Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

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| **x**      | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934**                                                                                  |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                                                                                               |
| ** ** | **For the quarterly period ended March 31, 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            .** |

 

**Commissionfile number 001-33782**

 

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**ARYxTHERAPEUTICS, INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address ofPrincipal Executive Offices including zip code)

 

**(510)585-2200**

(Registrant’sTelephone Number, Including Area Code)

 

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

 

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

 

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

 

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

 

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

 

Asof April 30, 2009, the registrant had 27,372,235 shares of common stockoutstanding.

 

 

 

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**ARYx THERAPEUTICS, INC.**

 

**FORM 10-QFOR THE QUARTER ENDED MARCH 31, 2009**

 

**INDEX**

** **
| ** **                                                                                               | ** ** | ** **                                                                                  | ** ** | **Page**   |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|------------|
| ** **                                                                                               | ** ** | **PART I — FINANCIAL INFORMATION**                                                | ** ** | ** ** |
| ** **                                                                                               | ** ** | ** **                                                                                  | ** ** | ** ** |
| Item 1.                                                                                                  |       | Financial Statements                                                                        |       | 2          |
| Condensed Consolidated Balance Sheets as of  March 31, 2009 and December 31, 2008              |       | 2                                                                                           |
| Condensed Consolidated Statements of Operations for  the three months ended March 31, 2009 and 2008 |       | 3                                                                                           |
| Condensed Consolidated Statements of Cash Flow for the  three months ended March 31, 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 |       | 10         |
| Item 3.                                                                                                  |       | Quantitative  and Qualitative Disclosures About Market Risk                                 |       | 17         |
| Item 4T.                                                                                                 |       | Controls and  Procedures                                                                    |       | 17         |
|                                                                                                     |       |                                                                                        |       |       |
| ** **                                                                                               | ** ** | **PART II  — OTHER INFORMATION**                                                  | ** ** | ** ** |
| Item 1.                                                                                                  |       | Legal Proceedings                                                                           |       | 18         |
| Item 1A.                                                                                                 |       | Risk Factors                                                                                |       | 18         |
| Item 2.                                                                                                  |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                |       | 38         |
| Item 3.                                                                                                  |       | Defaults  Upon Senior Securities                                                            |       | 38         |
| Item 4.                                                                                                  |       | Submission  of Matters to a Vote of Security Holders                                        |       | 38         |
| Item 5.                                                                                                  |       | Other Information                                                                           |       | 38         |
| Item 6.                                                                                                  |       | Exhibits                                                                                    |       | 38         |
|                                                                                                     |       |                                                                                        |       |       |
| SIGNATURE                                                                                                |       | 39                                                                                          |

 

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**PART I — FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS**

 

**ARYxTHERAPEUTICS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Inthousands)**

 
| ** **                                      | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| ** **                                      | ** ** | **(unaudited)**    | ** ** | **(Note 1)**     | ** ** |
| **ASSETS**                                      |       |               |       |                  |       |
| Current assets:                                 |       |               |       |                  |       |
| Cash and cash equivalents                       |       | $                  | 22,433     |                  | $          | 35,999 |   |
| Marketable securities                           |       | 10,198             |       | 8,588                 |       |
| Restricted cash - current                       |       | 150                |       | 150                   |       |
| Prepaid research and development expenses       |       | 517                |       | 381                   |       |
| Other prepaid, receivable, and current  assets  |       | 664                |       | 732                   |       |
| Total current assets                            |       | 33,962             |       | 45,850                |       |
| Restricted cash                                 |       | 1,203              |       | 1,203                 |       |
| Property and equipment, net                     |       | 2,990              |       | 3,198                 |       |
| Other assets                                    |       | 842                |       | 897                   |       |
| **Total assets**                                |       | $                  | 38,997     |                  | $          | 51,148 |   |
|                                            |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**   |       |               |       |                  |       |
| Current liabilities:                            |       |               |       |                  |       |
| Accounts payable                                |       | $                  | 1,016      |                  | $          | 2,454 |   |
| Accrued compensation                            |       | 585                |       | 494                   |       |
| Accrued research and development expenses       |       | 2,537              |       | 3,832                 |       |
| Current portion of notes payable                |       | 4,833              |       | 3,404                 |       |
| Other accrued liabilities                       |       | 903                |       | 835                   |       |
| Total current liabilities                       |       | 9,874              |       | 11,019                |       |
| Deferred lease credit                           |       | 1,344              |       | 1,436                 |       |
| Notes payable                                   |       | 9,768              |       | 11,278                |       |
| Commitments and contingencies                   |       |               |       |                  |       |
| Stockholders’ equity:                      |       |               |       |                  |       |
| Common stock                                    |       | 27                 |       | 27                    |       |
| Additional paid-in capital                      |       | 181,755            |       | 181,285               |       |
| Accumulated other comprehensive income          |       | 9                  |       | 45                    |       |
| Accumulated deficit                             |       | (163,780           | )          | (153,942              | )          |
| Total stockholders’ equity                 |       | 18,011             |       | 27,415                |       |
| Total liabilities and stockholders’ equity |       | $                  | 38,997     |                  | $          | 51,148 |   |

 

The accompanying notes are an integral partof these financial statements.

 

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**ARYxTHERAPEUTICS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                    | ** ** | **For the three months ended** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                    | ** ** | **March 31,**                                 | ** ** | **March 31,** | ** ** |
| ** **                                                                    | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
| Revenue:                                                                      | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Collaboration services                                                        |       | $                                                  | —     |   | $ | 68 |   |
| Technology license fees                                                       |       | —                                             |       | 974 |   |
| Total revenue                                                                 |       | —                                             |       | 1,042 |   |
|                                                                          |       |                                               |       |   |   |
| Costs and expenses:                                                           |       |                                               |       |   |   |
| Cost of collaboration services                                                |       | —                                             |       | 68 |   |
| Research and development                                                      |       | 6,789                                              |       | 7,600 |   |
| Selling, general and administrative                                           |       | 2,603                                              |       | 2,932 |   |
| Total costs and expenses                                                      |       | 9,392                                              |       | 10,600 |   |
| Loss from operations                                                          |       | (9,392                                             | )          | (9,558 | ) |
|                                                                          |       |                                               |       |   |   |
| Interest and other income, net                                                |       | 54                                                 |       | 549 |   |
| Interest expense                                                              |       | (500                                               | )          | (494 | ) |
| Net loss                                                                      |       | (9,838                                             | )          | (9,503 | ) |
|                                                                          |       |                                               |       |   |   |
| Basic and diluted net loss per share                                          |       | $                                                  | (0.36      | ) | $ | (0.54 | ) |
| Weighted average shares used to compute  basic and diluted net loss per share |       | 27,345                                             |       | 17,631 |   |

 

The accompanying notes are an integral partof these financial statements.

 

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**ARYxTHERAPEUTICS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOW**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **For the three months ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **March 31,**                                 | ** ** | **March 31,** | ** ** |
| ** **                                                                   | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
| **Cash flows from operating activities:**                                    | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Net loss                                                                     |       | $                                                  | (9,838     | ) | $ | (9,503 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                               |       |   |   |
| Depreciation and amortization                                                |       | 293                                                |       | 271 |   |
| Amortization of warrants                                                     |       | 55                                                 |       | 175 |   |
| Impairment of long-lived assets                                              |       | 11                                                 |       | — |   |
| Stock-based compensation                                                     |       | 528                                                |       | 565 |   |
| Change in assets and liabilities:                                            |       |                                               |       |   |   |
| Prepaid research and development expenses                                    |       | (136                                               | )          | (675 | ) |
| Other prepaid, receivable, and assets                                        |       | 68                                                 |       | 233 |   |
| Accounts payable and other accrued  liabilities                              |       | (1,462                                             | )          | (218 | ) |
| Accrued compensation                                                         |       | 91                                                 |       | (481 | ) |
| Accrued research and development expenses                                    |       | (1,295                                             | )          | 621 |   |
| Deferred revenue                                                             |       | —                                             |       | (974 | ) |
| Net cash used in operating activities                                        |       | (11,685                                            | )          | (9,986 | ) |
|                                                                         |       |                                               |       |   |   |
| **Cash flows from investing activities:**                                    |       |                                               |       |   |   |
| Purchases of marketable securities                                           |       | (4,665                                             | )          | (1,100 | ) |
| Proceeds from sales of marketable  securities                                |       | —                                             |       | 2,575 |   |
| Proceeds from maturities of marketable  securities                           |       | 3,000                                              |       | 4,090 |   |
| Increase in restricted cash                                                  |       | —                                             |       | (300 | ) |
| Purchases of fixed assets                                                    |       | (77                                                | )          | (416 | ) |
| Net cash (used in) provided by investing  activities                         |       | (1,742                                             | )          | 4,849 |   |
|                                                                         |       |                                               |       |   |   |
| **Cash flows from financing activities:**                                    |       |                                               |       |   |   |
| Proceeds from exercise of stock options and  issuance of common stock        |       | 34                                                 |       | 25 |   |
| Offering cost in connection with placement  of equity                        |       | (92                                                | )          | (36 | ) |
| Proceeds from issuance of notes payable                                      |       | —                                             |       | 9,000 |   |
| Principal payments on notes payable                                          |       | (81                                                | )          | (760 | ) |
| Net cash (used in) provided by financing  activities                         |       | (139                                               | )          | 8,229 |   |
|                                                                         |       |                                               |       |   |   |
| **Net (decrease) increase in cash and cash  equivalents**                    |       | (13,566                                            | )          | 3,092 |   |
| Cash and cash equivalents at beginning of  period                            |       | 35,999                                             |       | 55,476 |   |
| **Cash and cash equivalents at end of period**                               |       | $                                                  | 22,433     |   | $ | 58,568 |   |

 

The accompanying notes are an integral partof these financial statements.

 

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**ARYxTHERAPEUTICS, INC.**

**NOTES TOCONDENSED 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**

 

***The Company***

 

ARYx is a biopharmaceutical company focused on developing a portfolioof internally 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 anticoagulant, tecarfarin (ATI-5923), designed to have the same therapeuticbenefits as warfarin, currently in Phase 2/3 clinical development for thetreatment of patients who are at risk for the formation of dangerous bloodclots; an oral antiarrhythmic agent, budiodarone (ATI-2042), designed to havethe efficacy of amiodarone in Phase 2 clinical development for thetreatment of atrial fibrillation, a form of irregular heartbeat; an oralprokinetic agent, ATI-7505, designed to have the same therapeutic benefits ascisapride in Phase 2 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 development for the treatment of schizophrenia and otherpsychiatric disorders. Additionally, we have several product candidates inpreclinical development.

 

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

*** ***

***Basis of Presentation***

 

The accompanying unaudited condensed consolidated financial statementsinclude the accounts of our wholly-owned subsidiary, ARYxTherapeutics, Ltd. All intercompany accounts and transactions have beeneliminated. These unaudited condensed consolidated financial statements havebeen prepared in accordance with U.S. generally accepted accounting principlesfor interim financial information on the same basis as the annual financialstatements and with instructions to Form 10-Q and Rule 10-01 ofRegulation S-X. Accordingly, they do not include all of the information andfootnotes required by generally accepted accounting principles for completefinancial statements. These interim financial statements include alladjustments (consisting only of normal recurring adjustments) that managementbelieves are necessary for the fair presentation of the balances and resultsfor the periods presented. Interim financial results are not necessarilyindicative of results to be expected for the full fiscal year or any futureinterim period.

 

The balance sheet data at December 31, 2008 has been derived fromour audited consolidated financial statements for the year ended December 31,2008, contained in our Annual Report on Form 10-K. The unaudited condensedconsolidated financial statements and related disclosures contained in thisreport have been prepared with the presumption that users of the interimfinancial statements have read or have access to our audited financialstatements for the preceding year. Accordingly, these interim financialstatements should be read in conjunction with our audited financial statementsand notes thereto for the year ended December 31, 2008, contained in ourAnnual Report on Form 10-K.

 

***Risks and Uncertainties***

 

As of March 31, 2009, we had $33.0 million in cash, cashequivalents and marketable securities. We believe that our cash, cashequivalents and marketable securities on hand as of March 31, 2009 will besufficient to fund our operations through the end of the first quarter of 2010.Since our inception, we have incurred significant net operating losses and, asof March 31, 2009, we had an accumulated deficit of $163.8 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 and through collaboration agreements. We expect to incur substantialadditional operating losses for the next several years and will need 

 

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substantial additional funding in order to complete the clinical trialsof our product candidates, launch and commercialize product candidates forwhich we receive regulatory approval, continue research and developmentprograms, and license or acquire additional product candidates. We will seekadditional funds through financings, collaborations or public or private debtor equity financings, and may also seek to reduce expenses related to ouroperations. There can be no assurance that such financing will be available orwill be at terms acceptable to us, or at all.

*** ***

***Use of Estimates***

 

The preparation of financial statements inconformity with U.S. generally accepted accounting principles requiresmanagement to make judgments, assumptions and estimates that affect thereported amounts in the consolidated financial statements and accompanyingnotes. On an ongoing basis, we evaluate our critical accounting policies andestimates, including those related to clinical trial accruals and stock-basedcompensation. Management bases its estimates on historical experience and onassumptions believed to be reasonable under the circumstances. Actual resultscould differ from those estimates.

 

***Comprehensive Loss***

 

Comprehensive loss is comprised of net loss and other comprehensiveincome/loss. The only component of our other comprehensive income/loss is theunrealized gains and losses on our marketable securities. Comprehensive lossfor the three months ended March 31, 2009 and 2008 was $9.9 millionand $9.6 million, respectively.

*** ***

***Net Loss Per Share***

 

Basic net loss per share is computed bydividing net loss by the weighted average number of fully vested common sharesoutstanding during the period. Diluted net loss per share is computed by givingeffect to all potential dilutive common shares, including stock options andwarrants. For all periods presented in this report, stock options and warrantswere not included in the computation of diluted net loss per share because theinclusion would provide an antidilutive effect.

 

The following table presents the calculationof basic and diluted net loss per share:

 
| ** **                                                                      | ** ** | **Three Months Ended March 31,**       | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                      | ** ** | **2009**                                    | ** ** | **2008** | ** ** |
| ** **                                                                      | ** ** | **(in thousands, except per share amount)** | ** ** |
| *Numerator:*                                                                    |       |                                        |       |   |   |
| Net loss                                                                        |       | $                                           | (9,838     | ) | $ | (9,503 | ) |
| *Denominator:*                                                                  |       |                                        |       |   |   |
| Weighted average common shares outstanding                                      |       | 27,359                                      |       | 17,659 |   |
| Less: Weighted average unvested restricted  common shares                       |       | (14                                         | )          | (28 | ) |
| Weighted average shares used in computing  basic and diluted net loss per share |       | 27,345                                      |       | 17,631 |   |
| Basic and diluted net loss per share                                            |       | $                                           | (0.36      | ) | $ | (0.54 | ) |

 

***Income Taxes***

 

We utilize theliability method of accounting for income taxes. Under this method, deferredtax assets and liabilities are determined based on differences betweenfinancial reporting bases and the tax bases of assets and liabilities and aremeasured using the enacted tax rates and laws that will be in effect when thedifferences are expected to reverse. Based on known factors, our managementcannot currently conclude that it will be more likely than not that deferredtax assets will be utilized. Accordingly, deferred tax assets have been fullyoffset by a valuation allowance.

 

As permitted under the provisions of FIN 48, we will classify interestand penalties related to unrecognized tax benefits as part of our income taxprovision, although there have been no such interest or penalties recognizedto-date.

 

***Recent Accounting Pronouncements***

 

In April 2009, the Financial Accounting Standard Board, or FASB,issued three final Staff Positions, or FSPs, intended to provide additionalapplication guidance and enhance disclosures regarding fair value measurementsand impairments of securities. FSP FAS 157-4, *DeterminingFair Value When the Volume and Level of Activity for the Asset or LiabilityHave Significantly Decreased and Identifying Transactions That Are Not Orderly*,provides guidelines for making 

 

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fair valuemeasurements more consistent with the principles presented in FASB Statement No. 157,*Fair Value Measurements*, or SFAS 157. Itreaffirms the objective of fair value measurement, which is to reflect how muchan asset would be sold for in an orderly transaction (as opposed to a distressedor forced transaction) at the date of the financial statements under currentmarket conditions. FSP FAS 107-1 and APB 28-1, *InterimDisclosures about Fair Value of Financial Instruments*, relates tofair value disclosures for any financial instruments that are not currentlyreflected on the balance sheet at fair value. Prior to issuing this FSP, fairvalues for these assets and liabilities were only disclosed once a year. TheFSP now requires these disclosures on a quarterly basis, providing qualitativeand quantitative information about fair value estimates for all those financialinstruments not measured on the balance sheet at fair value. FSP FAS 115-2 andFAS 124-2, *Recognition and Presentation ofOther-Than-Temporary Impairments*, provides additional guidancedesigned to bring greater consistency to the timing of impairment recognition,and provide greater clarity to investors about the credit and noncreditcomponents of impaired debt securities that are not expected to be sold. ThisFSP also requires increased and more timely disclosures regarding expected cashflows, credit losses, and aging of securities with unrealized losses. The FSPsare effective for interim and annual periods ending after June 15, 2009,but entities may early adopt the FSPs for the interim and annual periods endingafter March 15, 2009 only if all of them are adopted at the same time. Wedo not expect the adoption of the FSPs to have a material impact on either ourconsolidated financial position or results of operations.

 

In November 2008, the Emerging Issues Task Force, or EITF, reacheda consensus-for-exposure on EITF Issue No. 08-1, *Revenue Arrangements with Multiple Deliverables*,or EITF 08-1, which was subsequently ratified by the FASB currentlysubject to a public comment period. The Task Force discussed a model that wouldamend EITF 00-21 to require an entity to estimate the selling price of theundelivered element of accounting and allocate the arrangement considerationusing the residual method when the entity does not have vendor-specificobjective evidence or acceptable third-party evidence of the selling price forthe undelivered element of accounting. If confirmed, EITF 08-1 will beeffective prospectively for revenue arrangements entered into or modified inthe fiscal years beginning after December 15, 2009. As we do not currentlyhave any revenue arrangement with multiple deliverables, we will evaluate theimpact of EITF 08-1 for revenue arrangements that we may enter into in thefuture.

 

**2.  FairValue Measurement**

 

The following tables summarize the fair valueof our financial assets as of March 31, 2009 and December 31, 2008that were recorded at fair value on a recurring basis consistent withthe fair value hierarchy provisions of SFAS No. 157.

 
| ** **                                    | ** ** | **March 31, 2009** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|
| ** **                                    | ** ** | **Total  Fair Value**   | ** ** | **Quoted Prices in  Active Markets for  Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable Inputs  (Level 2)** | ** ** | **Significant  Unobservable Inputs  (Level 3)** | ** ** |
| ** **                                    | ** ** | **(in thousands)**      | ** ** |
| Cash and cash equivalents                     |       | $                       | 22,433     |   | $ | 22,433 |   | $ | — |   | $ | — |   |
| Marketable securities                         |       | 10,198                  |       | — |   | 10,198 |   | — |   |
| Restricted cash                               |       | 150                     |       | 150 |   | — |   | — |   |
| Total fair value of current financial  assets |       | 32,781                  |       | 22,583 |   | 10,198 |   | — |   |
| Restricted cash—non-current              |       | 1,203                   |       | 1,203 |   | — |   | — |   |
| Auction rate securities:                      |       |                    |       |   |   |   |   |   |   |
| Balance as of December 31, 2008          |       | 367                     |       | — |   | — |   | 367 |   |
| Loss on marketable securities                 |       | —                  |       | — |   | — |   | — |   |
| Balance as of March 31, 2009             |       | 367                     |       | — |   | — |   | 367 |   |
| Total fair value of financial assets          |       | $                       | 34,351     |   | $ | 23,786 |   | $ | 10,198 |   | $ | 367 |   |

 
| ** **                                    | ** ** | **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 |   | $ | 2,405 |   | $ | — |   |
| Marketable securities                         |       | 8,588                           |       | — |   | 8,588 |   | — |   |
| Restricted cash                               |       | 150                             |       | 150 |   | — |   | — |   |
| Total fair value of current financial  assets |       | 44,737                          |       | 33,699 |   | 8,588 |   | — |   |
| 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 and the fair valueof these instruments was determined by our institutional portfolio managerswhose valuations were based upon market-corroborated inputs such asbroker/dealer quotes, reported trades, bids and offers that we believe arereasonable. The fair value of our remaining auction rate security was measuredusing Level 3 inputs as determined by a discounted cash flow model thatconsiders expected cash flows from the auction rate instrument includingexpected interest payments, market yields for similarly rated instruments, ourestimates of time to liquidity for the security, and a marketability discount.

 

As of March 31, 2009, the fair value of our remaining auction rateinstrument was $367,000, net of an estimated $133,000 loss representing a 26.6%reduction in the carrying value for this instrument. We revisited ourassumptions used in the discounted cash flow model as of March 31, 2009and determined that they remained unchanged. We continue to classify thisauction rate instrument as an other non-current asset on the balance sheet aswe do not expect that the instrument will likely to become liquid in the next12 months.

** **

**3.  Revenue Recognition**

 

We recognized $68,000 for the three months ended March 31, 2008 ascollaboration service revenue in connection with our prior collaborationagreement with Procter & Gamble Pharmaceuticals, Inc., orP&G, for product formulation and manufacturing, patent filing andmaintenance, and other development services related to the ATI-7505 program.Effective with P&G’s notice of termination on July 2, 2008, we nolonger provide these support services to P&G for the development ofATI-7505; therefore those services will no longer be 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*does not have a material impact onour consolidated financial statements.

 

**4.  Debt Financing**

 

As of March 31, 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 March 31, 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 $460,000 and $456,000 for the three months ended March 31,2009 and 2008, respectively.  The totalprincipal amount borrowed under the GE agreements was $1.9 million and thetotal unpaid principal balance outstanding as of March 31, 2009, was$231,000. We recorded interest expense related to the GE loan agreements of$9,000 and $39,000 for the three months ended March 31, 2009 and 2008,respectively.  The total principal amountborrowed under the Oxford loan agreement was $1.0 million and the total unpaidprincipal balance outstanding as of March 31, 2009, was $929,000. Werecorded interest expense related to the Oxford loan agreement, includingamortization of expense related to the terminal payment and the warrant issuedunder the agreement, of $31,000 and none for the three months ended March 31,2009 and 2008, respectively.

 

**5.  Warrants**

 

We issue freestanding warrants from time to time pursuant to variouscontractual arrangements. As of March 31, 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,in whole 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,in whole or in part, at anytime at the option of the holder or deemed to havebeen automatically 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,in whole or in part, at anytime at the option of the holder or deemed to havebeen automatically 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)           Warrantsto purchase 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.

(5)           Exercisable,in whole 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 yearsbeginning after December 15, 2008, any outstanding instrument at the dateof adoption requires retrospective application of the accounting through a cumulativeeffect adjustment to retained earnings upon adoption. The adoption of EITF 07-5did not have a material impact on our consolidated financial position orresults 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 March 31,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|
| ** **                | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| ** **                | ** ** | **(in thousands)**                    | ** ** |
| Lighthouse—Warrant 1 |       | $                                     | 14         |   | $ | 23 |   |
| Lighthouse—Warrant 2 |       | 13                                    |       | 152 |   |
| Lighthouse—Warrant 3 |       | 27                                    |       | — |   |
| Oxford                    |       | 1                                     |       | — |   |
|                      |       | $                                     | 55         |   | $ | 175 |   |

 

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

 

Thecomponents of our stock-based compensation expense recognized for the threemonths ended March 31, 2009 and 2008 were as follows:

 
| ** **                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------------|------------|
| ** **                           | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| ** **                           | ** ** | **(in thousands)**                               | ** ** |
| Research and development:            |       |                                             |       |   |   |
| Officer compensation                 |       | $                                                | 68         |   | $ | 76 |   |
| Employee and consultant compensation |       | 151                                              |       | 170 |   |
| Selling, general and administrative: |       |                                             |       |   |   |
| Director and officer compensation    |       | 271                                              |       | 276 |   |
| Employee and consultant compensation |       | 38                                               |       | 43 |   |
| Total compensation expense           |       | $                                                | 528        |   | $ | 565 |   |

 

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

 

*The following discussion of our financial conditionand the results of operations should be read in conjunction with the condensedconsolidated financial statements and notes to condensed consolidated  financial statements included elsewhere inthis quarterly report on Form 10-Q. This discussion contains forwardlooking statements that involve risks and uncertainties. When reviewing thediscussion 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 companyfocused on developing a portfolio of internally discovered product candidatesdesigned to eliminate known safety issues associated with well-established,commercially successful drugs. We use our RetroMetabolic Drug Design technologyto design structurally unique molecules that retain the efficacy of theseoriginal drugs but are metabolized through a potentially safer pathway to avoidspecific adverse side effects associated with these compounds. Our productcandidate portfolio includes an oral anticoagulant, tecarfarin (ATI-5923),designed to have the same therapeutic benefits as warfarin, currently inPhase 2/3 clinical development for the treatment of patients who are atrisk for the formation of dangerous blood clots; an oral antiarrhythmic agent,budiodarone (ATI-2042), designed to have the efficacy of amiodarone in Phase 2clinical development for the treatment of atrial fibrillation, a form ofirregular heartbeat; an oral prokinetic agent, ATI-7505, designed to have thesame therapeutic benefits as cisapride in Phase 2 clinical development forthe treatment of chronic constipation, gastroparesis, functional dyspepsia,irritable bowel syndrome with constipation, and gastroesophageal refluxdisease; and a novel, next-generation atypical antipsychotic agent, ATI-9242,currently in Phase 1 clinical development for the treatment ofschizophrenia and other psychiatric disorders. Additionally, we have severalproduct candidates in preclinical development. Each of our product candidatesis an orally available, patentable new chemical entity designed to addresssimilar indications as those of the original drug upon which each is based. Ourproduct candidates target what we believe to be multi-billion dollar marketopportunities.

 

Wewere incorporated 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.

 

We are engineering potentially safer oralproduct candidates that retain the efficacy of commercially successful drugsfor well-established chronic markets. We have established proof of concept withour three leading product candidates, tecarfarin, budiodarone, and ATI-7505.The following is a summary of our product candidates that are currently inclinical development:

 

***Tecarfarin***

 

Tecarfarin is an oral anticoagulant in Phase 2/3 clinical trialsfor the treatment of patients who are at risk for the formation of dangerousblood clots, 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. In preclinical testing and in clinical testing to date, it appearsthat tecarfarin may be inherently more stable than warfarin due to itspredictable metabolism through the esterase pathway that has a much largercapacity than CYP450. The rate of anticoagulation for both warfarin andtecarfarin is measured by the standard assay known as International NormalizedRatio, or INR. We completed a Phase 2 clinical trial with tecarfarininvolving 66 patients. In this study, tecarfarin achieved a significantimprovement in the maintenance of these 

 

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patients at the targeted INR and also demonstrated a significantreduction in the occurrence of dangerously low levels of anticoagulation aswell as a reduction in the occurrence of dangerously high levels ofanticoagulation compared to these patients’ historical levels ofanticoagulation when on warfarin. We have also completed a pilot clinical trialof 50 patients to prepare for an ongoing large Phase 2/3 trial. In thepilot trial, we successfully established the trial methodologies for the currentblinded Phase 2/3 trial, and, even though the primary purpose of the pilottrial was not to measure the effectiveness of tecarfarin in achieving thepatients’ target INR, the efficacy results essentially matched those of theearlier 66 patient study. In June 2008, we initiated a double-blind,parallel group, active control Phase 2/3 clinical trial involvingapproximately 600 patients to study the efficacy of tecarfarin in ahead-to-head comparison to warfarin. We announced, on November 3, 2008,that enrollment in this Phase 2/3 study had been completed. Each patientin this study will receive a minimum of six months of treatment with eithertecarfarin or warfarin. In preliminary discussions, the U.S. Food and DrugAdministration, or FDA, indicated that the ability to maintain patients withinthe targeted INR will likely be an acceptable surrogate and primary endpointfor tecarfarin’s clinical development. Using INR maintenance as a surrogate andprimary endpoint should reduce both the size of and time to complete ourplanned clinical trials for tecarfarin compared to clinical trials measuringsurvival rates or other outcomes. Based upon our discussions with the FDA, webelieve the current Phase 2/3 clinical trial may qualify as a registrationstudy. We are actively seeking a large pharmaceutical company partner for thefull development and eventual commercialization of tecarfarin, in the event weobtain requisite regulatory approval.

 

***Budiodarone***

 

Budiodarone isan oral antiarrhythmic agent in Phase 2 clinical development for the treatmentof patients 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 reduceddrug-drug interactions. We have completed a Phase 2 pilot study (CLN-208) withbudiodarone involving six atrial fibrillation patients with implantedrecordable pacemakers who failed previous drug therapy. This pilot studysuggested that the effect of budiodarone improved as the dose increased. Basedupon the results of this pilot study, we conducted an additional Phase 2b clinicaltrial to further demonstrate the efficacy of budiodarone in patients withatrial fibrillation. The clinical trial, which enrolled 72 patients, was amulti-centered, randomized, double blind, placebo-controlled study of theefficacy and safety of budiodarone in patients with paroxysmal atrialfibrillation, or PAF. All patients entering this study had previously implantedpermanent pacemakers with appropriate diagnostic and recording capabilities. InDecember 2008, we announced successful top-line efficacy results from thisPhase 2b clinical trial. By achieving statistical significance at the twohighest doses of the three tested, the results essentially mirrored thefindings of the earlier Phase 2 pilot study also conducted in paroxysmal atrialfibrillation patients. The Phase 2b study also demonstrated that patients inthe study quickly returned to their pre-treatment level of atrial fibrillationonce the treatment ended. We have also announced the complete safety resultsfrom this Phase 2b clinical trial which indicate that budiodarone is generallysafe and well-tolerated, and appears to avoid the tissue accumulation evidentwith amiodarone. We are actively seeking a large pharmaceutical company partnerfor the full development and eventual commercialization of budiodarone, in theevent we obtain requisite regulatory approval.

 

***ATI-7505***

 

ATI-7505 is anoral prokinetic drug that speeds up the motion of contents through the gut,which has successfully completed Phase 2 clinical trials for the treatment ofmultiple gastrointestinal disorders including gastroesophageal reflux disease,or GERD, functional dyspepsia and chronic idiopathic constipation. ATI-7505 wasdesigned to have the same therapeutic benefits as cisapride, a drug marketed byJohnson & Johnson as Propulsid in the United States. Launched in 1993,cisapride was withdrawn from the market in 2000 due to serious cardiovascularside effects. These side effects occurred as blood levels of the drug rosesignificantly when CYP450 clearance was inhibited because of the presence ofother drugs cleared by the same metabolic pathway. We designed ATI-7505 to bemetabolized through the esterase pathway, eliminating metabolism through CYP450as well as eliminating the off-target cardiovascular effects. More than 900subjects have been treated with ATI-7505 as part of our clinical trial program,which includes four Phase 2 trials to date. In June 2006, we entered into acollaboration agreement with Procter & Gamble Pharmaceuticals, Inc., orP&G, to develop and commercialize ATI-7505. On July 2, 2008, we receivednotice from P&G that it elected to exercise its option to terminate thecollaboration agreement effective July 2, 2008. P&G subsequently announcedthat it is exiting pharmaceutical drug development. Upon termination of thecollaboration agreement by P&G, all rights to ATI-7505 reverted to ARYx.Also on July 2, 2008, we announced the overall successful results of a ThoroughQT study, or TQT study, on ATI-7505, which we believe supports the agent’s favorablecardiac safety profile. In March 2009, we received written confirmation fromthe FDA that based on the FDA’s review of results from our TQT study ofATI-7505, the FDA concurs with our interpretation of the results that thefindings were negative, meaning ATI-7505 does not significantly increase the QTinterval at the proposed therapeutic or 

 

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supratherapeutic doses. 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 mg 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. Weintend to seek a new partner for ATI-7505.

 

***ATI-9242***

 

ATI-9242 is a novel antipsychotic agent in Phase 1 clinicaldevelopment for the treatment of schizophrenia and other psychiatric disorders.ATI-9242’s receptor profile is targeted at the treatment of both the positiveand the negative symptoms of schizophrenia as well as the improvement ofcognitive function. To date, preclinical work has supported this profile.ATI-9242 is also designed to avoid certain drug-drug interactions by avoidingCYP450 enzymes for metabolism, as well as reduce certain metabolic problemsassociated with this class of therapy, including weight gain and type 2diabetes. The Phase 1 single-dose clinical trial, testing the safety andtolerability of ATI-9242, is underway and is expected to be completed during2009 or as financial resources allow.

 

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 nonclinical 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.

 

***Research and Development Expense***

 

Our research and development expense consistsof expenses incurred in identifying, testing and developing our productcandidates. These expenses consist primarily of fees paid to contract researchorganizations and other third parties to assist us in managing, monitoring andanalyzing our clinical trials, clinical trial costs paid to sites andinvestigators’ fees, costs of nonclinical studies including toxicity studies inanimals, costs of contract manufacturing services, costs of materials used inclinical trials and nonclinical studies, laboratory related expenses, researchand development support costs including certain regulatory, quality assurance,project management and administration, allocated expenses such as facilitiesand information technology that are used to support our research anddevelopment activities and related personnel expenses, including stock-basedcompensation. Research and development costs are expensed as incurred.

 

Clinical trial costs are a significantcomponent of our research and development expense. Currently, we conduct ourclinical trials primarily through coordination with contract researchorganizations and other third-party service providers. We recognize researchand development expense for these activities based upon a variety of factors,including actual and estimated patient enrollment, clinical site initiationactivities, direct pass-through costs and other activity-based factors.

 

The following table summarizes our researchand development expense for the three months ended March 31, 2009 and2008:

 
| ** **                                                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| ** **                                                                           | ** ** | **(in thousands)**                              | ** ** |
| Direct research and development expense by  product candidate:                       |       |                                                 |       |   |   |
| Tecarfarin                                                                           |       | $                                                    | 2,831      |   | $ | 1,586 |   |
| Budiodarone                                                                          |       | 638                                                  |       | 1,949 |   |
| ATI-7505                                                                             |       | 52                                                   |       | 75 |   |
| ATI-9242                                                                             |       | (107                                                 | )          | 546 |   |
| Other research programs                                                              |       | 44                                                   |       | 254 |   |
| Total direct research and development  expense                                       |       | 3,458                                                |       | 4,410 |   |
| Personnel, administrative and other expense                                          |       | 3,331                                                |       | 3,216 |   |
| Less: Research and development portion of  the cost of collaboration service revenue |       | —                                               |       | (26 | ) |
| Total research and development expense                                               |       | $                                                    | 6,789      |   | $ | 7,600 |   |

 

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From our inception through March 31,2009, we estimate that approximately $35.6 million of expense was incurred forour tecarfarin product candidate, approximately $25.0 million was incurred forour budiodarone product candidate, approximately $22.6 million wasincurred for our ATI-7505 product candidate, approximately $5.0 million wasincurred for our ATI-9242 product candidate, and approximately $61.2 millionwas incurred for costs related to our research and development personnel,administrative and other research programs.

 

The expenditures summarized in the abovetable reflect costs directly attributable to each product candidate and to ourother research programs. We do not allocate salaries, employee benefits, orother indirect costs to our product candidates or other research programs andhave included those expenses in “personnel, administrative and other expense”in the above table. The portion of our research and development expense that isidentified as cost of collaboration service revenue is included within aseparate category of expense in our condensed consolidated financial statementsand is subtracted from total expenses in the above table to derive totalresearch and development expense as reported in our condensed consolidatedfinancial statements.

 

At this time, due to the risks inherent inthe clinical trial process and given the various stages of development of ourproduct candidates, we are unable to estimate with any certainty the costs wewill incur in the continued development of our product candidates. Clinicaldevelopment timelines, the probability of success and development costs candiffer materially from expectations. While we are currently focused onadvancing each of our product candidates, our future research and developmentexpense will depend on the clinical success of each product candidate, as wellas ongoing assessments as to each product candidate’s commercial potential. Inaddition, we cannot forecast with any degree of certainty which product candidateswill be subject to future collaborations, when such arrangements will besecured, if at all, and to what degree such arrangements would affect ourdevelopment plans and capital requirements.

 

The process of developing and obtaining FDAapproval of products is costly and time consuming. Development activities andclinical trials can take years to complete, and failure can occur at any timeduring the development and clinical trial process. In addition, the resultsfrom early clinical trials may not be predictive of results obtained insubsequent and larger clinical trials, and product candidates in later stagesof clinical trials may fail to show the desired safety and efficacy despitehaving progressed successfully through initial clinical testing. Although ourapproach to identifying and developing new product candidates is designed tomitigate risk, the successful development of our product candidates is highlyuncertain. Further, even if our product candidates are approved for sale, theymay not be successfully commercialized and therefore the future revenue weanticipate may not materialize.

 

If we fail to complete the development of anyof our product candidates in a timely manner, it could have a material effecton our operations, financial position and liquidity. In addition, any failureby us or our partners to obtain, or any delay in obtaining, regulatoryapprovals for our product candidates could have a material adverse effect onour results of operations. A further discussion of the risks and uncertaintiesassociated with completing our programs on schedule, or at all, and certainconsequences of failing to do so are discussed in Part II—Item 1A. “RiskFactors” section of this report.

 

**Critical Accounting Policies and Significant Estimates**

 

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

 

Ourcritical accounting policies are more fully described in Note 1 of the auditedconsolidated financial statements for the year ended December 31, 2008,which are included in our annual report on Form 10-K filed with theSecurities and Exchange Commission. There have been no material changes in ourcritical accounting policies and significant estimates during the three monthsended March 31, 2009.

 

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**Results of Operations**

 

***Comparison of Three Months Ended March 31,2009 and 2008***

 

***Revenue***

 
| ** **                    | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------|------------|----------------------------------|------------|------------|------------|------------|------------|
| ** **                    | ** ** | **March 31,**               | ** ** | **Change** | ** ** |
| ** **                    | ** ** | **2009**                         | ** ** | **2008**   | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **                    | ** ** | **(in thousands, except %)**     | ** ** |
| Collaboration service revenue |       | $                                | —     |       | $          | 68         |       | $ | (68 | ) | -100 | % |
| Technology license fees       |       | —                           |       | 974        |       | (974       | )          | -100 | % |
| Total revenue                 |       | $                                | —     |       | $          | 1,042      |       | $ | (1,042 | ) | -100 | % |

 

Revenue for the three months ended March 31, 2009, as compared tothe same period in 2008, decreased by $1.0 million. Our onlysource of revenue in 2008 was in connection with our prior collaborationagreement with Procter and Gamble Pharmaceuticals, Inc., or P&G, forthe licensing of our ATI-7505 technology and for providing pharmaceuticaldevelopment and other services to P&G. The decrease in revenue was due tothe termination of thecollaboration agreement with P&G in July 2008.

 

***Cost ofCollaboration Service Revenue***

 
| ** **                            | ** ** | **Three Months Ended** | ** **   | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------|------------|----------------------------------|--------------|------------|------------|------------|------------|
| ** **                            | ** ** | **March 31,**               | ** **   | **Change** | ** ** |
| ** **                            | ** ** | **2009**                         | ** **   | **2008**   | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(in thousands, except %)**     | ** **   |
| Cost of collaboration service revenue |       | $                                |  — |       | $          |  68   |       | $ |  (68 | ) | -100 | % |
|                                       |            |                                  |              |            |            |            |            |  |  |  |  |  |

 

We incurred costs for certain servicesprovided to P&G, including costs for pharmaceutical development, patentfiling and maintenance and other activities related to the ATI-7505 program, inconnection with our prior collaboration agreement with P&G. The$68,000 decrease in cost of revenue for the three months ended March 31,2009, as compared to the sameperiod in 2008, was a result of the termination of the collaboration agreementwith P&G in July 2008.

 

***Researchand Development Expense***

*** ***
| ** **                       | ** ** | **Three Months Ended** | ** **  | ** ** | ** ** | ** **  | ** ** |
|----------------------------------|------------|----------------------------------|-------------|------------|------------|-------------|------------|
| ** **                       | ** ** | **March 31,**               | ** **  | **Change** | ** ** |
| ** **                       | ** ** | **2009**                         | ** **  | **2008**   | ** ** | **$**       | ** ** | **%** | ** ** |
| ** **                       | ** ** | **(in thousands, except %)**     | ** **  |
| Research and development expense |       | $                                |  6,789 |       | $          |  7,600 |       | $ |  (811 | ) | -11 | % |
|                                  |            |                                  |             |            |            |             |            |  |  |  |  |  |

 

For the three months ended March 31, 2009, as compared to the sameperiod in 2008, our research and development expense decreased by $811,000, or11%. The decrease was primarily due to:

 

·                  a $1.3 million reduction in expendituresfollowing the substantive completion of our budiodarone Phase 2b clinicalstudy in December 2008;

 

·                  a $700,000 reduction in expenditures relatedto the completion of five cohorts of patient studies in a ATI-9242 Phase** **1 clinical study; and

 

·                  partially offset by a $1.2 million increasein clinical trial expenditures related to the double-blinded, placebo-controlledtecarfarin Phase 2/3 clinical trial involving approximately 600 patients.

 

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

*** ***
| ** **                                  | ** ** | **Three Months Ended** | ** **  | ** ** | ** ** | ** **  | ** ** |
|---------------------------------------------|------------|----------------------------------|-------------|------------|------------|-------------|------------|
| ** **                                  | ** ** | **March 31,**               | ** **  | **Change** | ** ** |
| ** **                                  | ** ** | **2009**                         | ** **  | **2008**   | ** ** | **$**       | ** ** | **%** | ** ** |
| ** **                                  | ** ** | **(in thousands, except %)**     | ** **  |
| Selling, general and administrative expense |       | $                                |  2,603 |       | $          |  2,932 |       | $ |  (329 | ) | -11 | % |
|                                             |            |                                  |             |            |            |             |            |  |  |  |  |  |

 

The lower selling, general and administrative expense for the threemonths ended March 31, 2009 as compared to the same period in 2008 wasprimarily due to decreased costs for Sarbanes-Oxley compliance, lower generallegal expense, and lower expense for executive bonuses.

 

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***Interestand Other Income, Net***

*** ***
| ** **                     | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|----------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **March 31,**               | ** ** | **Change** | ** ** |
| ** **                     | ** ** | **2009**                         | ** ** | **2008**   | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **                     | ** ** | **(in thousands, except %)**     | ** ** |
| Interest and other income, net |       | $                                |  54   |       | $          |  549  |       | $ |  (495 | ) | -90 | % |
|                                |            |                                  |            |            |            |            |            |  |  |  |  |  |

 

Interest and otherincome, net of other expenses, consist primarily of interest income from ourinvestments in marketable securities reduced by other expenses such as statefranchise tax. Lower interest income for the three months ended March 31,2009 as compared to the same period in 2008 was attributable to lower prevailingshort-term interest rates and a lower cash balance in our investment portfolio.

 

***InterestExpense***

*** ***
| ** **       | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------|------------|----------------------------------|------------|------------|------------|------------|------------|
| ** **       | ** ** | **March 31,**               | ** ** | **Change** | ** ** |
| ** **       | ** ** | **2009**                         | ** ** | **2008**   | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **       | ** ** | **(in thousands, except %)**     | ** ** |
| Interest expense |       | $                                |  500  |       | $          |  494  |       | $ |  6 |   | 1 | % |
|                  |            |                                  |            |            |            |            |            |  |  |  |  |  |

 

The increase ininterest expense for the three months ended March 31, 2009 as compared tothe same period in 2008 was primarily due to additional equipment financingprovided to us by Oxford Finance Corporation at year end 2008.

 

**Liquidity and Capital Resources**

 
| ** **                  | ** ** | **Three Months Ended** | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **March 31,**               | ** ** |
| ** **                  | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| ** **                  | ** ** | **(in thousands)**          | ** ** |
| Cash (used in) provided by: |       |                             |       |   |   |
| Operating activities        |       | (11,685                          | )          | (9,986 | ) |
| Investing activities        |       | (1,742                           | )          | 4,849 |   |
| Financing activities        |       | (139                             | )          | 8,229 |   |
| Total cash (used) provided  |       | (13,566                          | )          | 3,092 |   |

 

As of March 31, 2009, we had$33.0 million in cash, cash equivalents and marketable securities. Webelieve that our cash, cash equivalents and marketable securities on hand as ofMarch 31, 2009 will be sufficient to fund our operations through the endof the first quarter of 2010. Since our inception, we have incurred significantnet operating losses and, as of March 31, 2009, we had an accumulateddeficit of $163.8 million. We have not achieved sustainable profitability andanticipate that we will continue to incur significant net losses for the nextseveral years. Additionally, there can be no assurance that we will achievepositive cash flow in the foreseeable future or at all.

 

Due to adverse developments in globalfinancial markets, we have experienced reduced liquidity with respect to ourinvestment in a single auction rate instrument. If the need arose to liquidatesuch security before maturity, we may experience realized losses uponliquidation. Due to the short duration of all instruments held within ourinvestment portfolio with the exception of one auction rate instrument, webelieve that we have the ability to hold all but one of these securities tomaturity when they are expected to be redeemed at par value.

 

Net cash used in operating activities was$11.7 million and $10.0 million for the three months ended March 31,2009 and 2008, respectively. Net cash used in each of these periods wasprimarily used towards the funding of our operating costs and expenses inconnection with the conduct of our research, development and administrativeactivities.

 

Cash used in, or provided by, investing activities primarily related topurchases, sales and maturities of marketable securities, as well as changes inour restricted cash and levels of capital expenditure. For the threemonths ended March 31, 2009, net purchases of marketable securities was$1.7 million as compared to net sales of marketable securities of$5.6 million for the same period in 2008. Purchases of property andequipment were $77,000 and $416,000 for the three months ended March 31,2009 and 2008, respectively. Cash used in investing activities for the threemonths ended March 31, 2008 also included a $300,000 increase inrestricted cash.

 

Net cash used in financing activities was$139,000 for the three months ended March 31, 2009, and net cash providedby financing activities was $8.2 million for the three months ended March 31,2008. Net cash used in financing activities for the three months ended March 31,2009 primarily consisted of principal payments on our long-term debt.  Net cash provided by financing activities forthe three months ended March 31, 2008 was primarily due to the utilizationof the $9.0 million loan facility extended to us by Lighthouse CapitalPartners, net of principal payments on our long-term debt.

 

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As of March 31, 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 March 31, 2009, was $12.2 million. We recorded interestexpense related to the Lighthouse loan agreements, including amortization ofexpense related to the terminal payment and the warrants issued under theagreements, of $460,000 and $456,000 for the three months ended March 31,2009 and 2008, respectively.  The totalprincipal amount borrowed under the GE agreements was $1.9 million and thetotal unpaid principal balance outstanding as of March 31, 2009, was$231,000. We recorded interest expense related to the GE loan agreements of$9,000 and $39,000 for the three months ended March 31, 2009 and 2008,respectively.  The total principal amountborrowed under the Oxford agreement was $1.0 million and the total unpaidprincipal balance outstanding as of March 31, 2009, was $929,000. Werecorded interest expense related to the Oxford loan agreement, includingamortization of expense related to the terminal payment and the warrant issuedunder the agreement, of $31,000 and none for the three months ended March 31,2009 and 2008, respectively.

 

Our future funding requirements will dependupon many factors, including:

 

·                  thescope, rate of progress, results and cost of our preclinical testing, clinicaltrials and other research and development activities;

 

·                  theterms and timing of any collaborative, licensing and other arrangements that wemay establish;

 

·                  thecost, timing and outcomes of regulatory approvals;

 

·                  thenumber and characteristics of product candidates that we pursue;

 

·                  thecost and timing of establishing sales, marketing and distribution capabilities;

 

·                  thecost of establishing clinical and commercial supplies of our product candidatesand any products that we may develop;

 

·                  thetiming, receipt and amount of sales or royalties generated, if any, from ourproduct candidates; and

 

·                  thecost of preparing, filing, prosecuting, defending and enforcing any patentclaims and other intellectual property rights.

 

We will need to raise additional funds tosupport our operations, and such funding may not be available to us onacceptable terms, or at all. If we are unable to raise additional funds whenneeded, we may not be able to continue development of our product candidates orwe could be required to delay, scale back or eliminate some or all of ourresearch and development 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 or commercializationof our products. Our failure to raise capital when needed may harm our businessand operating results.

 

**Contractual Obligations**

 

There were no materialchanges to our contractual obligations from those disclosed in our annualreport on Form 10-K filed with the Securities and Exchange Commission on March 27, 2009, other than scheduled payments made through March 31,2009.

 

**Recent Accounting Pronouncements**

 

See Note 1 of the Notes to our CondensedConsolidated Financial Statements included elsewhere in this report for recentaccounting pronouncements that could have an effect on us.

 

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**Off-Balance Sheet Arrangements**

 

Since inception, except for standard operatingleases, we have not engaged in any off-balance sheet arrangements, includingthe use of structured finance, special purpose entities or variable interestentities.

 

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

 

There were no material changes to our market riskfrom those disclosed in our annual report on Form 10-K filed with theSecurities and Exchange Commission on March 27, 2009.

 

**ITEM 4T. CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controlsand Procedures***

 

Asof March 31, 2009, an evaluation was performed by management, with theparticipation of our Chief Executive Officer and Chief Financial Officer, ofthe effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15-d and 15(e) under the Securities Exchange Act of 1934, as amended).Disclosure controls and procedures are controls and procedures that aredesigned to ensure that information required to be disclosed in our reportsfiled or submitted under the Securities Exchange Act of 1934, as amended, isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms. Based on thatevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that, subject to the limitations described below, our disclosurecontrols and procedures were effective as of March 31, 2009.

 

***Limitations on the Effectiveness ofControls***

 

Our management, including our Chief Executive Officer andChief Financial Officer,does not expect that our disclosure controls and procedures or our internalcontrols will prevent all error and all fraud. A control system, no matter howwell conceived and operated, can provide only reasonable, not absolute,assurance that the objectives of the control system are met. Because of theinherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that all control issues and instances of fraud, 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.

 

***Changesin Internal Control over Financial Reporting***

 

No change was made in our internal control overfinancial reporting during the quarter ended March 31, 2009 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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**PART II— OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

From time to time we are involved in legal proceedings arising in theordinary course of our business. We believe there is no litigation pending thatcould have, individually or in the aggregate, a material adverse effect on ourresults of operations or financial condition.

 

**ITEM 1A. RISK FACTORS**

 

*We have identified the followingrisks and uncertainties that may have a material adverse effect on ourbusiness, financial condition or results of operations. The risks describedbelow are not the only ones we face. Additional risks not presently known to usor that we currently believe are immaterial may also significantly impair ourbusiness operations. Our business could be harmed by any of these risks.**Thetrading price of our common stock could decline due to any of these risks, andour investors may lose all or part of their investment.**We have marked with anasterisk (*) those risks described below that reflect substantive changesfrom the risks described in our Annual Report on Form 10-K for the yearended December 31, 2008, filed with the Securities and Exchange Commissionon March 27, 2009. In assessing these risks, you should also refer to theother information contained in this quarterly report on Form 10-Q,including our financial statements and related notes.*

 

**Risks Related to Our Business**

 

***We will needsubstantial additional funding and may be unable to raise capital when needed,which would force us to limit or cease our operations and related productdevelopment programs.****

 

Our ability to continue operations isdependent upon our ability to obtain substantial additional capital. Ouroperations have consumed substantial amounts of cash since inception. We expectto continue to spend substantial amounts of cash to fund our operations,including research and development expenses and costs associated with theconduct of clinical trials for our product candidates. It is our intention toenter into collaboration arrangements to commercialize our product candidates.Within those arrangements, we may retain the commercial right to co-promote ourproducts to selected physicians through a specialty sales force. However,should the collaboration arrangements fail to provide sufficient revenue tofund our operations adequately, we will need to raise additional capital tofund our operations and complete development of our product candidates. If anyof our product candidates receive regulatory approval for commercial sale, wemay need to raise additional capital to fund our portion of thecommercialization efforts. Our future funding requirements will depend on manyfactors, including:

 

·                  thescope, rate of progress, results and cost of our preclinical testing, clinicaltrials and other research and development activities;

 

·                  theterms and timing of any collaborative, licensing and other arrangements that wemay establish;

 

·                  thecost, timing and outcomes of regulatory approvals;

 

·                  thenumber and characteristics of product candidates that we pursue;

 

·                  thecost and timing of establishing sales, marketing and distribution capabilitiesfor our specialty sales force;

 

·                  thecost of establishing clinical and commercial supplies of our product candidatesand any products that we may develop;

 

·                  thetiming, receipt and amount of sales or royalties, if any, from our potentialproducts;

 

·                  thecost of preparing, filing, prosecuting, defending and enforcing any patentclaims and other intellectual property rights; and

 

·                  theextent to which we acquire or invest in businesses, products or technologies,although we currently have no commitments or agreements relating to any ofthese types of transactions.

 

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Until we can generate a sufficient amount ofproduct revenue, if we ever do, we expect to finance future cash needs throughcorporate collaboration and licensing arrangements, public or private equityofferings, debt financings or through interest income earned on cash balances.

 

If we raise additional funds by issuingequity securities, our stockholders will experience dilution. Any debtfinancing or additional equity that we raise may contain terms that are notfavorable to our stockholders or us. If we raise additional funds throughcollaboration and licensing arrangements with third parties, we may be requiredto relinquish some rights to our technologies or our product candidates, grantlicenses on terms that are not favorable to us or enter into a collaborationarrangement for a product candidate at an earlier stage of development than wemight otherwise choose.

 

We do not expect our existing capitalresources to be sufficient to enable us to fund the completion of thedevelopment of any of our product candidates. Although we believe our currentcash on hand is sufficient to fund our operations through the end of the firstquarter of 2010, our operating plan may change, and we may need additionalfunds sooner than planned to meet operational needs and capital requirementsfor product development and commercialization. Additional funds may not beavailable when we need them on terms that are acceptable to us, or at all. If adequatefunds are not available on a timely basis, we may:

 

·                  terminateor delay clinical trials for one or more of our product candidates;

 

·                  reduceour headcount and capital expenditures;

 

·                  delayour establishment of sales and marketing capabilities or other activities thatmay be necessary to commercialize our product candidates; or

 

·                  curtailsignificant drug research and development programs that are designed toidentify new product candidates.

 

***We have incurredsignificant operating losses since inception and expect to continue to incursubstantial and increasing losses for the foreseeable future. We may neverachieve or sustain profitability.***

 

We have a limited operating history and haveincurred significant losses since our inception. As of March 31, 2009, wehad an accumulated deficit of approximately $163.8 million. We expect ourresearch and development expenses to continue to increase as we continue toexpand our development programs subject to adequate funding. Subject toregulatory approval for any of our product candidates, we expect to incursignificant expenses associated with the potential establishment of a NorthAmerican specialty sales force and increased manufacturing expenses. Althoughit is not expected to occur in the next several years, the cost of establishinga 100 person North American specialty sales force will be substantial. As aresult, we expect to continue to incur substantial and increasing losses forthe foreseeable future. These losses have had and will continue to have anadverse effect on our stockholders’ equity and working capital.

 

Because of the numerous risks anduncertainties associated with drug development, we are unable to predict thetiming or amount of increased expenses or when or if we will be able to achieveor sustain profitability. Currently, we have no products approved forcommercial sale, and, to date, we have not generated any product revenue. Wehave financed our operations primarily through the sale of equity securities,capital lease and equipment financings, debt financings and a single corporatepartnership with P&G that was terminated in July 2008. We have devotedsubstantially all of our efforts to research and development, includingclinical trials. If we are unable to develop and commercialize any of ourproduct 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.

 

***Our success dependssubstantially on our most advanced product candidates, which are still underdevelopment. If we are unable to bring any or all of these product candidatesto market, or experience significant delays in doing so, our ability togenerate product revenue and our likelihood of success will be harmed.***

 

Our most advanced product candidate,tecarfarin, entered Phase 2/3 clinical trials in June 2008. Twoadditional product candidates, budiodarone and ATI-7505, are in Phase 2clinical trials and a fourth product candidate, ATI-9242, entered into aPhase 1 clinical trial in April 2008. Our ability to generate productrevenue in the future will depend heavily on the successful development andcommercialization of these product candidates. Our other product candidates arein the discovery stage. Any of our product candidates could be unsuccessful fora variety of reasons, including that they:

 

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·                  maynot demonstrate acceptable safety and efficacy in preclinical studies or clinicaltrials or otherwise may not meet applicable regulatory standards for approval;

 

·                  maynot offer therapeutic, safety or other improvements over existing or futuredrugs used to treat the same conditions;

 

·                  maynot be capable of being produced in commercial quantities at acceptable costs;or

 

·                  maynot be accepted in the medical community or by third-party payors.

 

We do not expect any of our current productcandidates to be commercially available in the next several years, if at all.If we are unable to make our product candidates commercially available, we willnot generate product revenues and we will not be successful. The results of ourclinical trials to date do not provide assurance that acceptable efficacy orsafety will be shown upon completion of Phase 3 clinical trials.

 

***Global credit andfinancial market conditions could negatively impact the value of our currentportfolio of cash equivalents or short-term investments.***

 

Currently, there is turmoil in the U.S.economy due to a global credit crisis that has resulted in tightening creditmarkets and rising liquidity concerns across most industries, including thebanking and investments sector. While as of the date of this filing, we are notaware of any material losses, or other significant deterioration in the fairvalue of our cash equivalents or investments in marketable securities since March 31,2009, 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.

 

***In periods ofworsening economic conditions, it may be difficult and costly for us to raiseadditional capital.***

 

As a result of worsening market conditions,banks and other credit grantors have faced liquidity concerns and havetightened their lending standards, investors have become more risk adverse andeconomic growth has been negatively impacted. These factors are contributing toreduced credit availability and rising costs for issuers needing to raiseadditional capital. If these factors continue to affect the credit and equitymarkets, our ability to raise capital may be adversely affected, if notcompletely hindered.

 

***We expect to dependon collaborative arrangements to complete the development and commercializationof each of our product candidates. Potential collaborative arrangements willlikely place the development of our product candidates outside of our controland will likely require us to relinquish important rights or may otherwise beon terms unfavorable to us.***

 

We plan to enter into collaborativearrangements with third parties to develop and commercialize each of our leadproduct candidates. Dependence on collaborative arrangements for developmentand commercialization of our product candidates will subject us to a number ofrisks, including:

 

·                  wemay not complete a collaborative arrangement in time to avoid delays inclinical development, if at all, and if no collaborative arrangement isachieved, product development may be halted altogether;

 

·                  wemay not be able to control the amount and timing of resources that ourcollaborators may devote to the development or commercialization of productcandidates or to their marketing and distribution;

 

·                  collaboratorsmay delay clinical trials, provide insufficient funding for a clinical trialprogram, stop a clinical trial or abandon a product candidate, repeat orconduct new clinical trials or require a new formulation of a product candidatefor clinical testing;

 

·                  wemay have limited control over our clinical trial design;

 

·                  disputesmay arise between us and our collaborators that result in the delay ortermination of the research, development or commercialization of our productcandidates or that result in costly litigation or arbitration that divertsmanagement’s attention and resources;

 

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·                  ourcollaborators may experience financial difficulties;

 

·                  collaboratorsmay not properly maintain or defend our intellectual property rights or may useour proprietary information in such a way as to invite litigation that couldjeopardize or invalidate our proprietary information or expose us to potentiallitigation;

 

·                  businesscombinations or significant changes in a collaborator’s business strategy mayadversely affect a collaborator’s willingness or ability to fulfill itsobligations under any arrangement;

 

·                  acollaborator could independently move forward with a competing productcandidate developed either independently or in collaboration with others,including our competitors; and

 

·                  anycollaborative arrangement may be terminated or allowed to expire, which woulddelay the development and may increase the cost of developing our productcandidates.

 

***Collaborativearrangements do not currently exist for any of our product candidates. If we donot establish collaborations for each of our tecarfarin, budiodarone, ATI-9242and ATI-7505 product candidates or future product candidates, we may have toalter our development and commercialization plans.***

 

Our strategy includes selectivelycollaborating with leading pharmaceutical and biotechnology companies to assistus in furthering the development and potential commercialization of some of ourproduct candidates, including tecarfarin, budiodarone, ATI-7505 and ATI-9242.We intend to seek partners because the commercialization of each of our firstfour product candidates involves a large, primary care market that must beserved by large sales and marketing organizations and because we do notcurrently have the capabilities to perform Phase 3 clinical trials. Weface significant competition in seeking appropriate collaborators, and thesecollaborations are complex and time-consuming to negotiate and document. We maynot be able to negotiate collaborations on acceptable terms, if at all. We areunable to predict when, if ever, we will enter into any collaborations becauseof the numerous risks and uncertainties associated with establishingcollaborations. If we are unable to negotiate an acceptable collaboration, wemay have to curtail the development of a particular product candidate, reduceor delay its development program or one or more of our other developmentprograms, delay its potential commercialization or reduce the scope of oursales or marketing activities or increase our expenditures and undertakedevelopment or commercialization activities at our own expense. If we elect toincrease our expenditures to fund development or commercialization activitieson our own, we may need to obtain additional capital, which may not beavailable to us on acceptable terms, if at all. If we do not have sufficientfunds, we will not be able to bring our product candidates to market andgenerate product revenues.

 

***The commercialsuccess of our potential collaborations will depend in part on the developmentand marketing efforts of our potential partners, over which we will havelimited control. If our collaborations are unsuccessful, our ability to developand commercialize and to generate future revenue from the sale of our productswill be significantly reduced.***

 

Our dependence on future collaborationarrangements will subject our company to a number of risks. Our ability todevelop and commercialize each of our product candidates will depend on our andour potential collaboration partner(s)’ ability to establish the safety andefficacy of each respective product candidate, obtain and maintain regulatoryapprovals and achieve market acceptance of the product candidate(s) oncecommercialized. Our potential collaboration partner(s) may elect to delayor terminate development of our product candidates, independently develop productsthat compete with ours, or fail to commit sufficient resources to the marketingand distribution of our product candidates. The termination of a collaborationagreement may cause us to incur additional and unanticipated costs that may bematerial to our operations.

 

Business combinations, significant changes inbusiness strategy, litigation and/or financial difficulties may also adverselyaffect the willingness or ability of our potential collaboration partners tofulfill their obligations to us. If a partner fails to perform in the manner weexpect, our potential to develop and commercialize the respective productcandidate(s) through other collaborations and to generate future revenuefrom the sale of the product candidate(s) may be significantly reduced. Ifa conflict of interest arises between us and our collaboration partner(s), theymay act in their own self-interest and not in the interest of our company orour stockholders. 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 ableto obtain required regulatory approvals, we will not be able to commercializeour product candidates, our ability to generate revenue will be materiallyimpaired and our business will not be successful.***

 

Our product candidates and the activitiesassociated with their development and commercialization are subject tocomprehensive regulation by the FDA and other federal and state regulatoryagencies in the United States and by comparable authorities in other countries.The inability to obtain FDA approval or approval from comparable authorities inother countries would prevent us and our collaborative partners fromcommercializing our product candidates in the United States or other countries.Future collaborative agreements will likely cause us to give up control ofinteractions and regulatory approval processes with the FDA and otherregulatory bodies. We or our partners may never receive regulatory approval forthe commercial sale of any of our product candidates. We have only limitedexperience in preparing and filing the applications necessary to gainregulatory approvals and have not received regulatory approval to market any ofour product candidates in any jurisdiction. The process of applying forregulatory approval is expensive and time-consuming, and can vary substantiallybased upon the type, complexity and novelty of the product candidates involved.

 

Because our product candidates are modeledafter drugs which are known to have safety problems, the FDA and otherregulatory agencies may require additional safety testing which may delay ourclinical progress, increase our expected costs or make further developmentunfeasible. For instance, because of known problems with the drug after whichit was modeled, we were required to conduct significant monitoring for cardiactoxicity in our clinical studies of ATI-7505.

 

Changes in regulatory approval policiesduring the development period, changes in, or the enactment of, additionalregulations or statutes or changes in the regulatory review team for eachsubmitted product application may cause delays in the approval or rejection ofan application. Even if the FDA or a foreign regulatory agency approves aproduct candidate, the approval may impose significant restrictions on theindicated uses, conditions for use, labeling, advertising, promotion, marketingand/or production of such product and may impose requirements for post-approvalstudies, including additional research and development and clinical trials. TheFDA and other agencies also may impose various civil or criminal sanctions forfailure to comply with regulatory requirements, including substantial monetarypenalties and withdrawal of product approval.

 

The FDA has substantial discretion in theapproval process and may refuse to accept any application or decide that ourdata are insufficient for approval and require additional preclinical, clinicalor other studies. For example, varying interpretations of the data obtainedfrom preclinical and clinical testing could delay, limit or prevent regulatoryapproval of a product candidate. Moreover, the FDA may not agree that certaintarget indications are approvable. For instance, the FDA has never approved adrug for postprandial distress syndrome, or PDS, and we cannot be certain thatthe FDA will recognize PDS as an indication for which ATI-7505 or other drugscan be approved. As another example, while we believe we have clear directionfrom the FDA as to the development path for our tecarfarin product candidatebased on our initial discussions, the FDA may change their judgment on theappropriate development pathway for tecarfarin at any time. Similarly, theclinical trials to be required by the FDA for approval of new anti-arrythmictherapies may change as they consider the approval of similar therapiessubmitted by competing pharmaceutical companies.

 

We will need to obtain regulatory approvalfrom authorities in foreign countries to market our product candidates in thosecountries. We have not yet initiated the regulatory process in any foreignjurisdictions. Approval by one regulatory authority does not ensure approval byregulatory authorities in other jurisdictions. If we fail to obtain approvalsfrom foreign jurisdictions, the geographic market for our product candidateswould be limited.

 

***Safety issuesrelating to our product candidates or the original drugs upon which our productcandidates have been modeled, or relating to approved products of third partiesthat are similar to our product candidates, could give rise to delays in theregulatory approval process.***

 

Discovery of previously unknown problems withan approved product may result in restrictions on its permissible uses, includingwithdrawal of the medicine from the market. Each of the opportunities uponwhich we have chosen to focus is based upon our belief that our RetroMetabolicDrug Design technology can be used to create a new product based upon anexisting product which is efficacious in treating a specific condition, butwhich has a known safety problem. Each of our four lead product candidates ismodeled on drugs which have significant safety problems. Tecarfarin is modeledon warfarin which is known to have safety risks because of its potential forbleeding and for drug-drug interactions with numerous other drugs as listed onthe package insert for the product. Budiodarone is modeled on amiodarone whichis used, but not approved, for atrial fibrillation in spite of known safetyproblems due to its accumulation in the body and interaction with other drugs.Both amiodarone and budiodarone contain iodine which can accumulate in thethyroid and must be monitored for safety purposes. In addition, budiodarone ispartially metabolized by CYP450 and, at certain levels has caused drug-druginteractions with warfarin, which increased INR and could increase the risk ofhemorrhage complications. ATI-9242 is 

 

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modeled to retain certain of the positive features of the class ofatypical antipsychotic drugs while lessening certain of the safety issues thatvary but exist within the class. The receptor profile which yields the positiveand avoids the negative features of this class of drugs is a matter of greatdebate. While we have designed ATI-9242 to have an appropriate balance across avery complex set of receptors, we may have targeted an inappropriate profile orthe profile attained may result in an unanticipated lack of efficacy or safetyproblems. ATI-7505 is modeled on cisapride which was withdrawn from the marketdue to fatal cardiac problems. Although we have designed our drugs to largelyaddress each of the original drugs’ key safety problems, we will need tocontinue to demonstrate this through continued clinical testing. It is possiblethat the FDA may impose additional requirements on the development or approvalof our products because of its concern about the original drug’s safetyproblems. These potential additional barriers could delay, increase the costof, or prevent the commercialization of our product candidates.

 

Our product candidates are engineered to bebroken down by the body’s natural metabolic processes in a manner we believe tobe safer than that of the original drug. There can be no assurance that theproducts we develop will actually be metabolized as we expect. While we havedesigned the breakdown products to be safe, it is possible that there will beunexpected toxicity associated with these breakdown products that could causeour products to be poorly tolerated by, or toxic to, humans. Additionally,while we believe we have addressed the key safety problem of each of theoriginal drugs, it is possible that our change to the chemical structure mayresult in new unforeseen safety issues. Any unexpected toxicity or suboptimaltolerance of our products would delay or prevent commercialization of theseproduct candidates. Additionally, problems with approved products marketed bythird parties that utilize the same therapeutic target as our productcandidates could adversely affect the development of our product candidates.For example, the product withdrawals of Vioxx by Merck & Co., Inc.and Bextra by Pfizer because of safety issues caused other drugs that have thesame therapeutic target, such as Celebrex from Pfizer, to receive additionalscrutiny from regulatory authorities. Another prokinetic, tegaserod marketed byNovartis Pharmaceuticals Corporation as Zelnorm, was temporarily withdrawn fromthe market and then reintroduced in a very limited manner due to certaincardiac effects reportedly related to its off-target effects. It is possiblethat we or a future collaboration partner may be required by regulatoryagencies to perform tests, in addition to those we have planned, in order todemonstrate that ATI-7505 does not have the safety problems associated withZelnorm. Any failure or delay in commencing or completing clinical trials orobtaining regulatory approvals for our product candidates would delaycommercialization of our product candidates and severely harm our business andfinancial condition.

 

***Any failure or delayin commencing or completing clinical trials for our product candidates couldseverely harm our business.***

 

To date, we have not completed the clinicaltrial program of any product candidate. The commencement and completion ofclinical trials for our product candidates may be delayed or terminated as aresult of many factors, including:

 

·                  our inability or the inability of ourcollaborators or licensees to manufacture or obtain from third partiesmaterials sufficient for use in preclinical studies and clinical trials;

 

·                  delaysin patient enrollment, which we previously experienced in certain trials, andvariability in the number and types of patients available for clinical trials;

 

·                  difficultyin maintaining contact with patients after treatment, resulting in incompletedata;

 

·                  pooreffectiveness of product candidates during clinical trials;

 

·                  poorpatient compliance while participating in one of our clinical trials;

 

·                  unforeseensafety issues or side effects; and

 

·                  governmentalor regulatory delays and changes in regulatory requirements, policies andguidelines.

 

Any delay in commencing or completingclinical trials for our product candidates would delay commercialization of ourproduct candidates and severely harm our business and financial condition. Itis also possible that none of our product candidates will complete clinicaltrials in any of the markets in which our collaborators or we intend to sellthose product candidates. Accordingly, our collaborators or we would notreceive the regulatory approvals needed to market our product candidates, whichwould severely harm our business and financial condition.

 

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***We rely on thirdparties to conduct our clinical trials. If these third parties do not performas contractually required or expected, we may not be able to obtain regulatoryapproval for or commercialize our product candidates.***

 

We do not have the ability to independentlyconduct clinical trials for our product candidates, and thus for each of ourproduct candidates we must rely on third parties such as contract researchorganizations, medical institutions, clinical investigators and contractlaboratories, to conduct our clinical trials. We have, in the ordinary courseof business, entered into agreements with these third parties. To date, we haveutilized numerous vendors to provide clinical trial management, data collectionand analysis and laboratory and safety analysis services to us in the conductof our clinical trials. In addition, to date we have conducted our clinicaltrials at numerous sites in North America and Europe. Nonetheless, we areresponsible for confirming that each of our clinical trials is conducted inaccordance with its general investigational plan and protocol. Moreover, theFDA requires us to comply with regulations and standards, commonly referred toas good clinical practices, for conducting and recording and reporting theresults of clinical trials to assure that data and reported results arecredible and accurate and that the trial participants are adequately protected.Our reliance on third parties that we do not control does not relieve us ofthese responsibilities and requirements. If these third parties do notsuccessfully carry out their contractual duties or regulatory obligations ormeet expected deadlines, if the third parties need to be replaced or if thequality or accuracy of the data they obtain is compromised owing to the failureto adhere to our clinical protocols or regulatory requirements or for otherreasons, our clinical trials may be extended, delayed, suspended or terminated,and we may not be able to obtain regulatory approval for, or successfullycommercialize, our product candidates.

 

***If some or all ofour patents expire, are invalidated or are unenforceable, or if some or all ofour patent applications do not yield issued patents or yield patents withnarrow claims, competitors may develop competing products using ourintellectual property and our business will suffer.***

 

Our success will depend in part on ourability to obtain and maintain patent and trade secret protection for ourtechnologies and product candidates both in the United States and othercountries. When referring to “our” patents and other intellectual property inthis section, we are referring both to patents and other intellectual propertythat we own or license. We rely on composition of matter patents for thecompounds we develop. We cannot guarantee that any patents will issue from anyof our pending or future patent applications. Alternatively, a third party maysuccessfully circumvent our patents. Our rights under any issued patents maynot provide us with sufficient protection against competitive products orotherwise cover commercially valuable products or processes.

 

The degree of future protection for ourproprietary technologies and product candidates is uncertain because legalmeans afford only limited protection and may not adequately protect our rightsor permit us to gain or keep our competitive advantage. For example, as appliedto both existing and future patents and other intellectual property:

 

·                  we might nothave been the first to make the inventions covered by each of our pendingpatent applications and issued patents;

 

·                  wemight not have been the first to file patent applications for the disclosedinventions;

 

·                  othersmay independently develop similar or alternative technologies or duplicate ourtechnologies;

 

·                  itis possible that none of our pending patent applications will result in issuedpatents;

 

·                  anypatents issued to us or our collaborators may not provide protection forcommercially viable products or may be challenged by third parties;

 

·                  thepatents of others may have an adverse effect on our ability to do business; or

 

·                  regulatorsor courts may retroactively diminish the value of our intellectual property.

 

Even if valid and enforceable patents coverour product candidates and technologies, the patents will provide protectiononly for a limited amount of time. As our patents are based on a parent drugwhere much research has been conducted, we may encounter many competitive patentsfrom covered analogs of the parent drug. Our know-how and trade secrets mayonly provide a competitive advantage for a short amount of time. Furthermore,we cannot guarantee that our patents, present or future, will have scopesufficient to prevent competing products.

 

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Our ability and our potential collaborators’ability to obtain and enforce patents is highly uncertain because of thecomplexity of the scientific and legal issues involved and the subjectivenature of issues upon which reasonable minds may differ. Legislative, judicial,and administrative bodies, both foreign and domestic, may issue laws, decisions,and regulations, respectively, that (a) detrimentally affect our abilityto obtain protection for our technologies, (b) increase our costs ofobtaining and maintaining patents, (c) detrimentally affect our ability toenforce our existing patents, (d) narrow the scope of our patentprotection, and/or (e) otherwise diminish the value of our intellectualproperty in any of the following ways: 1) U.S. Federal Courts and foreignjudicial authorities may render decisions that alter the application of thepatent laws and detrimentally affect our ability to enforce our patents andobtain patent protection for our technologies; 2) the U.S. Patent andTrademark Office, or USPTO, and foreign counterparts may change the nature ofhow patent applications are examined and issue regulations that detrimentallyaffect our ability to obtain patent protection for our technologies and/orincrease the costs for obtaining and maintaining protection; and/or3) Congress and other foreign legislative bodies may make changes to theirrespective patent laws that may make obtaining and enforcing patents moredifficult and/or costly, and/or otherwise diminish the value of ourintellectual property or narrow the scope of our patent protection.

 

Even if patents are issued regarding ourproduct candidates or methods of using them, those patents can be challenged byour competitors who can argue such patents are invalid and/or unenforceable.Defending against such challenges could be costly, and the outcome isinherently uncertain and may result in the loss of some or all of our rights.Patents also may not protect our product candidates if competitors devise waysof making these or similar product candidates without legally infringing ourpatents. The Federal Food, Drug and Cosmetic Act and FDA regulations andpolicies provide incentives to manufacturers to challenge patent validity orcreate modified, noninfringing versions of a drug in order to facilitate theapproval of generic substitutes. These same types of incentives encouragemanufacturers to submit new drug applications that rely on literature andclinical data not prepared for or by the drug sponsor.

 

Similarly, we may choose to challenge thepatents and other rights alleged or asserted by third parties. Such challenges,whether judicial or administrative in nature, could be costly and the outcomeuncertain. A negative outcome could detrimentally effect our ability to dobusiness.

 

In addition, we may enter into agreements tolicense technologies and patent rights. Should we fail to comply with the termsof those license agreements, including payment of any required maintenance feesor royalties, or should the licensors fail to maintain their licensed interestin the licensed patents, we could lose the rights to those technologies andpatents.

 

As of March 31, 2009, we held 44 issuedor allowed U.S. patents and had 17 patent applications pending before theUSPTO. For some of our inventions, corresponding foreign patent protection ispending. Of the 44 U.S. patents that we hold, 39 patents are compound andcomposition related, having expiration dates from 2013 to 2025. The compositionof matter patent for tecarfarin, our compound for anticoagulation, issued in August 2007and has an expiration date in 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. 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. The composition of matterpatent for ATI-7505, our compound for the treatment of gastrointestinaldisorders, issued in February 2007 and has an expiration date in 2025.Although third parties may challenge our rights to, or the scope or validityof, our patents, to date we have not received any communications from thirdparties challenging our patents or patent applications covering our clinicalcandidates.

 

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

 

Our research and development collaboratorsmay have rights to publish data and other information in which we have rights.In addition, we sometimes engage individuals or entities to conduct researchthat may be relevant to our business. The ability of these individuals orentities to publish or otherwise publicly disclose data and other informationgenerated during the course of their research is subject to certain contractuallimitations. In most cases, these individuals or entities are at the leastprecluded from publicly disclosing our confidential information and are onlyallowed to disclose other data or information generated during the course ofthe research after we have been afforded an opportunity to consider whetherpatent and/or other proprietary protection should be sought. If we do not applyfor patent protection prior to such publication or if we cannot otherwisemaintain the confidentiality of our technology and other confidentialinformation, then our ability to receive patent protection or protect ourproprietary information may be jeopardized.

 

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***Failure toadequately protect our trade secrets and other intellectual property couldsubstantially harm our business and results of operations.***

 

We also rely on trade secrets to protect ourtechnology, especially where we do not believe that patent protection isappropriate or obtainable. This is particularly true for our RetroMetabolicDrug Design technology. However, trade secrets are difficult to protect. Ouremployees, consultants, contractors, outside scientific collaborators and otheradvisors are required to sign confidential disclosure agreements but they mayunintentionally or willfully disclose our confidential information tocompetitors. Enforcing a claim that a third party illegally obtained and isusing our trade secrets is expensive and time-consuming, and the outcome isunpredictable. Failure to obtain or maintain trade secret protection couldadversely affect our competitive business position.

 

***Third-party claimsof intellectual property infringement would require us to spend significanttime and money and could prevent us from developing or commercializing ourproducts.***

 

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

 

·                  incursubstantial monetary damages;

 

·                  encountersignificant delays in marketing our products; and

 

·                  beunable to conduct or participate in the manufacture, use or sale of ourproducts or methods of treatment.

 

Similarly, if we initiate suits to defend ourpatents, such litigation could be costly and there is no assurance we would besuccessful in such processes. Any legal action against our collaborators or usclaiming damages and seeking to enjoin commercial activities relating to theaffected products and processes could, in addition to subjecting us topotential liability for damages, require our collaborators or us to obtain alicense to continue to manufacture or market the affected products andprocesses. Licenses required under any of these patents may not be available oncommercially acceptable terms, if at all. Failure to obtain such licenses couldmaterially and adversely affect our ability to develop, commercialize and sellour product candidates. We believe that there may continue to be significantlitigation in the biotechnology and pharmaceutical industry regarding patentand other intellectual property rights. If we become involved in litigation, itcould consume a substantial portion of our management and financial resourcesand we may not prevail in any such litigation.

 

Furthermore, our commercial success willdepend, in part, on our ability to continue to conduct research to identifyadditional product candidates in current indications of interest oropportunities in other indications. Some of these activities may involve theuse of genes, gene products, screening technologies and other research toolsthat are covered by third-party patents. In some instances, we may be requiredto obtain licenses to such third-party patents to conduct our research anddevelopment activities, including activities that may have already occurred. Itis not known whether any license required under any of these patents would bemade available on commercially acceptable terms, if at all. Failure to obtainsuch licenses could materially and adversely affect our ability to maintain apipeline of potential product candidates and to bring new products to market.If we are required to defend against patent suits brought by third partiesrelating to third-party patents that may be relevant to our researchactivities, or if we initiate such suits, we could incur substantial costs inlitigation. Moreover, the results of any such litigation are uncertain, and anadverse result from any legal action in which we are involved could subject usto damages and/or prevent us from conducting some of our research anddevelopment activities.

 

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***If third parties donot manufacture our product candidates in sufficient quantities or at anacceptable cost, clinical development and commercialization of our productcandidates would be delayed.***

 

We presently do not have sufficientquantities of our product candidates to complete clinical trials of any of ourlead product candidates. We do not currently own or operate manufacturingfacilities, and we rely and expect to continue to rely on a small number ofthird-party manufacturers and active pharmaceutical ingredient formulators forthe production of clinical and commercial quantities of our product candidates.We do not have long-term agreements with any of these third parties, and ouragreements with these parties are generally terminable at will by either partyat any time. If for any reason, these third parties are unable or unwilling toperform under our agreements or enter into new agreements, we may not be ableto locate alternative manufacturers or formulators or enter into favorableagreements with them. Any inability to acquire sufficient quantities of ourproduct candidates in a timely manner from these third parties could delayclinical trials and prevent us from developing and commercializing our productcandidates in a cost-effective manner or on a timely basis.

 

The starting materials for the production oftecarfarin are provided by Synquest Labs, Inc. and ChemUetikon, GmbH. To date, the active pharmaceutical ingredient fortecarfarin has been produced by ChemShop BV of the Netherlands and Corum Inc.of Taiwan on an ongoing purchase order basis. Should ChemShop BV orCorum Inc. be unable or unwilling to serve as the supplier of tecarfarin,a delay in the development of tecarfarin could occur, impairing our ability tocommercialize tecarfarin on our existing timeline. Tecarfarin’s activepharmaceutical ingredient is processed into 1 milligram, 2 milligram, 5milligram or 10 milligram tablets by QS Pharma of Boothwyn, PA.

 

The starting materials for the production ofbudiodarone are provided by the following vendors: SCI Pharmtech, Inc.,Lexen Inc., Panchim, Julich GmbH and Weylchem Inc. To date,Ricerca, Biosciences, LLC, ScinoPharm Ltd. and SCI Pharmtech haveproduced all of budiodarone’s active pharmaceutical ingredient. Historically,we have relied on Ricerca, ScinoPharm and SCI Pharmtech as single-sourcesuppliers for budiodarone’s active pharmaceutical ingredients. In the eventthat Ricerca, Biosciences, LLC, ScinoPharm Ltd. or SCI Pharmtech areunable or unwilling to serve as the supplier of budiodarone, we might not beable to manufacture budiodarone’s active pharmaceutical ingredient. This coulddelay the development of, and impair our ability to, commercialize budiodarone.To produce budiodarone drug product, drug substance is processed into 50milligram or 200 milligram capsule forms by Patheon Inc. of Mississauga,Ontario.

 

The starting materials for the production ofATI-9242 are provided by the following vendors: Corum Inc., Alfa Aesar,Apollo Scientific 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.

 

The starting materials for the production ofATI-7505 are provided by the following vendors: SCI Pharmtech, Inc., Corum, Inc.and Lexen Inc. To produce ATI-7505 drug products, drug substance isprocessed into 20 milligram or 40 milligram tablet form by PharmaceuticsInternational, Inc. of Hunt Valley, MD. In the event that any of thesevendors are unable or unwilling to produce sufficient quantities of materialfor the manufacture of ATI-7505, the development and/or commercialization ofATI-7505 could be delayed or impaired.

 

All of our current arrangements withthird-party manufacturers and suppliers for the production of our productcandidates are on a purchase order basis. We currently do not have long-termsupply contracts with any of the third-party manufacturers and suppliers forour product candidates, and they are not required to supply us with productsfor any specified periods, in any specified quantities or at any set price,except as may be specified in a particular purchase order. We have no reason tobelieve that any of the current manufacturers and suppliers for our productcandidates is the sole source for the materials they supply us. However, if wewere to lose one of these vendors and were unable to obtain an alternativesource on a timely basis or on terms acceptable to us, our clinical andproduction schedules could be delayed. In addition, to the extent that any ofthese vendors uses technology or manufacturing processes that are proprietary,we may be unable to obtain comparable materials from alternative sources.

 

***If we are requiredto obtain alternate third-party manufacturers, it could delay or prevent theclinical development and commercialization of our product candidates.***

 

We may not be able to maintain or renew ourexisting or any other third-party manufacturing arrangements on acceptableterms, if at all. If we are unable to continue relationships with our currentsuppliers, or to do so at acceptable costs, or if these suppliers fail to meetour requirements for these product candidates for any reason, we would berequired to obtain alternative suppliers. Any inability to obtain qualifiedalternative suppliers, including an inability to obtain or delay in obtainingapproval of an alternative supplier from the FDA, would delay or prevent theclinical development and commercialization of these product candidates.

 

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Changes in manufacturing site, process orscale can trigger additional regulatory requirements that could delay ourability to perform certain clinical trials or obtain product approval.

 

The manufacturing and formulation of each ofour lead product candidates that have been tested in humans to date has been performedby entities other than those that will likely manufacture the products forfuture clinical trials or commercial use. There is a possibility that analysisof future 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-partymanufacturers may increase the risk that we will not have adequate supplies ofour product candidates.***

 

Our current and anticipated future relianceon third-party manufacturers will expose us and our future collaborativepartners to risks that could delay or prevent the initiation or completion ofour clinical trials, the submission of applications for regulatory approvals,the approval of our product by the FDA or the commercialization of ourproducts, and may result in higher costs or lost product revenues. Inparticular, our contract manufacturers could:

 

·                  encounter difficulties in achievingvolume production, quality control and quality assurance or suffer shortages ofqualified personnel, which could result in their inability to manufacturesufficient quantities of drugs to meet our clinical schedules or tocommercialize our product candidates;

 

·                  terminateor choose not to renew manufacturing agreements, based on their own businesspriorities, at a time that is costly or inconvenient for us;

 

·                  failto establish and follow FDA-mandated current good manufacturing practices, orcGMPs, which are required for FDA approval of our product candidates, or failto document their adherence to cGMPs, either of which could lead to significantdelays in the availability of material for clinical studies and delay orprevent marketing approval for our product candidates; and

 

·                  breachor fail to perform as agreed under manufacturing agreements.

 

If we are not able to obtain adequatesupplies of our product candidates, it will be more difficult for us to developour product candidates and compete effectively. Our product candidates and anyproducts that we may develop may compete with other product candidates andproducts for access to manufacturing facilities.

 

In addition, Lexen, SCI Pharmtech,Scinopharm, Corum Inc. and ChemShop BV are located outside of theUnited States. This may give rise to difficulties in importing our productcandidates or their components into the United States as a result of, amongother things, FDA import inspections, incomplete or inaccurate importdocumentation, or defective packaging.

 

***If our preclinicalstudies do not produce successful results or our clinical trials do notdemonstrate safety and efficacy in humans, we will not be able to commercializeour product candidates.***

 

To obtain the requisite regulatory approvalsto market and sell any of our product candidates, we must demonstrate, throughextensive preclinical studies and clinical trials, that the product candidateis safe and effective in humans. To date, we have not completed all requiredclinical trials of any product candidate. Preclinical and clinical testing isexpensive, can take many years and has an uncertain outcome. A failure of oneor more of our clinical trials could occur at any stage of testing. Inaddition, success in preclinical testing and early clinical trials does notensure that later clinical trials will be successful, and interim results of aclinical trial do not necessarily predict final results. We may experiencenumerous unforeseen events during, or as a result of, preclinical testing andthe clinical trial process, which could delay or prevent our ability tocommercialize our product candidates, including:

 

·                  regulatorsor institutional review boards may not authorize us to commence a clinicaltrial at a prospective trial site;

 

·                  ourpreclinical studies or clinical trials may produce negative or inconclusiveresults, which may require us to conduct additional preclinical or clinicaltesting or to abandon development projects;

 

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·                  wemay suspend or terminate our clinical trials if the participating patients arebeing exposed to unacceptable health risks;

 

·                  regulatorsor institutional review boards may suspend or terminate clinical research forvarious reasons, including noncompliance with regulatory requirements;

 

·                  theeffects of our product candidates may not be the desired effects or may includeundesirable side effects; and

 

·                  ourpreclinical studies or clinical trials may show that our product candidates arenot superior to the original drugs on which our product candidates are modeled.

 

For instance, our preclinical studies andclinical trials may indicate that our product candidates cause unexpecteddrug-drug interactions and result in adverse events. As another example,additional clinical trials of tecarfarin will be necessary in order to demonstrateclinical superiority to warfarin. Even if we adequately demonstrate thattecarfarin is safe and effective and obtain FDA approval, we may not bepermitted to market it as superior to warfarin. In addition, budiodarone’spreclinical studies contain results that are currently being monitored in theclinic. Inhibition of testicular function was observed in one animal species aspart of these studies. No such effect has been observed to date in the clinicand monitoring continues. In published studies, a similar effect is thought tobe correlated with the accumulation of amiodarone in tissues. A possible renaleffect was also observed at high doses in our rat and dog toxicology studiesfor budiodarone. While we will continue to monitor patients for these effects,there is no assurance these effects will not occur in patients as part of ourongoing and planned clinical trials for budiodarone, and have a resultingadverse effect on our ability to obtain requisite regulatory approval to marketand sell budiodarone. Similarly, in the clinical testing of budiodarone inpatients whose condition also required treatment with warfarin, doseadjustments of warfarin were sometimes required. As is common to most clinicaltrials, the potential for drug-drug interactions will be monitored. In a caninetoxicology study of ATI-7505 performed by our former collaboration partner,P&G, six deaths occurred at doses that were 10 and 20 times greater thandoses currently being used in clinical trials. Our clinical trials to date haveindicated only mild to moderate side effects in humans. However, furtherobservation is warranted.

 

Even when our product candidates do not causeany adverse effects, clinical studies of efficacy may show that our productcandidates do not have significant effects on target symptoms or may beinconclusive. For example, ATI-7505 was tested in two Phase 2 clinicaltrials in which the primary endpoints were not met in comparison to placebo.Although these studies did support ATI-7505’s efficacy against certain symptomsas secondary endpoints, if future studies show that ATI-7505 is notsufficiently efficacious to justify its use as a therapy, our business andprospects may be materially adversely affected. In addition, we may need toreformulate the ATI-9242 drug product should we find in our on-goingPhase 1 testing that adequate blood levels are not achieved with ourcurrent formulation.

 

Unforeseen events could cause us toexperience significant delays in, or the termination of, clinical trials. Anysuch events would increase our costs and could delay or prevent our ability tocommercialize our product candidates, which would adversely impact ourfinancial results.

 

***We may not besuccessful in our efforts to identify or discover additional candidates usingour RetroMetabolic Drug Design Technology.***

 

An important element of our strategy is tocontinue to identify existing molecules which have demonstrated efficacy, buthave safety problems that are amenable to our RetroMetabolic Drug Designtechnology. Other than tecarfarin, budiodarone, ATI-9242 and ATI-7505, all ofour programs are in the preclinical or discovery stage. Research programs toidentify new product candidates require substantial technical, financial andhuman resources. These programs may initially show promise in identifyingpotential product candidates, yet fail to yield product candidates for clinicaldevelopment for a number of reasons, including:

 

·                  theresearch methodology used may not be successful in identifying potentialproduct candidates; or

 

·                  potentialproduct candidates may, on further study, be found not to retain the efficacyprofile of the original molecule or be shown to retain harmful side effects orother characteristics suggesting that they are unlikely to be effective products.For instance, at high doses our budiodarone product candidate interacts withwarfarin and causes prolonged INR which could increase the risk of hemorrhagecomplications.

 

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If we are unable to develop suitable productcandidates through internal research programs or otherwise, we may not be ableto increase our revenues in future periods, which could result in significantharm to our financial position and adversely impact our stock price.

 

***Our productcandidates will remain subject to ongoing regulatory review even if theyreceive marketing approval. If we fail to comply with continuing regulations,we could lose these approvals and the sale of our products could be suspended.***

 

Even if we receive regulatory approval tomarket a particular product candidate, the approval could be conditioned on ourconducting additional costly post-approval studies, implementing a RiskEvaluation and Mitigation Strategy, or REMS, if the FDA determines that a REMSis necessary to ensure the benefits of the drug outweigh the risks, or couldlimit the indicated uses included in our labeling. Moreover, the product maylater cause adverse effects that limit or prevent its widespread use, force usto withdraw it from the market or impede or delay our ability to obtainregulatory approvals in additional countries. In addition, the manufacturer ofthe product and its facilities will continue to be subject to FDA review andperiodic inspections to ensure adherence to applicable GMPA regulations. Afterreceiving marketing approval, the manufacturing, labeling, packaging, adverseevent reporting, storage, advertising, promotion and record keeping related tothe product will remain subject to extensive regulatory requirements.

 

If we fail to comply with the regulatoryrequirements of the FDA and other applicable U.S. and foreign regulatoryauthorities or previously unknown problems with our products, manufacturers ormanufacturing processes are discovered, we could be subject to administrativeor judicially imposed sanctions, including:

 

·                  restrictionson the products, manufacturers or manufacturing processes;

 

·                  warningletters;

 

·                  civilor criminal penalties or fines;

 

·                  injunctions;

 

·                  productseizures, detentions or import bans;

 

·                  voluntaryor mandatory product recalls and publicity requirements which could vary inforeign jurisdictions;

 

·                  suspensionor withdrawal of regulatory approvals;

 

·                  totalor partial suspension of production; and

 

·                  refusalto approve pending applications for marketing approval of new drugs orsupplements to approved applications.

 

***Because we have anumber of product candidates and are considering a variety of target indications,we may expend our limited resources to pursue a particular candidate orindication and fail to capitalize on candidates or indications that may be moreprofitable or for which there is a greater likelihood of success.***

 

Because we have limited financial andmanagerial resources, we must focus on research programs and product candidatesfor the specific opportunities that we believe are the most amenable to ourRetroMetabolic Drug Design and are the most commercially promising. As aresult, we may forego or delay pursuit of opportunities with other productcandidates or other indications that later prove to have greater commercialpotential. Our resource allocation decisions may cause us to fail to capitalizeon viable commercial products or profitable market opportunities. In addition,we may spend valuable time and managerial and financial resources on researchprograms and product candidates for specific indications that ultimately do notyield any commercially viable products. If we do not accurately evaluate thetechnical feasibility and the commercial potential or target market for aparticular product candidate, we may relinquish valuable rights to that productcandidate through collaboration, licensing or other royalty arrangements insituations where it would have been more advantageous for us to retain solerights to development and commercialization.

 

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***The commercialsuccess of any products that we may develop will depend upon the degree ofmarket acceptance among physicians, patients, healthcare payors and the medicalcommunity.***

 

Any products that we may develop may not gainmarket acceptance among physicians, patients, healthcare payors and the medicalcommunity. If these products do not achieve an adequate level of acceptance, wemay not generate material product revenues and we may not become profitable.The degree of market acceptance of any of our product candidates, if approvedfor commercial sale, will depend on a number of factors, including:

 

·                  demonstrationof efficacy and safety in clinical trials;

 

·                  demonstrationthat we have adequately addressed the specific safety problem of the originalmolecule;

 

·                  theprevalence and severity of any side effects;

 

·                  potentialor perceived advantages over alternative treatments;

 

·                  perceptionsabout the relationship or similarity between our product candidates and theoriginal drug upon which each RetroMetabolic Drug Design candidate was based;

 

·                  advantageover other drugs may not be sufficiently great enough to obtain premiumpricing;

 

·                  thetiming of market entry relative to competitive treatments;

 

·                  theability to offer our product candidates for sale at competitive prices;

 

·                  relativeconvenience and ease of administration;

 

·                  thestrength of marketing and distribution support;

 

·                  sufficientthird-party coverage or reimbursement; and

 

·                  theproduct labeling or product insert required by the FDA or regulatoryauthorities in other countries.

 

***If we are unable toestablish sales and marketing capabilities or enter into agreements with thirdparties to market and sell our product candidates, we may be unable to generateproduct revenue.***

 

We do not have a sales and marketingorganization and have no experience in the sales, marketing and distribution ofpharmaceutical products. It is our intention to use collaborative arrangementsto gain access to large sales and marketing organizations in order to commercializeour product candidates. Additionally, in the event we enter into anycollaboration arrangements for any of our product candidates, we may retain theright to co-promote the sales of any ultimate product(s) by establishing asmall specialty sales force to market such product(s) to specificphysician groups. There are risks involved with establishing our own sales andmarketing capabilities and entering into arrangements with third parties toperform these services. Developing an internal sales force is expensive andtime-consuming and could delay any product launch. On the other hand, if weenter into arrangements with third parties to perform sales, marketing anddistribution services, our product revenues are likely to be lower than if wemarket and sell any products that we develop ourselves.

 

We may decide to establish our own specialtysales force and engage pharmaceutical or other healthcare companies with anexisting sales and marketing organization and distribution system to sell,market and distribute our products. We may not be able to establish these salesand distribution relationships on acceptable terms, or at all. Factors that mayinhibit our efforts to commercialize our products without collaborators orlicensees include:

 

·                  ourinability to convince future corporate partners to allow us to retaincommercialization rights for specific physician groups;

 

·                  ourinability to obtain financing to establish the specialty sales force;

 

·                  ourinability to recruit and retain adequate numbers of effective sales andmarketing personnel;

 

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·                  the inability of sales personnel toobtain access to or persuade adequate numbers of physicians to prescribe ourproducts;

 

·                  thelack of complementary products to be offered by sales personnel, which may putus at a competitive disadvantage relative to companies with more extensiveproduct lines; and

 

·                  unforeseencosts and expenses associated with creating an independent sales and marketingorganization.

 

Because the establishment of sales andmarketing capabilities depends on the progress toward commercialization of ourproduct candidates and because of the numerous risks and uncertainties involvedwith establishing our own sales and marketing capabilities, we are unable topredict when we will establish our own sales and marketing capabilities. If weare not able to partner with a third party and are not successful in recruitingsales and marketing personnel or in building a sales and marketinginfrastructure, we will have difficulty commercializing our product candidates,which would adversely affect our business and financial condition.

 

***Our ability togenerate revenue from any products that we may develop will depend on reimbursementand drug pricing policies and regulations.***

 

Many patients may be unable to pay for anyproducts that we may develop. In the United States, many patients will rely onMedicare, Medicaid, private health insurers and other third-party payors to payfor their medical needs. Our ability to achieve acceptable levels ofreimbursement for drug treatments by governmental authorities, private healthinsurers and other organizations will have an effect on our ability tosuccessfully commercialize, and attract collaborative partners to invest in thedevelopment of, our product candidates. We cannot be sure that reimbursement inthe United States, Europe or elsewhere will be available for any products thatwe may develop, and any reimbursement that may become available may bedecreased or eliminated in the future. Third-party payors increasingly arechallenging prices charged for medical products and services, and manythird-party payors may refuse to provide reimbursement for particular drugswhen an equivalent generic drug is available. Although we believe that thesafety profile of any products that we may develop will be sufficientlydifferent from the original drugs from which they are modeled to be consideredunique and not subject to substitution by a generic of the original drug in thecase of budiodarone and tecarfarin, it is possible that a third-party payor mayconsider our product candidate and the generic original drug as equivalents andonly offer to reimburse patients for the generic drug. There are five atypicalantipsychotics which currently dominate an estimated $16.0 billion marketfor such drugs. Most will be generic competitors of ATI-9242 if it ever reachesthe marketplace. While we have designed ATI-9242 to have the improved efficacy andsafety features over the existing atypical antipsychotics, these desiredfeatures may not be proven in clinical testing or payors may be unwilling topay a higher price for improved features when generic alternatives areavailable. Even if we show improved safety with our product candidates, pricingof the existing original drug may limit the amount we will be able to chargefor each of our product candidates. In the case of ATI-7505, the originalmolecule, cisapride, was withdrawn from the market and no generic versionexists, but there are many competitive products which may limit the amount wecan charge for this product candidate. If reimbursement is not available or isavailable only at limited levels, we may not be able to successfullycommercialize our product candidates, and may not be able to obtain asatisfactory financial return on products that we may develop.

 

The trend toward managed healthcare in theUnited States and the changes in health insurance programs, as well aslegislative proposals to reform healthcare or reduce government insuranceprograms, may result in lower prices for pharmaceutical products, including anyproducts that may be offered by us. In addition, any future regulatory changesregarding the healthcare industry or third-party coverage and reimbursement mayaffect demand for any products that we may develop and could harm our sales andprofitability.

 

***If our competitorsare able to develop and market products that are more effective, safer or lesscostly than any products that we may develop, our commercial opportunity willbe reduced or eliminated.***

 

We face competition from establishedpharmaceutical and biotechnology companies, as well as from academicinstitutions, government agencies and private and public research institutions.Our commercial opportunity will be reduced or eliminated if our competitorsdevelop and commercialize products that are safer, more effective, have fewerside effects or are less expensive than any products that we may develop. Inaddition, significant delays in the development of our product candidates couldallow our competitors to bring products to market before us and impair ourability to commercialize our product candidates.

 

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Competition for tecarfarin for use as an oralanticoagulant will continue to come from generic coumadin owing to its pricingand the years of experience physicians and patients have with the drug. Otheroral anticoagulants 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.

 

We believe generic amiodarone will continueto provide competition to budiodarone for the treatment of atrial fibrillation,even though it is not labeled for use in atrial fibrillation. Amiodarone willcontinue to be used off-label in spite of its safety problems because of itsgeneric pricing. Other treatments for atrial fibrillation, such as sotalol,marketed by Bayer HealthCare Pharmaceuticals, Inc., flecainide, marketedby 3M Company, and propafenone, marketed by Reliant Pharmaceuticals, Inc.,do not have equivalent efficacy to amiodarone, but will continue to compete inthe atrial fibrillation marketplace. Cardiome Pharma Corp. is in Phase 2testing with an oral product, vernakalant, for the treatment of atrialfibrillation which they hope will have efficacy equal to or better thanflecainide or sotalol, but with reduced pro-arrhythmic effects. Sanofi-aventishas completed Phase 3 clinical trials on their oral product, dronedarone(Multaq®),for the treatment of atrial fibrillation. Sanofi-aventis has filed forregulatory approval from the FDA in the United States. This Phase 3clinical trial data demonstrated improved outcomes for patients suffering fromatrial fibrillation. The FDA may now require outcome studies for the approvalof other treatments for atrial fibrillation, including budiodarone. Should thisbe required, the Phase 3 clinical trials necessary for budiodarone may bemore expensive and time consuming than we currently anticipate. However, basedupon a recent meeting of the FDA advisory panel considering the regulatoryapproval of dronedarone, it appears that long-term survival studies will not berequired. There are other companies developing devices or procedures to treatatrial fibrillation through ablation, including CryoCor, Inc. and CryoCathTechnologies, Inc.

 

Competition for ATI-9242 will likely comefrom the five largest selling atypical antipsychotics: Risperdal by JanssenPharmaceutica, Seroquel by AstraZeneca Pharmaceuticals LP, Zyprexa by EliLilly and Company, Abilify by Bristol-Myers Squibb/Otsuka AmericaPharmaceutical, Inc. and Geodon by Pfizer Inc., which sold acollective $15.7 billion in 2007. It is likely that virtually all of thesewould be sold as generic versions by the time ATI-9242 could come to market.Other antipsychotics are in development which may also be competitive toATI-9242.

 

ATI-7505 has potential use in fiveindications: chronic constipation, functional dyspepsia, GERD, gastroparesisand IBS with constipation. Some of these indications may not be recognized bythe FDA as sufficiently defined to enable regulatory approval of a drug fortreatment. ATI-7505 is a prokinetic which has been shown to increase motilityin the upper and lower gastrointestinal tract, including the ability to improvegastric emptying and colonic motility. Products which affect thegastrointestinal system’s motility could be useful in the treatment of each ofthese disorders. Other prokinetics are on the market or in development whichwill also compete with ATI-7505, including tegaserod, marketed by NovartisPharmaceuticals Corporation as Zelnorm, which was temporarily withdrawn from themarket and recently re-introduced with restrictive use labeling, TD-5108, whichis being developed by Theravance, and erythromycin. Many additional prokineticsare in development targeting these indications. We believe the most significantcompetition to ATI-7505 for the treatment of GERD is proton pump inhibitors andH2 blockers, which are currently on the market in both prescriptionformulations and strengths as well as in over-the-counter forms. Many majorpharmaceutical companies currently market proton pump inhibitors and H2blockers generating worldwide sales of over $17.0 billion in 2006.ATI-7505 is targeted, in part, at the approximately 20-25% of GERD patients whodo not receive adequate relief from proton pump inhibitors, which reduce thecreation of acid in the stomach. ATI-7505 will face competition fromprokinetics as well as many inexpensive over-the-counter drug products for thetreatment of these gastrointestinal disorders. Substantial competition alsoexists with products indicated to treat chronic idiopathic constipation, anindication for which ATI-7505 has demonstrated efficacy in a Phase 2bclinical trial.

 

Many of our competitors have significantlygreater financial resources and expertise in research and development,manufacturing, preclinical testing, conducting clinical trials, obtainingregulatory approvals and marketing approved products than we do. Establishedpharmaceutical companies may invest heavily to quickly discover and developnovel compounds that could make our product candidates obsolete. Smaller orearly-stage companies may also prove to be significant competitors,particularly through collaborative arrangements with large and establishedcompanies. In addition, these companies compete with us in recruiting and retainingqualified scientific and management personnel, establishing clinical trialsites and patient registration for clinical trials, as well as in acquiringtechnologies and technology licenses complementary to our programs or

 

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advantageous to our business. Accordingly, our competitors may succeedin obtaining patent protection, receiving FDA approval or discovering,developing and commercializing medicines before we do. We are also aware ofother companies that may currently be engaged in the discovery of medicinesthat will compete with the product candidates that we are developing. Inaddition, in the markets that we are targeting, we expect to compete againstcurrent market-leading medicines. If we are not able to compete effectivelyagainst our current and future competitors, our business will not grow and ourfinancial condition will suffer.

*** ***

***If we fail toattract and keep senior management and key scientific personnel, we may beunable to successfully develop or commercialize our product candidates.***

 

Our success depends on our continued abilityto attract, retain and motivate highly qualified management, clinical andscientific personnel and on our ability to develop and maintain importantrelationships with leading clinicians. If we are not able to retain Dr. Goddard,our Chairman and Chief Executive Officer, Dr. Milner, our President,Research and Development, Mr. Varian, our Chief Operating Officer andChief Financial Officer, Dr. Canafax, our Vice President and ChiefDevelopment Officer, and Dr. Druzgala, our Senior Vice President and ChiefScientific Officer, we may not be able to successfully develop or commercializeour product candidates. Competition for experienced scientists may limit ourability to hire and retain highly qualified personnel on acceptable terms. Inaddition, none of our employees have employment commitments for any fixedperiod of time and could leave our employment at will. We carry “key person”insurance in the amount of $1.0 million for each of Drs. Milner andDruzgala, but do not carry “key person” insurance covering any other members ofsenior management or key scientific personnel. If we fail to identify, attractand retain qualified personnel, we may be unable to continue our developmentand commercialization activities.

*** ***

***We will need to hireadditional employees in order to commercialize our product candidates. Anyinability to manage future growth could harm our ability to commercialize ourproduct candidates, increase our costs and adversely impact our ability tocompete effectively.***

 

In order to commercialize our productcandidates, we will need to expand the number of our managerial, operational,financial and other employees. Because the projected time frame for hiringthese additional employees depends on the development status of our productcandidates and because of the numerous risks and uncertainties associated withdrug development and our existing capital resources, we are unable to projectwhen we will hire these additional employees. While to date we have notexperienced difficulties in recruiting, hiring and retaining qualifiedindividuals, the competition for qualified personnel in the pharmaceutical andbiotechnology field is intense.

 

Future growth will impose significant addedresponsibilities on members of management, including the need to identify,recruit, maintain and integrate additional employees. Our future financialperformance and our ability to commercialize our product candidates and competeeffectively will depend, in part, on our ability to manage any future growtheffectively.

*** ***

***If product liabilitylawsuits are brought against us, we will incur substantial liabilities and may berequired to limit commercialization of any products that we may develop.***

 

We face an inherent risk of product liabilityexposure related to the testing of our product candidates in human clinicaltrials and will face an even greater risk if we commercially sell any productsthat we may develop. If we cannot successfully defend ourselves against claimsthat our product candidates or products that we may develop caused injuries, wewill incur substantial liabilities. Regardless of merit or eventual outcome,liability claims may result in:

 

·                  decreaseddemand for any product candidates or products that we may develop;

 

·                  injuryto our reputation;

 

·                  withdrawalof clinical trial participants;

 

·                  coststo defend the related litigation;

 

·                  increaseddemands on management’s attention in defending the related litigation;

 

·                  substantialmonetary awards to clinical trial participants or patients;

 

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·                  lossof revenue; and

 

·                  theinability to commercialize any products that we may develop.

 

We have product liability insurance thatcovers our clinical trials up to an aggregate $10.0 million annual limit.We intend to expand our insurance coverage to include the sale of commercialproducts if marketing approval is obtained for any products that we maydevelop. Insurance coverage is increasingly expensive, and we may not be ableto maintain insurance coverage at a reasonable cost or obtain insurancecoverage that will be adequate to satisfy any liability that may arise.

*** ***

***If we use biologicaland hazardous materials in a manner that causes contamination, injury orviolates laws, we may be liable for damages.***

 

Our research and development activitiesinvolve the use of potentially harmful biological materials as well ashazardous materials, chemicals and various radioactive compounds. We cannotcompletely eliminate the risk of accidental contamination or injury from theuse, storage, handling or disposal of these materials. In the event ofcontamination or injury, we could be held liable for damages that result, andany liability could exceed our resources. We, the third parties that conductclinical trials on our behalf and the third parties that manufacture ourproduct candidates are subject to federal, state and local laws and regulationsgoverning the use, storage, handling and disposal of these materials and wasteproducts. The cost of compliance with these laws and regulations could besignificant. The failure to comply with these laws and regulations could resultin significant fines and work stoppages and may harm our business.

 

Our principal facility is located inCalifornia’s Silicon Valley, in an area with a long history of industrialactivity and use of hazardous substances, including chlorinated solvents.Certain environmental laws, including the U.S. Comprehensive, EnvironmentalResponse, Compensation and Liability Act of 1980, impose strict, joint andseveral liabilities on current operators of real property for the cost ofremoval or remediation of hazardous substances. These laws often imposeliability even if the owner or operator did not know of, or was not responsiblefor, the release of such hazardous substances. As a result, while we have notbeen notified of any claim against us, we are not aware of any such release,nor have we been held liable for costs to address contamination at the propertybeneath our facility in the past, we cannot rule out the possibility thatthis may occur in the future. We do not carry specific insurance against such aclaim.

*** ***

***We will need toimplement additional finance and accounting systems, procedures and controls inthe future as we grow our business and organization and to satisfy newreporting requirements.***

 

As a public reporting company, we need tocomply with the Sarbanes-Oxley Act of 2002 and the related rules andregulations of the Securities and Exchange Commission, including expandeddisclosures and accelerated reporting requirements and more complex accountingrules. Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 andother requirements will increase our costs and require additional managementresources. We are continuing to upgrade our finance and accounting systems,procedures and controls and may need to continue to implement additionalfinance and accounting systems, procedures and controls as we grow our businessand organization 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 couldadversely affect our stock price and our ability to raise capital.

*** ***

***Our principalfacility is located near known earthquake fault zones, and the occurrence of anearthquake, extremist attack or other catastrophic disaster could cause damageto our facilities and equipment, which could require us to cease or curtailoperations.***

 

Our principal facility is located inCalifornia’s Silicon Valley near known earthquake fault zones and, therefore,is vulnerable to damage from earthquakes. In October 1989, a majorearthquake struck this area and caused significant property damage and a numberof fatalities. We are also vulnerable to damage from other types of disasters,including power loss, attacks from extremist organizations, fire, floods andsimilar events. If any disaster were to occur, our ability to operate ourbusiness could be seriously impaired. In addition, the unique nature of ourresearch activities and of much of our equipment could make it difficult for usto recover from this type of disaster. We currently may not have adequateinsurance to cover our losses resulting from disasters or other similarsignificant business interruptions, and we do not currently plan to purchaseadditional insurance to cover such losses because of the cost of obtaining suchcoverage. Any significant losses that are not recoverable under our insurancepolicies could seriously impair our business and financial condition. Ourcurrent insurance does not specifically cover property loss or businessinterruption due to earthquake damage.

 

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**Risks Related to Ownership of Our CommonStock**

*** ***

***Our stock price maybe extremely volatile, and your investment in our common stock could suffer adecline in value.***

 

You should consider an investment in ourcommon stock risky and invest only if you can withstand a significant loss andwide fluctuations in the market value of your investment. Investors whopurchase our common stock may not be able to sell their shares at or above thepurchase price. Security market prices for securities of biopharmaceuticalcompanies have been highly volatile. In addition, the volatility ofbiopharmaceutical company stocks often does not correlate to the operatingperformance of the companies represented by such stocks. Some of the factorsthat may cause the market price of our common stock to fluctuate include:

 

·                  adverseresults or delays in our clinical trials;

 

·                  thetiming or delay of achievement of our clinical, regulatory, partnering andother milestones, such as the commencement of clinical development, thecompletion of a clinical trial, the receipt of regulatory approval or theestablishment or termination of a commercial partnership for one or more of ourproduct candidates;

 

·                  announcementof FDA approval or nonapproval of our product candidates or delays in the FDAreview process;

 

·                  actionstaken by regulatory agencies with respect to our product candidates, ourclinical trials or our sales and marketing activities;

 

·                  thecommercial success of any product approved by the FDA or its foreigncounterparts;

 

·                  regulatorydevelopments in the United States and foreign countries;

 

·                  changesin the structure of healthcare payment systems;

 

·                  anyintellectual property infringement lawsuit involving us;

 

·                  announcementsof technological innovations or new products by us or our competitors;

 

·                  marketconditions for the biotechnology or pharmaceutical industries in general;

 

·                  changesin financial estimates or recommendations by securities analysts;

 

·                  salesof large blocks of our common stock;

 

·                  salesof our common stock by our executive officers, directors and significantstockholders;

 

·                  restatementsof our financial results and/or material weaknesses in our internal controls;and

 

·                  theloss of any of our key scientific or management personnel.

 

The stock markets in general, and the marketsfor biotechnology stocks in particular, have experienced extreme volatility andprice and volume fluctuations that have often been unrelated or disproportionateto the operating performance of particular companies. These broad market andindustry factors may seriously harm the market price of our common stock,regardless of our operating performance. In the past, class action litigationhas often been instituted against companies whose securities have experiencedperiods of volatility in market price. Any such litigation brought against uscould result in substantial costs, which would hurt our financial condition andresults of operations, divert management’s attention and resources, andpossibly delay our clinical trials or commercialization efforts.

 

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***Fluctuations in ouroperating results could cause our stock price to decline.***

 

The following factors are likely to result influctuations of our operating results from quarter to quarter and year to year:

 

·                  adverseresults or delays in our clinical trials;

 

·                  thetiming or delay of achievement of our clinical, regulatory, partnering andother milestones, such as the commencement of clinical development, thecompletion of a clinical trial, the receipt of regulatory approval or theestablishment or termination of a commercial partnership for one or more of ourproduct candidates;

 

·                  announcementof FDA approval or nonapproval of our product candidates or delays in the FDAreview process;

 

·                  actionstaken by regulatory agencies with respect to our product candidates, ourclinical trials or our sales and marketing activities;

 

·                  thecommercial success of any product approved by the FDA or its foreigncounterparts;

 

·                  regulatorydevelopments in the United States and foreign countries;

 

·                  changesin the structure of healthcare payment systems;

 

·                  anyintellectual property infringement lawsuit involving us; and

 

·                  announcementsof technological innovations or new products by us or our competitors.

 

Because of these potential fluctuations inour operating results, a period-to-period comparison of our results ofoperations may not be a good indication of our future performance. In anyparticular financial period the actual or anticipated fluctuations could bebelow the expectations of securities analysts or investors and our stock pricecould decline.

*** ***

***Because a smallnumber of existing stockholders own a large percentage of our voting stock,they may be able to control our management and operations, acting in their bestinterests and not necessarily those of other stockholders.***

 

Based on our outstanding shares as of February 10,2009 (which excludes any shares of common stock issuable upon exercise ofwarrants and options outstanding on such date), our executive officers,directors and holders of 5% or more of our outstanding common stockbeneficially own approximately 67% of our common stock. As a result, thesestockholders, acting together, will be able to control all matters requiringapproval by our stockholders, including the election of directors and theapproval of mergers or other business combination transactions. The interestsof this group of stockholders may not always coincide with our interests or theinterests of other stockholders.

*** ***

***Anti-takeoverprovisions in our charter documents and under Delaware law could make anacquisition of us, which may be beneficial to our stockholders, more difficultand may prevent attempts by our stockholders to replace or remove our currentmanagement.***

 

Provisions in our certificate ofincorporation and our bylaws may delay or prevent an acquisition of us, achange in our management or other changes that stockholders may considerfavorable. These provisions include:

 

·                  aclassified board of directors;

 

·                  aprohibition on actions by our stockholders by written consent;

 

·                  theability of our board of directors to issue preferred stock without stockholderapproval, which could be used to adopt a stockholders’ rights plan that wouldmake it difficult for a third party to acquire us;

 

·                  noticerequirements for nominations for election to the board of directors; and

 

·                  limitationson the removal of directors.

 

Moreover, we are governed by the provisionsof Section 203 of the Delaware General Corporation Law, which prohibits aperson who owns in excess of 15% of our outstanding voting stock from mergingor combining with us for a period of three years after the date of thetransaction in which the person acquired in excess of 15% of our outstandingvoting stock, unless the merger or combination is approved in a prescribedmanner.

 

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***Future sales of ourcommon stock in the public market could cause our stock price to dropsubstantially.***

 

Sales of a substantial number of shares ofour common stock in the public market, or the perception that these sales mightoccur, could depress the market price of our common stock and could impair ourability to raise capital through the sale of additional equity securities.

 

As of March 31, 2009, we had 27,372,235shares of common stock outstanding, which excludes any shares of common stockissuable upon exercise of warrants and options outstanding as of such date. Theshares outstanding are freely tradable without restriction in the public marketunless held by an affiliate of ours. Shares held by our affiliates are eligiblefor sale in the public market only in accordance with the volume limitationsand manner of sale requirements under Rule 144. Any common stock that iseither subject to outstanding options or warrants or reserved for futureissuance under our 2001 Equity Incentive Plan, 2007 Equity Incentive Plan, 2007Non-Employee Directors’ Stock Option Plan and 2007 Employee Stock Purchase Plancould also become eligible for sale in the public market to the extentpermitted 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 withrespect to registration of a significant number of our shares of common stockunder the Securities Act of 1933, as amended. If such holders, by exercisingtheir registration rights, cause a large number of securities to be sold in thepublic market, these sales could have an adverse effect on the market price forour common stock and may impair our ability to raise additional capital. Inaddition, as of March 31, 2009, we have filed two registration statementson Form S-8 under the Securities Act of 1933, as amended, to register upto an aggregate of 3,621,522 shares of our common stock for issuance under ourstock option and employee stock purchase plans, and intend to file additionalregistration statements on Form S-8 to register the shares automaticallyadded each year to the share reserves under these plans.

 

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

 

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

 

On November 7, 2007, our registrationstatement on Form S-1/A (File No. 333-145813) was declared effectiveby the Securities and Exchange Commission for our initial public offering. Weregistered 5,000,000 shares of our common stock for an aggregate offering priceof $50.0 million, all of which were sold at $10.00 per share. Of thisamount, $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 withMPM Capital and OrbiMed Advisors, LLC, two of our principal stockholders,purchased an aggregate of 600,000 shares of common stock in our initial publicoffering at the offering price of $10.00 per share. The underwriters of the offeringwere Morgan Stanley & Co. Incorporated, CIBC World MarketsCorp., 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 March 31, 2009, we have usedapproximately $37.6 million of the net proceeds from our initial publicoffering to fund our (i) external clinical trial activities, includingfunding manufacturing expenses related to the clinical development of ourproduct candidates; (ii) research and development activities other thanexternal clinical trial expenses; and (iii) general and administrativeexpenses, working capital needs and other general corporate purposes. Wecontinually assess the specific uses and allocations for these funds. However,we do not expect our existing capital resources and the net proceeds from ourinitial public offering to be sufficient to enable us to fund the completion ofthe development of any of our product candidates without a future raise ofadditional capital. Pending use of the remaining net proceeds of this offering,we have invested the funds in interest bearing, investment grade, short-termsecurities.

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

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

 

None.

 

**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**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

Dated:May 14, 2009

 

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

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description of Document**                                                                                                                                            |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                             |
| 3.2(1)              |       | Amended and Restated Certificate of Incorporation.                                                                                                                               |
|                |       |                                                                                                                                                                             |
| 3.3(1)              |       | Bylaws.                                                                                                                                                                          |
|                |       |                                                                                                                                                                             |
| 4.1                 |       | Reference is made to Exhibit 3.2 and 3.3 above.                                                                                                                             |
|                |       |                                                                                                                                                                             |
| 4.2(1)              |       | Specimen Common Stock Certificate.                                                                                                                                               |
|                |       |                                                                                                                                                                             |
| 4.3(1)              |       | Form of Warrant to purchase shares of Series C preferred  stock, issued September 3, 2003.                                                                        |
|                |       |                                                                                                                                                                             |
| 4.4(1)              |       | Form of Warrant to purchase shares of Series C preferred  stock, issued December 23, 2002.                                                                        |
|                |       |                                                                                                                                                                             |
| 4.5(1)              |       | Form of Warrant to purchase shares of Series D preferred  stock, issued March 28, 2005.                                                                           |
|                |       |                                                                                                                                                                             |
| 4.6(1)              |       | Amended and Restated Investor Rights Agreement by and between the  Registrant and certain of its security holders.                                                               |
|                |       |                                                                                                                                                                             |
| 4.7(1)              |       | Form of Warrant to purchase shares of Series E preferred  stock, issued October 19, 2007.                                                                         |
|                |       |                                                                                                                                                                             |
| 4.8(2)              |       | Form of Warrant to purchase shares of common stock, issued October 17,  2008 to Lighthouse.                                                                            |
|                |       |                                                                                                                                                                             |
| 4.9(3)              |       | Registration Rights Agreement by and between the Registrant and the  investors identified on the signature pages thereto, dated  November 11, 2008.                    |
|                |       |                                                                                                                                                                             |
| 4.10(3)             |       | Form of Warrant to purchase shares of common stock, issued  November 11, 2008 to several purchasers.                                                                   |
|                |       |                                                                                                                                                                             |
| 4.11(4)             |       | Form of Warrant to purchase shares of common stock, issued  December 31, 2008 to Oxford Financial Corporation.                                                         |
|                |       |                                                                                                                                                                             |
| 10.16*              |       | Non-Employee Director Compensation Arrangements.                                                                                                                                 |
|                |       |                                                                                                                                                                             |
| 10.20(5)*           |       | Compensation Information for Named Executive Officers.                                                                                                                           |
|                |       |                                                                                                                                                                             |
| 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 or arrangement.

 

(1)   Previously filedas the like numbered exhibit to registrant’s Registration Statement on Form S-1(No. 333-145813), initially filed with the Securities and Exchange Commissionon August 30, 2007, as amended, and incorporated by reference herein.

 

(2)   Previously filedas the like-numbered exhibit to registrant’s Current Report on Form 8-K(File No. 001-33782), filed with the SEC on October 23, 2008 andincorporated herein by reference.

 

(3)   Previously filedas the like-numbered exhibit to registrant’s Current Report on Form 8-K(File No. 001-33782), filed with the SEC on November 12, 2008 andincorporated herein by reference.

 

(4)   Previously filed as the like numbered exhibit toregistrant’s Annual Report on Form 10-K (File No. 001-33782), filedwith the SEC on March 27, 2009 and incorporate herein by reference.

 

(5)   Previously filed as the like numbered exhibit toregistrant’s Current Report on Form 8-K (File No. 001-33782), filedwith the SEC on February 24, 2009 and incorporated herein by reference.

 

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