,2008, filed with theSecurities and Exchange Commission on March 27,2009, other than scheduled payments made through June 30, 2009.

 

**RecentAccounting Pronouncements**

 

See Note 1 of theNotes to our Condensed Consolidated Financial Statements included elsewhere inthis report for recent accounting pronouncements that could have an effect onus.

 

**Off-BalanceSheet Arrangements**

 

Since inception,except for standard operating leases, we have not engaged in any off-balancesheet arrangements, including the use of structured finance, special purposeentities or variable interest entities.

 

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

 

Therewere no material changes to our market risk from those disclosed in our annualreport on Form 10-K for the year ended December 31, 2008, filed withthe Securities and Exchange Commission on March 27, 2009.

 

**ITEM 4T.CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controls and Procedures***

 

We maintain disclosure controlsand procedures, as such term is defined in Rule 13a-15(e) under theSecurities Exchange Act of 1934, as amended, that are designed to ensure thatinformation required to be disclosed in our reports under the SecuritiesExchange Act of 1934, as amended, is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow for timely decisions regardingrequired disclosure.

 

As of June 30, 2009,we carried out an evaluation, under the supervision and with the participationof our management, including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures.  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 June 30, 2009.

 

***Limitations on the Effectiveness of Controls***

 

Ourmanagement, including our Chief Executive Officer and Chief Financial Officer, does notexpect that our disclosure controls and procedures or our internal controlswill prevent all error and all fraud. A control system, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the control system are met. Because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any,within the company have been detected. These inherent limitations include therealities that judgments in decision-making can be faulty, and that breakdownscan occur because of simple error or mistake. Additionally, controls can becircumvented by the individual acts of some persons, by collusion of two ormore people, or by management override of the control. The design of any systemof controls also is based in part upon certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions. Over time,control may become inadequate because of changes in conditions, or the degreeof compliance with the policies or procedures may deteriorate. Because of theinherent limitations in a cost-effective control system, misstatements due toerror or fraud may occur and not be detected.

 

***Changes in Internal Control overFinancial Reporting***

 

No change was madein our internal control over financial reporting during the quarter ended June 30,2009 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PART II — OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

From time to timewe are involved in legal proceedings arising in the ordinary course of ourbusiness. We believe there is no litigation pending that could have,individually or in the aggregate, a material adverse effect on our results ofoperations or financial condition.

 

**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.**The trading price of ourcommon stock could decline due to any of these risks, and our investors maylose all or part of their investment.**We have marked with an asterisk(*) those risks described below that reflect substantive changes from therisks described in our Annual Report on Form 10-K for the year ended December 31,2008, filed with the Securities and Exchange Commission on March 27, 2009.In assessing these risks, you should also refer to the other informationcontained in this quarterly report on Form 10-Q, including our financialstatements and related notes.*

 

**RisksRelated to Our Business**

 

***We will need substantial additionalfunding and may be unable to raise capital when needed, which would force us tolimit or cease our operations and related product development programs.****

 

As of June 30,2009, we had $22.6 million in cash, cash equivalents and marketablesecurities on hand, which is less than the amount needed for us to maintain ourcurrent operations for the next 12 months. Our ability to continueoperations is dependent upon our ability to obtain substantial additionalcapital. Our operations have consumed substantial amounts of cash sinceinception. We expect to continue to spend substantial amounts of cash to fundour operations, including research and development expenses and costsassociated with the conduct of clinical trials for our product candidates. Itis our intention to enter into collaboration arrangements to commercialize ourproduct candidates. Within those arrangements, we may retain the commercial rightto co-promote our products to selected physicians through a specialty salesforce. However, should the collaboration arrangements fail to providesufficient revenue to fund our operations adequately, we will need to raiseadditional capital to fund our operations and complete development of ourproduct candidates. If any of our product candidates receive regulatoryapproval for commercial sale, we may need to raise additional capital to fundour portion of the commercialization efforts. Our future funding requirementswill depend on many factors, including:

 

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

 

·                  the scope, rate of progress,results and cost of our preclinical testing, clinical trials and other researchand development activities;

 

·                  the cost, timing andoutcomes of regulatory approvals;

 

·                  the number andcharacteristics of product candidates that we pursue;

 

·                  the cost and timing ofestablishing sales, marketing and distribution capabilities for our specialtysales force;

 

·                  the cost of establishingclinical and commercial supplies of our product candidates and any productsthat we may develop;

 

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

 

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

 

·                  the extent to which weacquire or invest in businesses, products or technologies, although wecurrently have no commitments or agreements relating to any of these types of transactions.

 

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Until we can generate a sufficient amount of product revenue, if weever do, we expect to finance future cash needs through corporate collaborationand licensing arrangements, public or private equity offerings, debt financingsor through interest income earned on cash balances.

 

If we raise additional funds by issuing equity securities, ourstockholders will experience dilution. Any debt financing or additional equitythat we raise may contain terms that are not favorable to our stockholders orus. If we raise additional funds through collaboration and licensingarrangements with third parties, we may be required to relinquish some rightsto our technologies or our product candidates, grant licenses on terms that arenot favorable to us or enter into a collaboration arrangement for a productcandidate at an earlier stage of development than we might otherwise choose.

 

We do not expect our existing capital resources to be sufficient toenable us to fund the completion of the development of any of our productcandidates. Although we believe our current cash on hand is sufficient to fundour operations through the end of the first quarter of 2010, our operating planmay change, and we may need additional funds sooner than planned to meetoperational needs and capital requirements for product development andcommercialization. Additional funds may not be available when we need them onterms that are acceptable to us, or at all. If adequate funds are not availableon a timely basis, we may:

 

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

 

·                  reduce our headcount andcapital or operating expenditures;

 

·                  delay our establishment ofsales and marketing capabilities or other activities that may be necessary tocommercialize our product candidates; or

 

·                  curtail significant drugresearch and development programs that are designed to identify new productcandidates.

 

***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 June 30, 2009, we had an accumulateddeficit of approximately $173.2 million. We expect our research and developmentexpenses to continue to be a significant portion of our operating costs thatmay increase as we continue to expand our development programs subject toadequate funding. Subject to regulatory approval for any of our productcandidates, we expect to incur significant expenses associated with thepotential establishment of a North American specialty sales force and increasedmanufacturing expenses. Although it is not expected to occur in the nextseveral years, the cost of establishing a small North American specialty salesforce will be substantial. As a result, we expect to continue to incursubstantial and increasing losses for the foreseeable future. These losses havehad and will continue to have an adverse effect on our stockholders’ equity andworking capital.

 

Because of the numerous risks and uncertainties associated with drugdevelopment, we are unable to predict the timing or amount of increased expenseor when or if we will be able to achieve or sustain profitability. Currently,we have no products approved for commercial sale, and, to date, we have not generatedany product revenue. We have financed our operations primarily through the saleof equity securities, capital lease and equipment financings, debt financingsand a single corporate partnership with 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 anyFDA-approved product candidate is insufficient or if we fail to enter intopartnering arrangements for our product candidates on terms favorable to us, wemay never become profitable. Even if we do become profitable, we may not beable to sustain or increase our profitability on a quarterly or annual basis.

 

***In periods of worsening economicconditions, it may be difficult and costly for us to raise additional capital.***

 

As a result of worsening market conditions, banks and other creditgrantors have faced liquidity concerns and have tightened their lendingstandards, investors have become more risk adverse and economic growth has beennegatively impacted. These factors are contributing to reduced creditavailability and rising costs for issuers needing to raise additional capital.If these factors continue to affect the credit and equity markets, our abilityto raise capital may be adversely affected, if not completely hindered.

 

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***Global credit and financial marketconditions could negatively impact the value of our current portfolio of cashequivalents or short-term investments.***

 

Currently, there remains much caution in the U.S. economy due to aglobal credit crisis that has resulted in tightening credit markets and risingliquidity concerns across most industries, including the banking andinvestments sector. While as of the date of this filing we are not aware of anymaterial losses, or other significant deterioration in the fair value of ourcash equivalents or investments in marketable securities since June 30,2009, no assurance can be given that further deterioration in conditions of theglobal credit and financial markets would not negatively impact our currentportfolio of cash equivalents or investments in marketable securities or ourability to meet our financing objectives to allow us to continue ouroperations.

 

***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 2/3 , and budiodarone and ATI-7505 in Phase 2b. Afourth product candidate, ATI-9242, entered into a Phase 1 clinical trialin April 2008.******Our ability to generateproduct revenue in the future will depend heavily on the successful developmentand commercialization of these product candidates. Our other product candidatesare in the discovery stage. Any of our product candidates could be unsuccessfulfor a variety of reasons, including that they:

 

·                  may not demonstrateacceptable safety and efficacy in preclinical studies 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. If we are unableto make our product candidates commercially available, we will not generateproduct revenues and we will not be successful. The results of our clinicaltrials to date do not provide assurance that acceptable efficacy or safety willbe shown upon completion of Phase 3 clinical trials.

 

***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.***

 

We plan to enter into collaborative arrangements with third parties todevelop and commercialize each of our lead product candidates. Dependence oncollaborative arrangements for development and commercialization of our productcandidates will subject us to a 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;

 

·                  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, stopa clinical trial or abandon a product candidate, repeat or conduct new clinicaltrials or require a new formulation of a product candidate for clinicaltesting;

 

·                  we may have limited controlover our clinical trial design;

 

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·                  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;

 

·                  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 budiodarone, tecarfarin, ATI-7505 and ATI-9242product candidates or future product candidates, we may have to alter ourdevelopment and commercialization plans.***

 

Our strategy includes selectively collaborating with leadingpharmaceutical and biotechnology companies to assist us in furthering thedevelopment and potential commercialization of some of our product candidates,including budiodarone,tecarfarin, ATI-7505 and ATI-9242. We intend to seek partners becausethe commercialization of each of our first four product candidates involves alarge, primary care market that must be served by large sales and marketingorganizations and because we do not currently have the capabilities to performPhase 3 clinical trials. We face significant competition in seekingappropriate collaborators, and these collaborations are complex andtime-consuming to negotiate and document. We may not be able to negotiate collaborationson acceptable terms, if at all. We are unable to predict when, if ever, we willenter into any collaborations because of the numerous risks and uncertaintiesassociated with establishing collaborations. If we are unable to negotiate anacceptable collaboration, we may have to curtail the development of aparticular product candidate, reduce or delay its development program or one ormore of our other development programs, delay its potential commercializationor reduce the scope of our sales or marketing activities or increase ourexpenditures and undertake development or commercialization activities at ourown expense. If we elect to increase our expenditures to fund development orcommercialization activities on our own, we may need to obtain additionalcapital, which may not be available to us on acceptable terms, if at all. If wedo not have sufficient funds, we will not be able to bring our productcandidates to market and generate 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,litigation and/or financial difficulties may also adversely affect thewillingness or ability of our potential collaboration partners to fulfill theirobligations to us. If a partner fails to perform in the manner we expect, ourpotential to develop 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 ATI-7505, and we may experience asimilar result with potential collaboration partners in the future with respectto any of our product candidates.

 

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***If we are not able to obtain requiredregulatory 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 their developmentand commercialization are subject to comprehensive regulation by the FDA andother federal and state regulatory agencies in the United States and bycomparable authorities in other countries. The inability to obtain FDA approvalor approval from comparable authorities in other countries would prevent us andour collaborative partners from commercializing our product candidates in theUnited States or other countries. Future collaborative agreements will likelycause us to give up control of interactions and regulatory approval processeswith the FDA and other regulatory bodies. We or our partners may never receiveregulatory approval for the commercial sale of any of our product candidates.We have only limited experience in preparing and filing the applicationsnecessary to gain regulatory approvals and have not received regulatoryapproval to market any of our product candidates in any jurisdiction. Theprocess of applying for regulatory approval is expensive and time-consuming,and can vary substantially based upon the type, complexity and novelty of theproduct 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 studies ofATI-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 may imposerequirements for post-approval studies, 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 studies. 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 ATI-7505 or other drugs can be approved. Asanother example, while we believe we have clear direction from the FDA as tothe development path for our tecarfarin product candidate based on our initialdiscussions, the FDA may change their judgment on the appropriate developmentpathway for tecarfarin at any time. Similarly, the clinical trials to berequired by the FDA for approval of new anti-arrythmic therapies may change asthey consider the approval of similar therapies submitted by competingpharmaceutical 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 aresimilar to our product candidates, could give rise to delays in the regulatoryapproval process.***

 

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 

 

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causeddrug-drug interactions with warfarin, which increased INR and could increasethe risk of hemorrhage complications. Tecarfarin is modeled on warfarin whichis known to have safety risks because of its potential for bleeding and forinteractions with numerous other drugs as listed on the package insert for theproduct. ATI-7505 is modeled on cisapride which was withdrawn from the marketdue to fatal cardiac problems. ATI-9242 is modeled to retain certain of thepositive features of the class of atypical antipsychotic drugs while lesseningcertain of the safety issues that vary but exist within the class. The receptorprofile which yields the positive and avoids the negative features of thisclass of drugs is a matter of great debate. While we have designed ATI-9242 tohave an appropriate balance across a very complex set of receptors, we may havetargeted an inappropriate profile or the profile attained may result in anunanticipated lack of efficacy or safety problems. Although we have designedour drugs to largely address each of the original drugs’ key safety problems,we will need to continue to demonstrate this through continued clinicaltesting. It is possible that the FDA may impose additional requirements on thedevelopment or approval of our products because of its concern about theoriginal drug’s safety problems. These potential additional barriers coulddelay, increase the cost of, or prevent the commercialization of our productcandidates.

 

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 certain cardiaceffects reportedly related to its off-target effects. It is possible that we ora future collaboration partner may be required by regulatory agencies toperform tests, in addition to those we have planned, in order to demonstratethat ATI-7505 does not have the safety problems associated with Zelnorm. Anyfailure or delay in commencing or completing clinical trials or obtainingregulatory approvals for our product candidates would delay commercializationof our product candidates and severely harm our business and financialcondition.

 

***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 studies and clinicaltrials;

 

·                  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.

 

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***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.In addition, 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 successfully carry out their contractual duties orregulatory obligations or meet expected deadlines, if the third parties need tobe replaced or if the quality or accuracy of the data they obtain iscompromised owing to the failure to adhere to our clinical protocols orregulatory requirements or for other reasons, our clinical trials may beextended, delayed, suspended or terminated, and we may not be able to obtainregulatory approval for, or successfully commercialize, our product 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 or license. We rely oncomposition of matter patents for the compounds we develop. We cannot guaranteethat any patents will issue from any of our pending or future patentapplications. Alternatively, a third party may successfully circumvent ourpatents. Our rights under any issued patents may not provide us with sufficientprotection against competitive products or otherwise cover commerciallyvaluable products or processes.

 

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 challenged by third parties;

 

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

 

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

 

Even if valid and enforceable patents cover our product candidates andtechnologies, the patents will provide protection only for a limited amount oftime. As our patents are based on a parent drug where much research has beenconducted, we may encounter many competitive patents from covered analogs ofthe parent drug. Our know-how and trade secrets may only provide a competitiveadvantage for a short amount of time. Furthermore, we cannot guarantee that ourpatents, present or future, will have scope sufficient to prevent competingproducts.

 

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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) otherwisediminish the value of our intellectual property in any of the following ways:1) U.S. Federal Courts and foreign judicial authorities may renderdecisions that alter the application of the patent laws and detrimentallyaffect our ability to enforce our patents and obtain patent protection for ourtechnologies; 2) the U.S. Patent and Trademark Office, or USPTO, andforeign counterparts may change the nature of how patent applications areexamined and issue regulations that detrimentally affect our ability to obtainpatent protection for our technologies and/or increase the costs for obtainingand maintaining protection; and/or 3) Congress and other foreignlegislative bodies may make changes to their respective patent laws that maymake obtaining and enforcing patents more difficult and/or costly, and/orotherwise diminish the value of our intellectual property or narrow the scopeof our patent protection.

 

Even if patents are issued regarding our product candidates or methodsof using them, those patents can be challenged by our competitors who can arguesuch patents are invalid and/or unenforceable. Defending against such challengescould be costly, and the outcome is inherently uncertain and may result in theloss of some or all of our rights. Patents also may not protect our productcandidates if competitors devise ways of making these or similar productcandidates without legally infringing our patents. The Federal Food, Drug andCosmetic 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 drugapplications that rely on literature and clinical data not prepared for or bythe drug sponsor.

 

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.

 

In addition, we may enter into agreements to license technologies andpatent rights. Should we fail to comply with the terms of those licenseagreements, including payment of any required maintenance fees or royalties, orshould the licensors fail to maintain their licensed interest in the licensedpatents, we could lose the rights to those technologies and patents.

 

As of June 30, 2009, we held 45 issued or allowed U.S. patents andhad 17 patent applications pending before the USPTO. For some of ourinventions, corresponding foreign patent protection is pending. Of the 45 U.S.patents that we hold, 40 patents are compound and composition related, havingexpiration 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 ATI-7505, ourcompound for the treatment of gastrointestinal disorders, issued in February 2007and has an expiration date in 2025. Our composition of matter patentapplications for ATI-9242, our product candidate for the treatment ofschizophrenia and other psychiatric disorders, are currently pending, one inthe United States and two in foreign jurisdictions. Although third parties maychallenge our rights to, or the scope or validity of, our patents, to date wehave not received any communications from third parties challenging our patentsor patent applications covering our clinical candidates.

 

While budiodarone, tecarfarin and ATI-7505 are all covered in theUnited States by issued composition of matter patents, additional patentapplications would be required to extend patent protection beyond 2020, 2025and 2025, respectively (assuming the validity and enforceability of the currentcomposition of matter patents). We cannot guarantee that any patents will beissued from our pending or future patent applications, and any patents thatissue from such pending or future patent applications would be subject to thesame risks described herein for currently issued 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 other dataor information generated during the course of the research after we have beenafforded an opportunity to consider whether patent and/or other proprietaryprotection should be sought. If we do not apply for patent protection prior tosuch publication or if we cannot otherwise maintain the confidentiality of ourtechnology and other confidential information, then our ability to receivepatent protection or protect our proprietary information may be jeopardized.

 

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***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.

 

***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 patents andproprietary rights of other parties and not breaching any licenses that we haveentered into with regard to our technologies and products. Because others mayhave filed, and in the future are likely to file, patent applications coveringproducts or other technologies of interest to us that are similar or identicalto ours, patent applications or issued patents of others may have priority overor dominate our patent applications or issued patents. There are numerousissued and applied for patents related to the original molecules and analogs ofsuch from which our products are engineered. If the patents are determined tobe valid and construed to cover our products, the development andcommercialization of any or all could be affected. We do not believe that ouractivities infringe the patents of others or that the patents of others inhibitour freedom to operate, but we cannot guarantee that we have identified allUnited States and foreign patents and patent applications that pose a risk ofinfringement. We may be forced to litigate if an intellectual property disputearises, and it is possible that others may choose to challenge our position andthat a judge or jury will disagree with our conclusions. We could incursubstantial costs in litigation if we are required to defend against patentsuits brought by third parties. If we do not successfully defend aninfringement action, are unable to have infringed patents declared invalid, anddo not obtain a license to the patented 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 be successful in suchprocesses. Any legal action against our collaborators or us claiming damagesand seeking to enjoin commercial activities relating to the affected productsand processes could, in addition to subjecting us to potential liability fordamages, require our collaborators or us to obtain a license to continue tomanufacture or market the affected products and processes. Licenses requiredunder any of these patents may not be available on commercially acceptableterms, if at all. Failure to obtain such licenses could materially andadversely affect our ability to develop, commercialize and sell our productcandidates. We believe that there may continue to be significant litigation inthe biotechnology and pharmaceutical industry regarding patent and otherintellectual property rights. If we become involved in litigation, it couldconsume a substantial portion of our management and financial resources and wemay not prevail in any such 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 of our research and development activities.

 

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***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 agreements withthem. Any inability to acquire sufficient quantities of our product candidatesin a timely manner from these third parties could delay clinical trials andprevent us from developing and commercializing our product candidates in acost-effective manner or on a timely basis.

 

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 forbudiodarone’s active pharmaceutical ingredients. In the event that Ricerca,Biosciences, LLC, ScinoPharm Ltd. or SCI Pharmtech is unable orunwilling to serve as the supplier of budiodarone, we might not be able tomanufacture budiodarone’s active pharmaceutical ingredient. This could delaythe development of, and impair our ability to, commercialize budiodarone. Toproduce budiodarone drug product, drug substance is processed into 50 milligramor 200 milligram capsule forms 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 1 milligram,2 milligram, 5 milligram or 10 milligram tablets by QS Pharma of Boothwyn, PA.

 

The starting materials for the production of ATI-7505 are provided bythe following vendors: SCI Pharmtech, Inc., Corum, Inc. andLexen Inc. To produce ATI-7505 drug products, drug substance is processedinto 20 milligram or 40 milligram tablet form by Pharmaceutics International, Inc.of Hunt Valley, MD. In the event that any of these vendors are unable orunwilling to produce sufficient quantities of material for the manufacture ofATI-7505, the development and/or commercialization of ATI-7505 could be delayedor impaired.

 

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. inTaiwan. In the event that Corum Inc. is unable or unwilling to serve asthe supplier 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.

 

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Changes in manufacturing site, process or scale can trigger additionalregulatory requirements that could delay our ability to perform certainclinical trials 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.

 

***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 risks thatcould delay or prevent the initiation or completion of our clinical trials, thesubmission of applications for regulatory approvals, the approval of ourproduct by the FDA or the commercialization of our products, and may result inhigher 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 studies and delay or prevent marketing approval forour product 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 studies 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 preclinicalstudies and clinical trials, that the product candidate is safe and effectivein humans. To date, we have not completed all required clinical trials of anyproduct candidate. Preclinical and clinical testing is expensive, can take manyyears and has an uncertain outcome. A failure of one or more of our clinicaltrials could 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;

 

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·                  our preclinical studies orclinical trials may produce negative or inconclusive results, which may requireus to conduct additional preclinical or clinical testing or to abandondevelopment projects;

 

·                  we may suspend or terminateour clinical trials if the participating patients are being exposed tounacceptable health 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 studies orclinical trials may show that our product candidates are not superior to theoriginal drugs on which our product candidates are modeled.

 

For instance, our preclinical studies and clinical trials may indicatethat our product candidates cause unexpected drug-drug interactions and resultin adverse events. For example, budiodarone’s preclinical studies containresults that are currently being monitored in the clinic. Inhibition oftesticular function was observed in one animal species as part of thesestudies. No such effect has been observed to date in the clinic and monitoringcontinues. In published studies, a similar effect is thought to be correlatedwith the accumulation of amiodarone in tissues. A possible renal effect wasalso observed at high doses in our rat and dog toxicology studies forbudiodarone. While we will continue to monitor patients for these effects,there is no assurance these effects will not occur in patients as part of ourclinical trials for budiodarone, and have a resulting adverse effect on our abilityto obtain requisite regulatory approval to market and sell budiodarone.Similarly, in the clinical testing of budiodarone in patients whose conditionalso required treatment with warfarin, dose adjustments of warfarin weresometimes required. As is common to most clinical trials, the potential fordrug-drug interactions will be monitored. As another example, due to the resultof our Phase 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 study of ATI-7505 performed by ourformer collaboration partner, P&G, six deaths occurred at doses that were10 and 20 times greater than doses currently being used in clinical trials. Ourclinical trials to date have indicated only mild to moderate side effects inhumans. However, further observation is warranted.

 

Even when our product candidates do not cause any adverse effects,clinical studies of efficacy may show that our product candidates do not havesignificant effects on target symptoms or may be inconclusive. For example,ATI-7505 was tested in two Phase 2 clinical trials in which the primaryendpoints were not met in comparison to placebo. Although these studies didsupport ATI-7505’s efficacy against certain symptoms as secondary endpoints, iffuture studies show that ATI-7505 is not sufficiently efficacious to justifyits use as a therapy, our business and prospects may be materially adverselyaffected. In addition, we may need to reformulate the ATI-9242 drug productshould we find in our on-going Phase 1 testing that adequate blood levelsare 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.

 

***We may not be successful in ourefforts to identify or discover additional candidates using our RetroMetabolicDrug Design Technology.***

 

An important element of our strategy is to continue to identifyexisting molecules which have demonstrated efficacy, but have safety problemsthat are amenable to our RetroMetabolic Drug Design technology. Other thanbudiodarone, tecarfarin, ATI-7505 and ATI-9242, all of our programs are in thepreclinical or discovery stage. Research programs to identify new product candidatesrequire substantial technical, financial and human resources. These programsmay initially show promise in identifying potential product candidates, yetfail to yield product candidates for clinical development for a number ofreasons, including:

 

·                  the research methodologyused may not be successful in identifying potential product candidates; or

 

·                  potential product candidatesmay, on further study, be found not to retain the efficacy profile of theoriginal molecule or be shown to retain harmful side effects or othercharacteristics suggesting that they are unlikely to be effective products. Forinstance, at high doses our budiodarone product candidate interacts withwarfarin and causes prolonged INR which could increase the risk of hemorrhage complications.

 

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If we are unable to develop suitable product candidates throughinternal research programs or otherwise, we may not be able to increase ourrevenues in future periods, which could result in significant harm to ourfinancial position and adversely impact our stock price.

 

***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 studies, 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 in additionalcountries. In addition, the manufacturer of the product and its facilities willcontinue to be subject to FDA review and periodic inspections to ensureadherence to applicable GMPA regulations. After receiving marketing approval,the manufacturing, labeling, packaging, adverse event reporting, storage,advertising, promotion and record keeping related to the product will remainsubject 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;

 

·                  total or partial suspensionof production; and

 

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

 

***Because we have a number of productcandidates and are considering a variety of target indications, we may expendour limited resources to pursue a particular candidate or indication and failto capitalize on candidates or indications that may be more profitable or forwhich there is a greater likelihood of success.***

 

Because we have limited financial and managerial resources, we mustfocus on research programs and product candidates for the specificopportunities that we believe are the most amenable to our RetroMetabolic DrugDesign and are the most commercially promising. As a result, we may forego ordelay pursuit of opportunities with other product candidates or otherindications that later prove to have greater commercial potential. Our resourceallocation decisions may cause us to fail to capitalize on viable commercialproducts or profitable market opportunities. In addition, we may spend valuabletime and managerial and financial resources on research programs and productcandidates for specific indications that ultimately do not yield anycommercially viable products. If we do not accurately evaluate the technicalfeasibility and the commercial potential or target market for a particularproduct candidate, we may relinquish valuable rights to that product candidatethrough collaboration, licensing or other royalty arrangements in situationswhere it would have been more advantageous for us to retain sole rights todevelopment and commercialization.

 

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***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 establish salesand marketing capabilities or enter into agreements with third parties tomarket and sell our product candidates, we may be unable to generate productrevenue.***

 

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. Additionally, in the event we enter into any collaborationarrangements for any of our product candidates, we may retain the right to co-promotethe sales of any ultimate product(s) by establishing a small specialtysales force to market such product(s) to specific physician groups. Thereare risks involved with establishing our own sales and marketing capabilitiesand entering into arrangements with third parties to perform these services.Developing an internal sales force is expensive and time-consuming and coulddelay any product launch. On the other hand, if we enter into arrangements withthird parties to perform sales, marketing and distribution services, ourproduct revenues are likely to be lower than if we market and sell any productsthat we develop ourselves.

 

We may decide to establish our own specialty sales force and engagepharmaceutical or other healthcare companies with an existing sales andmarketing organization and distribution system to sell, market and distributeour products. We may not be able to establish these sales and distributionrelationships on acceptable terms, or at all. Factors that may inhibit ourefforts to commercialize our products without collaborators or licenseesinclude:

 

·                  our inability to convincefuture corporate partners to allow us to retain commercialization rights forspecific physician groups;

 

·                  our inability to obtainfinancing to establish the specialty sales force;

 

·                  our inability to recruit andretain adequate numbers of effective sales and marketing personnel;

 

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

 

·                  the lack of complementaryproducts to be offered by sales personnel, which may put us at a competitive disadvantagerelative to companies with more extensive product lines; and

 

·                  unforeseen costs andexpenses associated with creating an independent sales and marketingorganization.

 

Because the establishment of sales and marketing capabilities dependson the progress toward commercialization of our product candidates and becauseof the numerous risks and uncertainties involved with establishing our ownsales and marketing capabilities, we are unable to predict when we willestablish our own sales and marketing capabilities. If we are not able topartner with a third party and are not successful in recruiting sales andmarketing personnel or in building a sales and marketing infrastructure, wewill have difficulty commercializing our product candidates, which wouldadversely affect 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 ATI-7505, the original molecule, cisapride,was withdrawn from the market and no generic version exists, but there are manycompetitive products which may limit the amount we can charge for this productcandidate. There are five atypical antipsychotics which currently dominate anestimated $16.0 billion market for such drugs. Most will be generic competitorsof ATI-9242 if it ever reaches the marketplace. While we have designed ATI-9242to have the improved efficacy and safety features over the existing atypicalantipsychotics, these desired features may not be proven in clinical testing orpayors may be unwilling to pay a higher price for improved features whengeneric alternatives are available. Even if we show improved safety with ourproduct candidates, pricing of the existing original drug may limit the amountwe will be able to charge for each of our product candidates. If reimbursementis not available or is available only at limited levels, we may not be able tosuccessfully commercialize our product candidates, and may not be able toobtain a satisfactory financial return on products 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.***

 

We face competition from established pharmaceutical and biotechnologycompanies, as well as from academic institutions, government agencies andprivate and public research institutions. Our commercial opportunity will bereduced or eliminated if our competitors develop and commercialize productsthat are safer, more effective, have fewer side effects or are less expensivethan any products that we may develop. In addition, significant delays in thedevelopment of our product candidates could allow our competitors to bringproducts to market before us and impair our ability to commercialize ourproduct candidates.

 

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We believe generic amiodarone will continue to provide competition tobudiodarone for the treatment of atrial fibrillation, even though it is notlabeled for use in atrial fibrillation. Amiodarone will continue to be usedoff-label in spite of its safety problems because of its generic pricing. Othertreatments for atrial fibrillation, such as sotalol, marketed by BayerHealthCare Pharmaceuticals, Inc., flecainide, marketed by 3M Company, andpropafenone, marketed by Reliant Pharmaceuticals, Inc., do not haveequivalent efficacy to amiodarone, but will continue to compete in the atrialfibrillation marketplace. Merck and Cardiome Pharma Corp. are in Phase 2btesting with an oral product, vernakalant (oral), for the treatment of atrialfibrillation, including as a follow-on therapy to vernakalant (IV), anintravenous formulation, for which a New Drug Application has been submitted tothe FDA. Sanofi-aventis has obtained FDA approval to market in the UnitedStates their oral product, dronedarone (Multaq®), for the treatment of atrial fibrillation. TheirPhase 3 clinical trial data demonstrated improved outcomes of reduction inthe risk of cardiovascular related hospitalizations for patients suffering fromatrial fibrillation. While we believe a similar endpoint will be required forbudiodarone approval, the FDA may require additional outcome studies for theapproval of other treatments for atrial fibrillation, including budiodarone.Should this be required, the Phase 3 clinical trials necessary forbudiodarone may be more expensive and time consuming than we currentlyanticipate. However, based upon a recent meeting of the FDA advisory panelconsidering the regulatory approval of dronedarone, it appears that long-termsurvival studies will not be required. There are other companies developing devicesor procedures to treat atrial fibrillation through ablation, including CryoCor, Inc.and CryoCath Technologies, Inc.

 

Competition for tecarfarin for use as an oral anticoagulant willcontinue to come from generic coumadin owing to its pricing and the years ofexperience physicians and patients have with the drug. Other oralanticoagulants are in development throughout the pharmaceutical andbiotechnology industry. Most of these development programs fall into either thefactor Xa or direct thrombin inhibitor categories. We are aware that Johnson &Johnson in collaboration with Bayer AG has a factor Xa before the FDA forapproval, and that Bristol-Myers Squibb Company in collaboration with Pfizer, Inc.,Eli Lilly and Company and Portola Pharmaceuticals, Inc. each have factorXa programs in Phase 2 or Phase 3 testing. We are aware of a directthrombin inhibitor program at Boehringer-Ingelheim GmbH. The first directthrombin inhibitor presented to the FDA for approval, ximelagatran, previously marketedas Exanta by AstraZeneca plc, has not been recommended for approval due toidiosyncratic liver toxicity problems. Although we believe tecarfarin’smechanism of action (VKOR inhibition as with warfarin) and broadly availableinexpensive monitoring methodology (INR) provide an advantage, these factor Xaand direct thrombin inhibitor programs will likely present major competition inthis market. In addition, there may be other compounds of which we are notaware that are at an earlier stage of development and may compete with ourproduct candidates. If any of those compounds are successfully developed andapproved, they could compete directly with our product candidates.

 

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. ATI-7505 is a prokineticwhich 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 or in development which will also compete with ATI-7505,including tegaserod, marketed by Novartis Pharmaceuticals Corporation asZelnorm, which was temporarily withdrawn from the market and recentlyre-introduced with restrictive use labeling, TD-5108, which is being developedby Theravance, and erythromycin. Many additional prokinetics are in developmenttargeting these indications. We believe the most significant competition toATI-7505 for the treatment of GERD is proton pump inhibitors and H2 blockers,which are currently on the market in both prescription formulations andstrengths as well as in over-the-counter forms. Many major pharmaceuticalcompanies currently market proton pump inhibitors and H2 blockers generatingworldwide sales of over $17.0 billion in 2006. ATI-7505 is targeted, inpart, at the approximately 20-25% of GERD patients who do not receive adequaterelief from proton pump inhibitors, which reduce the creation of acid in thestomach. ATI-7505 will face competition from prokinetics as well as manyinexpensive over-the-counter drug products for the treatment of thesegastrointestinal disorders. Substantial competition also exists with productsindicated to treat chronic idiopathic constipation, an indication for whichATI-7505 has demonstrated efficacy in a Phase 2b clinical trial.

 

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.

 

Many of our competitors have significantly greater financial resourcesand expertise in research and development, manufacturing, preclinical testing,conducting clinical trials, obtaining regulatory approvals and marketingapproved products than we do. Established pharmaceutical companies may investheavily to quickly discover and develop novel compounds that could make ourproduct candidates obsolete. Smaller or early-stage companies may also prove tobe significant competitors, particularly through collaborative arrangementswith large and established companies. In addition, these companies compete withus in recruiting and retaining qualified scientific and management personnel,establishing clinical trial sites and patient 

 

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registrationfor clinical trials, as well as in acquiring technologies and technologylicenses complementary to our programs or advantageous to our business.Accordingly, our competitors may succeed in obtaining patent protection,receiving FDA approval or discovering, developing and commercializing medicinesbefore we do. We are also aware of other companies that may currently beengaged in the discovery of medicines that will compete with the productcandidates that we are developing. In addition, in the markets that we aretargeting, we expect to compete against current market-leading medicines. If weare not able to compete effectively against our current and future competitors,our business will not grow and our financial condition will suffer.

 

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

 

Our success depends on our continued ability to attract, retain andmotivate highly qualified management, clinical and scientific personnel and onour ability to develop and maintain important relationships with leadingclinicians. If we are not able to retain Dr. Goddard, our Chairman andChief Executive Officer, Dr. Milner, our President, Research andDevelopment, Mr. Varian, our Chief Operating Officer and Chief FinancialOfficer, Dr. Canafax, our Vice President and Chief Development Officer,and Dr. Druzgala, our Senior Vice President and Chief Scientific Officer,we may not be able to successfully develop or commercialize our product candidates.Competition for experienced scientists may limit our ability to hire and retainhighly qualified personnel on acceptable terms. In addition, none of ouremployees have employment commitments for any fixed period of time and couldleave our employment at will. We carry “key person” insurance in the amount of$1.0 million for each of Drs. Milner and Druzgala, but do not carry “keyperson” insurance covering any other members of senior management or keyscientific personnel. If we fail to identify, attract and retain qualifiedpersonnel, we may be unable to continue our development and commercializationactivities.

 

***We will need to hire additionalemployees in order to commercialize our product candidates. Any inability tomanage future growth could harm our ability to commercialize our productcandidates, increase our costs and adversely impact our ability to competeeffectively.***

 

In order to commercialize our product candidates, we will need toexpand the number of our managerial, operational, financial and otheremployees. Because the projected time frame for hiring these additionalemployees depends on the development status of our product candidates andbecause of the numerous risks and uncertainties associated with drugdevelopment and our existing capital resources, we are unable to project whenwe will hire these additional employees. While to date we have not experienceddifficulties in recruiting, hiring and retaining qualified individuals, thecompetition for qualified personnel in the pharmaceutical and biotechnologyfield 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 tocommercialize our product candidates and compete effectively will depend, inpart, on our ability to manage any future growth effectively.

 

***If product liability lawsuits arebrought against us, we will incur substantial liabilities and may be requiredto limit 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 on management’sattention in defending the related litigation;

 

·                  substantial monetary awardsto clinical trial participants or patients;

 

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·                  loss of revenue; and

 

·                  the inability tocommercialize any products that we may develop.

 

We have product liability insurance that covers our clinical trials upto an aggregate $10.0 million annual limit. We intend to expand our insurancecoverage to include the sale of commercial products if marketing approval isobtained for any products that we may develop. Insurance coverage isincreasingly expensive, and we may not be able to maintain insurance coverageat a reasonable cost or obtain insurance coverage that will be adequate tosatisfy 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 thepast, we cannot rule out the possibility that this may occur in thefuture. We do not carry specific insurance against such a claim.

 

***We will need to implement additionalfinance and accounting systems, procedures and controls in the future as wegrow our business and organization and to satisfy new reporting requirements.***

 

As a public reporting company, we need to comply with theSarbanes-Oxley Act of 2002 and the related rules and regulations of theSecurities and Exchange Commission, including expanded disclosures andaccelerated reporting requirements and more complex accounting rules.Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and otherrequirements will increase our costs and require additional managementresources. We are continuing to upgrade our finance and accounting systems, proceduresand controls and may need to continue to implement additional finance andaccounting systems, procedures and controls as we grow our business andorganization and to satisfy new reporting requirements. Compliance with Section 404first applied to our annual report on Form 10-K for our year ending December 31,2008, to be followed by a requirement for attestation by our independentauditors as to our compliance as of December 31, 2009. If our independentregistered public accounting firm is unable to provide us with an unqualifiedreport as to the effectiveness of our internal controls over financialreporting as of December 31, 2009, investors could lose confidence in thereliability of our internal controls over financial reporting, which could adverselyaffect our stock price and our ability to raise 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 any disasterwere to occur, our ability to operate our business could be seriously impaired.In addition, the unique nature of our research activities and of much of ourequipment could make it difficult for us to recover from this type of disaster.We currently may not have adequate insurance to cover our losses resulting fromdisasters or other similar significant business interruptions, and we do notcurrently plan to purchase additional insurance to cover such losses because ofthe cost of obtaining such coverage. Any significant losses that are notrecoverable under our insurance policies could seriously impair our businessand financial condition. Our current insurance does not specifically coverproperty loss or business interruption due to earthquake damage.

 

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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. Securitymarket 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:

 

·                  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;

 

·                  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.

 

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

 

The following factors are likely to result in fluctuations of our operatingresults from quarter to quarter and year to year:

 

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·                  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 termination ofa 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 continue to comply with the listingrequirements of The NASDAQ Global Market, the price of our common stock and ourability to access the capital markets could be negatively impacted.**********

 

Our common stock iscurrently listed on The NASDAQ Global Market. To maintain the listing of ourcommon stock on The NASDAQ Global Market we are required to meet certainlisting requirements, including a minimum closing bid price of $1.00 per share,a market value of publicly held shares (excluding shares held by our executiveofficers, directors and 10% or more stockholders) of at least $5 millionand stockholders’ equity of at least $10 million. As of June 30, 2009, ourstockholders’ equity was $9.4 million.  As a result, we do not meetThe NASDAQ Global Market’s stockholders’ equity listing requirement as of June 30,2009.  In the event we receive sufficient additional capital in thenear term from a potential collaboration arrangement involving any of our leadproduct candidates or through an equity financing, our stockholders’ equitycould be in excess of $10 million, which may forestall our delisting from TheNASDAQ Global Market.

 

If we fail to comply withthe listing standards of The NASDAQ Global Market, we may consider transferringto The NASDAQ Capital Market, provided we met the transfer criteria, which is alower tier market, or our common stock may be delisted and traded on theover-the-counter bulletin board network. Moving our listing to The NASDAQCapital Market could adversely affect the liquidity of our commonstock.  If our common stock were to be delisted by NASDAQ, we couldface 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 our stockholders;

 

·                  potential loss of confidenceby collaboration partners and employees; and

 

·                  loss of institutionalinvestor interest and fewer business development opportunities.

 

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***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 June 30, 2009 (whichexcludes any shares of common stock issuable upon exercise of warrants andoptions outstanding on such date), our executive officers, directors and holdersof 5% or more of our outstanding common stock beneficially own approximately55% of our common stock. As a result, these stockholders, acting together, willbe able to control all matters requiring approval by our stockholders,including the election of directors and the approval of mergers or otherbusiness combination transactions. The interests of this group of stockholdersmay not always coincide with our interests or the interests of otherstockholders.

 

***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;

 

·                  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 the DelawareGeneral Corporation Law, which prohibits a person who owns in excess of 15% ofour outstanding voting stock from merging or combining with us for a period ofthree years after the date of the transaction in which the person acquired inexcess of 15% of our outstanding voting stock, unless the merger or combinationis 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 June 30, 2009, we had 27,339,149 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, and Rules 144and 701 under the Securities Act of 1933, as amended. If these additionalshares are sold, or if it is perceived that they will be sold, in the publicmarket, the trading price of our common stock could decline.

 

Certain of our affiliates have rights with respect to registration of asignificant number of our shares of common stock under the Securities Act of1933, as amended. If such holders, by exercising their registration rights,cause a large number of securities to be sold in the public market, these salescould have an adverse effect on the market price for our common stock and mayimpair our ability to raise additional capital. In addition, as of June 30,2009, we have filed three registration statements on Form S-8 under theSecurities Act of 1933, as amended, to register up to an aggregate of 5,005,132shares of our common stock for issuance under our stock option and employeestock purchase plans, and intend to file additional registration statements on Form S-8to register the shares automatically added each year to the share reservesunder these plans.

 

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

 

**Use ofProceeds from the Sale of Registered Securities**

 

On November 7, 2007, our registration statement on Form S-1/A(File No. 333-145813) was declared effective by the Securities andExchange Commission for our initial public offering. We registered 5,000,000shares of our common stock for an aggregate offering price of$50.0 million, all of which were sold at $10.00 per share. Of this amount,$3.5 million was paid in underwriters’ discounts and an additional$2.7 million of other expenses were incurred, all of which was incurredduring the year ended December 31, 2007. Entities affiliated with MPM Capital and OrbiMedAdvisors, LLC, two of our principal stockholders, purchased an aggregateof 600,000 shares of common stock in our initial public offering at theoffering price of $10.00 per share. The underwriters of the offering wereMorgan Stanley & Co. Incorporated, CIBC World Markets Corp.,Jefferies and Company, Inc. and Leerink Swann LLC. No offeringexpenses were paid directly or indirectly to our directors, officers or theirassociates, or to persons owning 10% or more of any of our equity securities.

 

As of June 30, 2009, all $43.8 million of the net proceeds fromour initial public offering have been used to fund our (i) externalclinical trial activities, including funding manufacturing expenses related tothe clinical development of our product candidates; (ii) R&Dactivities other than external clinical trial expenses; and (iii) generaland administrative expenses, working capital needs and other general corporatepurposes.

 

**ITEM 3.DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

On May 20, 2009, ourAnnual Meeting of Stockholders was held at our corporate offices in Fremont,California. Of the 27,372,235 shares of our common stock entitled to vote atthe meeting, 22,141,974 shares were represented at the meeting in person or byproxy, constituting a quorum. At this meeting, our stockholders voted on thefollowing two proposals:

 

(i)         Proposal to elect three directors to holdoffice as Class II directors until our 2012 Annual Meeting ofStockholders:

 
| **Name**                    | ** ** | **Shares Voted For** | ** ** | **Votes Withheld** | ** ** |
|-----------------------------|------------|--------------------------------|------------|-------------------------|------------|
| Lars  G. Ekman, M.D., Ph.D. |       | 21,922,889                     |       | 219,085                 |       |
| Keith  R. Leonard           |       | 20,831,697                     |       | 1,310,277               |       |
| Paul  J. Sekhri             |       | 20,829,524                     |       | 1,312,450               |       |

 

Our Class IIIdirectors, David Beier, Paul Goddard, Ph.D., and Herm Rosenman, will eachcontinue to serve on our Board of Directors until our 2010 Annual Meeting ofStockholders and until their respective successor is elected and qualified orsuch director’s earlier death, resignation or removal. Our Class Idirectors, Peter G. Milner, M.D. and Nicholas Simon, will each continue toserve on our Board of Directors until our 2011 Annual Meeting of Stockholdersand until their respective successor is elected and qualified or such director’searlier death, resignation or removal.

 

(ii)      Proposal to ratify the selection by theAudit Committee of our Board of Directors of Ernst & Young LLP as ourindependent registered public accounting firm for the year ending December 31,2009:

 
| **For**    | ** ** | **Votes Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------------|------------|-------------|------------|
| 21,927,643 |       | 210,918           |       | 3,413       |       |

 

**ITEM 5.OTHER INFORMATION**

 

Not applicable.

 

**ITEM 6.EXHIBITS**

 

A list of exhibits filed with this report orincorporated herein by reference is found in the Exhibit Index immediatelyfollowing the signature page 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: August 13, 2009

 

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

 

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**EXHIBITINDEX**

 
| **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.                                                        |
|                |       |                                                                                                                                                                             |
| 10.16(5)*           |       | Non-Employee  Director Compensation Arrangements.                                                                                                                                |
|                |       |                                                                                                                                                                             |
| 10.31(6)*           |       | ARYx  Therapeutics, Inc. Executive Severance Benefit Plan.                                                                                                                  |
|                |       |                                                                                                                                                                             |
| 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.                     |
|                |       |                                                                                                                                                                             |
| 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 management contract, compensatory plan orarrangement.

 

(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 Exchange Commission on August 30,2007, as amended, and incorporated by reference herein.

 

(2)          Previously filed as thelike-numbered exhibit to registrant’s Current Report on Form 8-K (File No. 001-33782),filed with the SEC on October 23, 2008 and incorporated herein byreference.

 

(3)          Previously filed as thelike-numbered exhibit to registrant’s Current Report on Form 8-K (File No. 001-33782),filed with the SEC on November 12, 2008 and incorporated herein byreference.

 

(4)          Previously filedas the like numbered exhibit to registrant’s Annual Report on Form 10-K(File No. 001-33782), filed with the SEC on March 27, 2009 andincorporate herein by reference.

 

(5)   Previously filed as the like numberedexhibit to registrant’s Quarterly Report on Form 10-Q (FileNo. 001-33782), filed with the SEC on May 14, 2009 and incorporateherein by reference.

 

(6)          Previouslyfiled as the like numbered exhibit to registrant’s Current Report on Form 8-K(File No. 001-33782), filed with the SEC on May 27, 2009 andincorporated herein by reference.

 

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