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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

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| **x**      |       | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934**                                                                                   |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                |
| ** ** | ** ** | **For  the quarterly period ended September 30, 2009.**                                                                                                                              |
| ** ** | ** ** | ** **                                                                                                                                                                                |
| **or**     |
| ** ** |
| **o**      |       | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934**                                                                                  |
| ** ** | ** ** | ** **                                                                                                                                                                                |
| ** ** | ** ** | **For  the Transition Period  From              to            .** |

 

**Commission file number 001-33782**

 

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**ARYx THERAPEUTICS, INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address ofPrincipal Executive Offices including zip code)

 

**(510) 585-2200**

(Registrant’sTelephone Number, Including Area Code)

 

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

 

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

 

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

 

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

 

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

 

As of October 31,2009, the registrant had 27,587,765 shares of common stock outstanding.

 

 

 

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**ARYx THERAPEUTICS, INC.**

 

**FORM 10-Q FOR THE QUARTER ENDEDSEPTEMBER 30, 2009**

 

**INDEX**

** **
| ** **                                                                                                             | **Page**                                                                                    |
|------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|
| **PART I —  FINANCIAL INFORMATION**                                                                          | ** **                                                                                  |
| ** **                                                                                                             | ** **                                                                                  | ** ** |
| Item 1.                                                                                                                | Financial  Statements                                                                       |   |
| Condensed  Consolidated Balance Sheets as of September 30, 2009 and  December 31, 2008                       | 2                                                                                           |
| Condensed  Consolidated Statements of Operations for the three and nine months ended  September 30, 2009 and 2008 | 3                                                                                           |
| Condensed  Consolidated Statements of Cash Flow for the nine months ended  September 30, 2009 and 2008            | 4                                                                                           |
| Notes to  Condensed Consolidated Financial Statements                                                                  | 5                                                                                           |
| Item 2.                                                                                                                | Management’s Discussion and Analysis  of Financial Condition and Results of Operations | 14 |
| Item 3.                                                                                                                | Quantitative and Qualitative  Disclosures About Market Risk                                 | 22 |
| Item 4T.                                                                                                               | Controls and Procedures                                                                     | 22 |
|                                                                                                                   |                                                                                        |   |
| **PART II  — OTHER INFORMATION**                                                                             | ** **                                                                                  |
| Item 1.                                                                                                                | Legal Proceedings                                                                           | 24 |
| Item 1A.                                                                                                               | Risk Factors                                                                                | 24 |
| Item 2.                                                                                                                | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 45 |
| Item 3.                                                                                                                | Defaults  Upon Senior Securities                                                            | 45 |
| Item 4.                                                                                                                | Submission  of Matters to a Vote of Security Holders                                        | 45 |
| Item 5.                                                                                                                | Other Information                                                                           | 45 |
| Item 6.                                                                                                                | Exhibits                                                                                    | 45 |
|                                                                                                                   |                                                                                        |   |
| SIGNATURE                                                                                                              | 46                                                                                          |

 

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**PART I— FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**ARYx THERAPEUTICS, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(In thousands)**

 
| ** **                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                       | ** ** | **(unaudited)**        | ** ** | **(Note 1)**          | ** ** |
| **ASSETS**                                       |       |                   |       |                  |       |
| Current  assets:                                 |       |                   |       |                  |       |
| Cash  and cash equivalents                       |       | $                      | 6,845      |                  | $          | 35,999 |   |
| Marketable  securities                           |       | 7,342                  |       | 8,588                 |       |
| Restricted  cash - current                       |       | 150                    |       | 150                   |       |
| Prepaid  research and development expenses       |       | 195                    |       | 381                   |       |
| Other  prepaid, receivable, and current assets   |       | 569                    |       | 732                   |       |
| Total  current assets                            |       | 15,101                 |       | 45,850                |       |
| Restricted  cash                                 |       | 1,003                  |       | 1,203                 |       |
| Property  and equipment, net                     |       | 2,465                  |       | 3,198                 |       |
| Other  assets                                    |       | 718                    |       | 897                   |       |
| **Total assets**                                 |       | $                      | 19,287     |                  | $          | 51,148 |   |
|                                             |       |                   |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**    |       |                   |       |                  |       |
| Current  liabilities:                            |       |                   |       |                  |       |
| Accounts  payable                                |       | $                      | 1,095      |                  | $          | 2,454 |   |
| Accrued  compensation                            |       | 601                    |       | 494                   |       |
| Accrued  research and development expenses       |       | 486                    |       | 3,832                 |       |
| Current  portion of notes payable                |       | 6,792                  |       | 3,404                 |       |
| Other  accrued liabilities                       |       | 978                    |       | 835                   |       |
| Total  current liabilities                       |       | 9,952                  |       | 11,019                |       |
| Deferred  lease credit                           |       | 1,150                  |       | 1,436                 |       |
| Notes  payable                                   |       | 6,369                  |       | 11,278                |       |
| Commitments  and contingencies                   |       |                   |       |                  |       |
| Stockholders’  equity:                      |       |                   |       |                  |       |
| Common  stock                                    |       | 27                     |       | 27                    |       |
| Additional  paid-in capital                      |       | 183,109                |       | 181,285               |       |
| Accumulated  other comprehensive income          |       | 2                      |       | 45                    |       |
| Accumulated  deficit                             |       | (181,322               | )          | (153,942              | )          |
| Total  stockholders’ equity                 |       | 1,816                  |       | 27,415                |       |
| Total  liabilities and stockholders’ equity |       | $                      | 19,287     |                  | $          | 51,148 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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**ARYx THERAPEUTICS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(In thousands, except per shareamounts)**

**(Unaudited)**

 
| ** **                                  | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|---------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                  | ** ** | **September 30,**         | ** ** | **September 30,**        | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                  | ** ** | **2009**                       | ** ** | **2008**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenue:                                    | ** ** | ** **                     |       |                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Collaboration  services                     |       | $                              | —     |                          | $          | — |   | $ | — |   | $ | 232 |   |
| Technology  license fees                    |       | —                         |       | 17,544                        |       | — |   | 19,492 |   |
| Total  revenue                              |       | —                         |       | 17,544                        |       | — |   | 19,724 |   |
|                                        |       |                           |       |                          |       |   |   |   |   |
| Costs  and expenses:                        |       |                           |       |                          |       |   |   |   |   |
| Cost  of collaboration services             |       | —                         |       | —                        |       | — |   | 232 |   |
| Research  and development                   |       | 4,994                          |       | 11,716                        |       | 18,054 |   | 29,207 |   |
| Selling,  general and administrative        |       | 2,638                          |       | 2,415                         |       | 7,863 |   | 8,166 |   |
| Total  costs and expenses                   |       | 7,632                          |       | 14,131                        |       | 25,917 |   | 37,605 |   |
| Loss  from operations                       |       | (7,632                         | )          | 3,413                         |       | (25,917 | ) | (17,881 | ) |
|                                        |       |                           |       |                          |       |   |   |   |   |
| Interest  and other income, net             |       | 1                              |       | 292                           |       | 66 |   | 1,149 |   |
| Interest  expense                           |       | (519                           | )          | (474                          | )          | (1,515 | ) | (1,437 | ) |
| Other-than-temporary  loss on investments   |       | —                         |       | —                        |       | (14 | ) | — |   |
| Net  (loss) income                          |       | (8,150                         | )          | 3,231                         |       | (27,380 | ) | (18,169 | ) |
|                                        |       |                           |       |                          |       |   |   |   |   |
| Net  (loss) income per share                |       |                           |       |                          |       |   |   |   |   |
| Basic                                       |       | $                              | (0.30      | )                             | $          | 0.18 |   | $ | (1.00 | ) | $ | (1.03 | ) |
| Diluted                                     |       | $                              | (0.30      | )                             | $          | 0.17 |   | $ | (1.00 | ) | $ | (1.03 | ) |
|                                        |       |                           |       |                          |       |   |   |   |   |
| Weighted  average shares used in computing: |       |                           |       |                          |       |   |   |   |   |
| Basic  net (loss) income per share          |       | 27,443                         |       | 17,663                        |       | 27,387 |   | 17,645 |   |
| Diluted  net (loss) income per share        |       | 27,443                         |       | 18,628                        |       | 27,387 |   | 17,645 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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**ARYx THERAPEUTICS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOW**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,**        | ** ** | **September 30,** | ** ** |
| ** **                                                                   | ** ** | **2009**                      | ** ** | **2008** | ** ** |
| **Cash flows from operating activities:**                                    | ** ** | ** **                    | ** ** | ** ** | ** ** |
| Net  loss                                                                    |       | $                             | (27,380    | ) | $ | (18,169 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |       |                          |       |   |   |
| Depreciation                                                                 |       | 819                           |       | 821 |   |
| Amortization  of premium on marketable securities                            |       | 157                           |       | 45 |   |
| Amortization  of warrants                                                    |       | 164                           |       | 254 |   |
| Impairment  losses                                                           |       | 26                            |       | — |   |
| Stock-based  compensation                                                    |       | 1,724                         |       | 1,693 |   |
| Change  in assets and liabilities:                                           |       |                          |       |   |   |
| Prepaid  research and development expenses                                   |       | 186                           |       | (153 | ) |
| Other  prepaid, receivable, and assets                                       |       | 163                           |       | 263 |   |
| Accounts  payable and other accrued liabilities                              |       | (1,502                        | )          | (538 | ) |
| Accrued  compensation                                                        |       | 107                           |       | (212 | ) |
| Accrued  research and development expenses                                   |       | (3,346                        | )          | 919 |   |
| Deferred  revenue                                                            |       | —                        |       | (19,497 | ) |
| Net  cash used in operating activities                                       |       | (28,882                       | )          | (34,574 | ) |
|                                                                         |       |                          |       |   |   |
| **Cash flows from investing activities:**                                    |       |                          |       |   |   |
| Purchases  of marketable securities                                          |       | (11,162                       | )          | (15,716 | ) |
| Proceeds  from sales of marketable securities                                |       | —                        |       | 3,500 |   |
| Proceeds  from maturities of marketable securities                           |       | 12,208                        |       | 6,240 |   |
| Change  in restricted cash                                                   |       | 200                           |       | (300 | ) |
| Purchases  of fixed assets                                                   |       | (97                           | )          | (614 | ) |
| Net  cash provided by (used in) investing activities                         |       | 1,149                         |       | (6,890 | ) |
|                                                                         |       |                          |       |   |   |
| **Cash flows from financing activities:**                                    |       |                          |       |   |   |
| Proceeds  from exercise of stock options and issuance of common stock        |       | 192                           |       | 57 |   |
| Offering  cost in connection with placement of equity                        |       | (92                           | )          | — |   |
| Proceeds  from issuance of notes payable                                     |       | —                        |       | 9,000 |   |
| Principal  payments on notes payable                                         |       | (1,521                        | )          | (2,258 | ) |
| Net  cash (used in) provided by financing activities                         |       | (1,421                        | )          | 6,799 |   |
|                                                                         |       |                          |       |   |   |
| **Net decrease in cash and cash equivalents**                                |       | (29,154                       | )          | (34,665 | ) |
| Cash  and cash equivalents at beginning of period                            |       | 35,999                        |       | 55,476 |   |
| **Cash and cash equivalents at end of period**                               |       | $                             | 6,845      |   | $ | 20,811 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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**ARYx THERAPEUTICS, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

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

 

***TheCompany***

 

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

 

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

 

***Basisof Presentation***

 

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

 

The balance sheetdata at December 31, 2008 has been derived from our audited consolidatedfinancial statements for the year ended December 31, 2008, contained inour Annual Report on Form 10-K. The unaudited condensed consolidatedfinancial statements and related disclosures contained in this report have beenprepared with the presumption that users of the interim financial statementshave read or have access to our audited financial statements for the precedingyear. Accordingly, these interim financial statements should be read inconjunction with our audited financial statements and notes thereto for theyear ended December 31, 2008, contained in our Annual Report on Form 10-K.

 

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

 

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***Need to Raise Additional Capital***

 

As of September 30,2009, we had $14.2 million in cash, cash equivalents and marketablesecurities excluding our auction rate security holding. While our cashresources as of September 30, 2009 are less than the amount needed for usto maintain our current operations for the next 12 months, we believe that ourcash, cash equivalents and marketable securities on hand will be sufficient tofund our operations through the end of the first quarter of 2010.****On October 6, 2009, we entered into a committed equityline financing facility under which wehave an option to sell up to $35 million of our common stock, subject tocertain limitations, over a 24-month period. (See Note 7 — SubsequentEvents for further discussion.) Since our inception, we have incurredsignificant net operating losses and, as of September 30, 2009, we had anaccumulated deficit of $181.3 million. We have generated no revenue fromproduct sales to date. We have funded our operations principally from the saleof our convertible preferred and common stock, through collaboration agreementsand debt financing.

 

Our level of capitalresources as of September 30, 2009 could raise doubt about our ability tocontinue to fund our operations at current levels and meet our obligations asthey become due. Our ability to continue operations is dependent upon ourability to obtain substantial additional capital to continue our research anddevelopment programs and to bring any potential future products to market. Inorder to satisfy our projected cash needs for at least the next 12 months, weare considering various options that may be available to us, including enteringinto collaborative arrangements for one or more of our product candidates,public or private equity financings, debt financing or a combination of theaforementioned. However, there is no assurance that we will be able to raiseadditional capital on terms acceptable to us or at all. Furthermore, anyadditional equity financings may be dilutive to our stockholders, and debtfinancing, if available to us on acceptable terms or at all, may involvecovenants that place substantial restrictions on our business. If we fail toraise sufficient capital as and when needed, we have developed contingencyplans that may require us to delay, reduce the scope of, or eliminate one ormore of our research and development programs, partner one or more of ourproduct candidates at an earlier stage of development than we might otherwisechoose, or to reduce personnel and related costs and other discretionaryexpenditures that are within our control. On October 29, 2009, weannounced a restructuring of our operations which included a reduction inpersonnel from 73 employees to 56 employees. (See Note 7 — Subsequent Eventsfor further discussion.) Even assuming we successfully raise additionalcapital, there can be no assurance that we will achieve positive cash flow inthe foreseeable future, or at all.

 

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

 

***Useof Estimates***

 

The preparation of financial statements in conformity with U.S.generally accepted accounting principles requires management to make judgments,assumptions and estimates that affect the reported amounts in the consolidatedfinancial statements and accompanying notes. On an ongoing basis, we evaluateour critical accounting policies and estimates, including those related toclinical trial accruals and stock-based compensation. Management bases itsestimates on historical experience and on assumptions believed to be reasonableunder the circumstances. Actual results could differ from those estimates.

 

***Reclassification***

 

Certain reclassifications of prior year amounts have been made toconform to current year presentation. The reclassifications do not impactpreviously reported assets and liabilities or the results of operations.

 

***FairValue of Financial Instruments***

 

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

 

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

 

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

 

Accounts payable, accrued liabilities and the current portion of notespayable are carried at cost and amortized cost, respectively, that approximatefair value due to their expected short maturities. Based on the borrowing ratesavailable to us for loans with similar terms and average maturities, we employa discounted cash flow model using our estimate of risk premiums andcorresponding yields to maturity to determine the fair value of our non-currentportion of notes payable. The fair value was estimated to be $5.6 millionand $9.3 million as of September 30, 2009 and December 31, 2008,respectively, assuming transfer in an orderly market transaction. The carryingamount of our non-current portion of notes payable was stated on the face ofour consolidated balance sheet at amortized cost for all periods presented.

 

***ComprehensiveIncome (Loss)***

 

Comprehensive income (loss) is comprised of net income (loss) and othercomprehensive income (loss). The only component of our other comprehensiveincome (loss) is the unrealized gains and losses on our marketable securities.Comprehensive income (loss) for the three months ended September 30, 2009and 2008 was $(8.1) million and $3.2 million, respectively, andfor the nine months ended September 30, 2009 and 2008 was $(27.4) million and $(18.3) million, respectively.

 

***NetIncome (Loss) Per Share***

 

Basic net income (loss) per share is computed by dividing net income(loss) by the weighted average number of fully vested common shares outstandingduring the period. Diluted net income (loss) per share is computed by givingeffect to all potential dilutive common shares, including outstanding stockoptions and warrants. For the three months ended September 30, 2008, ourcomputation of diluted net income per share reflects the application of thetreasury stock method by assuming the exercise of options at the beginning ofthe period, that proceeds from exercise are used to purchase common stock atthe average market price during the period, and that the incremental shares areincluded in the denominator of the diluted net income per share calculation.For reporting periods other than the three months ended September 30,2008, our computation of diluted net loss per share excludes the effects ofcommon stock equivalents because the inclusion would have been anti-dilutivedue to our net loss position.

 

The following table presents the calculation of basic and diluted netincome (loss) per share:

 
| ** **                                                                     | ** ** | **Three Months Ended  September 30,**  | ** ** | **Nine Months Ended********September 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2009**                                    | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                     | ** ** | **(in thousands, except per share amount)** | ** ** |
| **Basic  Net Income (Loss) Per Share:**                                        |       |                                        |       |                                            |       |   |   |   |   |
| *Numerator:*                                                                   |       |                                        |       |                                            |       |   |   |   |   |
| Net (loss) income                                                              |       | $                                           | (8,150     | )                                               | $          | 3,231 |   | $ | (27,380 | ) | $ | (18,169 | ) |
| *Denominator:*                                                                 |       |                                        |       |                                            |       |   |   |   |   |
| Weighted average common shares outstanding                                     |       | 27,453                                      |       | 17,684                                          |       | 27,399 |   | 17,670 |   |
| Less: Weighted average unvested restricted common  shares                      |       | (10                                         | )          | (21                                             | )          | (12 | ) | (25 | ) |
| Weighted average shares used in computing basic  net (loss) income per share   |       | 27,443                                      |       | 17,663                                          |       | 27,387 |   | 17,645 |   |
| Basic net (loss) income per share                                              |       | $                                           | (0.30      | )                                               | $          | 0.18 |   | $ | (1.00 | ) | $ | (1.03 | ) |
| **Diluted  Net Income (Loss) Per Share:**                                      |       |                                        |       |                                            |       |   |   |   |   |
| *Numerator:*                                                                   |       |                                        |       |                                            |       |   |   |   |   |
| Net (loss) income                                                              |       | $                                           | (8,150     | )                                               | $          | 3,231 |   | $ | (27,380 | ) | $ | (18,169 | ) |
| *Denominator:*                                                                 |       |                                        |       |                                            |       |   |   |   |   |
| Weighted average shares used in computing basic  net (loss) income per share   |       | 27,443                                      |       | 17,663                                          |       | 27,387 |   | 17,645 |   |
| Plus: Incremental dilutive options and awards  shares *                        |       | —                                      |       | 965                                             |       | — |   | — |   |
| Weighted average shares used in computing diluted  net (loss) income per share |       | 27,443                                      |       | 18,628                                          |       | 27,387 |   | 17,645 |   |
| Diluted net (loss) income per share                                            |       | $                                           | (0.30      | )                                               | $          | 0.17 |   | $ | (1.00 | ) | $ | (1.03 | ) |

 

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*                 Outstanding warrants andstock options are excluded from the diluted net income per share computationbecause the exercise price of the warrants and options exceeds the averagemarket price of our common stock for the period.

 

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***IncomeTaxes***

 

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

 

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

 

***RecentAccounting Updates***

 

In June 2009,the FASB issued *The* *FASB Accounting Standards Codification and the Hierarchy of GenerallyAccepted Accounting Principles — A Replacement of* *FASBStatement No. 162*, or ASC. The ASC becomes the source ofauthoritative U.S. GAAP recognized by the FASB applicable to non-governmentalentities. Rules and interpretive releases of the SEC under authority offederal securities laws are also sources of authoritative U.S. GAAP for SECregistrants. On its effective date, the ASC supersedes all existing non-SECaccounting and reporting standards, and all other non-grandfathered non-SECaccounting literature not included in the ASC is no longer authoritative. TheASC is effective for us for the nine-month period ended September 30, 2009and the adoption had no effect on either our consolidated financial position orresults of operations.

 

In May 2009, the FASB issued ASC Topic 855, *SubsequentEvents*. Topic 855 is effective on a prospective basis for interimand annual financial periods ending after June 15, 2009. Topic 855provides authoritative guidance largely similar to the current guidance in theauditing literature with some exceptions that are not intended to result insignificant changes in practice. The modifications to the subsequent eventsguidance in existing auditing literature are: (i) to name the two types ofsubsequent events either as recognized subsequent events (currently known asType I subsequent events) or non-recognized subsequent events (currently knownas Type II subsequent events); (ii) to modify the definition of subsequentevents to refer to events or transactions that occur after the balance sheetdate but before the financial statements are issued (for public entities); and (iii) torequire entities to disclose the date through which an entity has evaluatedsubsequent events and the basis for that date. We have adopted Topic 855 and evaluated subsequent events forrecognition or disclosure through November 13, 2009, the date on which theaccompanying unaudited condensed consolidated financial statements being presentedwere issued as part of this Quarterly Report on Form 10-Q, and not beyondthat date.

 

In April 2009, the FASB amended certain contents of three topicsin the ASC to provide additional application guidance and enhance disclosuresregarding fair value measurements and impairments of securities. ASU820-15-35-51, *Determining Fair Value When the Volume andLevel of Activity for the Asset or Liability Have Significantly Decreased andIdentifying Transactions That Are Not Orderly*, provides guidelinesfor making fair value measurements more consistent with the principlespresented in Topic 820, *Fair Value Measurementsand Disclosures*. It reaffirms the objective of fair valuemeasurement, which is to reflect how much an asset would be sold for in anorderly transaction (as opposed to a distressed or forced transaction) at thedate of the financial statements under market conditions prevalent at the timeof valuation. ASU 825-10-50-10, *Interim Disclosures AboutFair Value of Financial Instruments*, relates to fair valuedisclosures for any financial instruments that are not currently reflected onthe balance sheet at fair value. Prior to issuing this update, fair values forthese assets and liabilities 

 

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wereonly disclosed once a year. The update now requires these disclosures on aquarterly basis to provide qualitative and quantitative information about fairvalue estimates for all those financial instruments not measured on the balancesheet at fair value. ASU 320-10-35-33 through 320-10-35-35, *Recognition and Presentation of Other-Than-Temporary Impairments*,provides additional guidance designed to bring greater consistency to thetiming of impairment recognition, and provides greater clarity to investorsabout the credit and non-credit components of impaired debt securities that arenot expected to be sold. This update also requires increased and more timelydisclosures regarding expected cash flows, credit losses, and aging ofsecurities with unrealized losses. These three updates are effective forinterim and annual periods ending after June 15, 2009. The adoption ofthese updates did not have an impact on either our consolidated financialposition or results of operations.

 

**2. Fair Value Measurement**

 

The following tables summarize the fair value of our financial assetsas of September 30, 2009 and December 31, 2008 that were recorded atfair value on a recurring basis consistent with the fair value hierarchy.

 
| ** **                                   | ** ** | **September 30, 2009** | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **Total  Fair Value**       | ** ** | **Quoted Prices in  Active Markets for  Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| ** **                                   | ** ** | **(in thousands)**          | ** ** |
| Cash and cash equivalents                    |       | $                           | 6,845      |   | $ | 6,845 |   | $ | — |   | $ | — |   |
| Marketable securities                        |       | 7,342                       |       | — |   | 7,342 |   | — |   |
| Restricted cash                              |       | 150                         |       | 150 |   | — |   | — |   |
| Total fair value of current financial assets |       | 14,337                      |       | 6,995 |   | 7,342 |   | — |   |
| Restricted cash—non-current             |       | 1,003                       |       | 1,003 |   | — |   | — |   |
| Auction rate securities:                     |       |                        |       |   |   |   |   |   |   |
| Balance as of December 31, 2008         |       | 367                         |       | — |   | — |   | 367 |   |
| Other-than-temporary loss on investments     |       | (14                         | )          | — |   | — |   | (14 | ) |
| Balance as of September 30, 2009        |       | 353                         |       | — |   | — |   | 353 |   |
| Total fair value of financial assets         |       | $                           | 15,693     |   | $ | 7,998 |   | $ | 7,342 |   | $ | 353 |   |

 
| ** **                                   | ** ** | **December 31, 2008** | ** ** |
|----------------------------------------------|------------|----------------------------|------------|
| ** **                                   | ** ** | **Total  Fair Value**      | ** ** | **Quoted Prices in  Active Markets for  Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| ** **                                   | ** ** | **(in thousands)**         | ** ** |
| Cash and cash equivalents                    |       | $                          | 35,999     |   | $ | 33,549 |   | $ | 2,450 |   | $ | — |   |
| Marketable securities                        |       | 8,588                      |       | — |   | 8,588 |   | — |   |
| Restricted cash                              |       | 150                        |       | 150 |   | — |   | — |   |
| Total fair value of current financial assets |       | 44,737                     |       | 33,699 |   | 11,038 |   | — |   |
| Restricted cash—non-current             |       | 1,203                      |       | 1,203 |   | — |   | — |   |
| Auction rate securities                      |       | 367                        |       | — |   | — |   | 367 |   |
| Total fair value of financial assets         |       | $                          | 46,307     |   | $ | 34,902 |   | $ | 11,038 |   | $ | 367 |   |

 

Our financial assets valued using Level 1 inputs consist primarily ofcash, money market funds, and certificates of deposit at a financialinstitution. Our financial assets valued using Level 2 inputs consist primarilyof U.S. government agencies debt instruments, commercial paper, and corporatedebt securities. The fair value of these instruments was determined by ourinstitutional portfolio managers whose valuations were based uponmarket-corroborated inputs such as broker/dealer quotes, reported trades, bidsand offers that we believe are reasonable. The fair value of our remainingauction rate security was measured using Level 3 inputs as determined by adiscounted cash flow model that considers expected cash flows from the auctionrate instrument including expected interest payments, market yields forsimilarly rated instruments, our estimates of time to liquidity for thesecurity and a marketability discount.

 

As of September 30, 2009, the fair value of our remaining auctionrate instrument was $353,000, net of an estimated $147,000 loss representing a29.4% reduction in the carrying value for this instrument. We revisited ourassumptions used in the discounted cash flow model as of September 30,2009 and recorded zero and a $14,000 loss on marketable securities for thethree and nine months ended September 30, 2009 in our statement ofoperations. We continue to classify this auction rate instrument as an othernon-current asset on the balance sheet as we do not expect that the instrumentwill likely become liquid in the next 12 months.

 

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

 
| ** **                                           | ** ** | **September 30, 2009** | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **Amortized  Cost**         | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Unrealized********Other-than-  temporary  Impairment** | ** ** | **Fair  Value** | ** ** |
| ** **                                           | ** ** | **(in thousands)**          | ** ** |
| **Available-for-sale marketable  securities:**       |       |                        |       |   |   |   |   |   |   |   |   |
| U.S. government agencies debt                        |       | $                           | 5,536      |   | $ | 2 |   | — |   | — |   | $ | 5,538 |   |
| Commercial paper                                     |       | 1,000                       |       | — |   | — |   | — |   | 1,000 |   |
| Corporate debt securities                            |       | 804                         |       | — |   | — |   | — |   | 804 |   |
| Auction rate securities                              |       | 353                         |       | — |   | — |   | — |   | 353 |   |
| Total marketable securities                          |       | $                           | 7,693      |   | $ | 2 |   | $ | — |   | $ | — |   | $ | 7,695 |   |
| **Maturing:**                                        |       |                        |       |   |   |   |   |   |   |   |   |
| Within 1 year                                   |       | $                           | 7,340      |   |   |   |   |   |   |   | $ | 7,342 |   |
| Between 1 and 2 years                           |       | —                      |       |   |   |   |   |   |   | — |   |
| Auction rate securities maturing beyond  1 year |       | 353                         |       |   |   |   |   |   |   | 353 |   |
|                                                 |       | $                           | 7,693      |   |   |   |   |   |   |   | $ | 7,695 |   |
|                                                      |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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

 

**3.  Revenue Recognition**

 

We generated no revenue for the three and nine months ended September 30,2009. We recognized $17.5 million and $19.5 million for the three andnine months ended September 30, 2008, respectively, as license feesrevenue, and zero and $232,000 for the three and nine months ended September 30,2008, respectively, as collaboration service revenue in connection with ourprior collaboration agreement with Procter & Gamble Pharmaceuticals, Inc.,or P&G. Effective with P&G’s notice of termination on July 2,2008, we no longer provide any support services to P&G for the developmentof ATI-7505 and therefore those services are no longer a source of revenue forus. In accounting for our prior collaboration agreement with P&G, we haveconsistently reported activities between third parties and us on a gross basisand therefore the adoption of ASC 808-10, *Collaborative Arrangements*,effective for interim periods ending after March 15, 2009, did not have animpact on our consolidated financial statements.

 

**4.  Debt Financing**

 

As of September 30,2009, we have loan commitments outstanding with Lighthouse Capital Partners V,L.P., or Lighthouse, General Electric Commercial Finance, or GE, and OxfordFinance Corporation, or Oxford. The total principal amount borrowed under theLighthouse agreements was $19.0 million and the total unpaidprincipal balance outstanding as of September 30, 2009 was $10.8 million. We recordedinterest expense related to the Lighthouse loan agreement, including

 

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amortization of expense related to the terminalpayment and the warrants issued under the agreement, of $488,000 and $456,000for the three months ended September 30, 2009 and 2008, respectively, and$1.4 million and$1.4 million for thenine months ended September 30, 2009 and 2008, respectively. The totalprincipal amount borrowed under the GE agreements was $1.9 million and the total unpaidprincipal balance outstanding as of September 30, 2009 was $122,000. Werecorded interest expense related to the GE loan agreements of $5,000 and$18,000 for the three months ended September 30, 2009 and 2008,respectively, and $20,000 and $79,000 for the nine months ended September 30,2009 and 2008, respectively.  The totalprincipal amount borrowed under the Oxford loan agreement was $1.0 million and the total unpaidprincipal balance outstanding as of September 30, 2009 was $781,000. Werecorded interest expense related to the Oxford loan agreement, includingamortization of expense related to the terminal payment and the warrant issuedunder the agreement, of $27,000 and zero for the three months ended September 30,2009 and 2008, respectively, and $87,000 and zero for the nine months ended September 30,2009 and 2008, respectively.

 

**5.  Warrants**

 

We issue freestanding warrants from time to time pursuant to variouscontractual arrangements. As of September 30, 2009, the following warrantsto purchase our common stock were issued and outstanding:

 
| **Warrant Holder**    | ** ** | **Issue Date** | ** ** | **In Connection With**       | ** ** | **Warrant to Purchase** | ** ** | **Shares** | ** ** | **Exercise  Price  (per share)** | ** ** | **Expire Date** | ** ** |
|-----------------------|------------|----------------|------------|------------------------------|------------|-------------------------|------------|------------|------------|----------------------------------|------------|-----------------|------------|
| ATEL                  |       | 12/23/2002     |       | Leasing arrangement          |       | Common Stock            |       | 5,611      |       | $                                | 8.91       |            | 11/13/2012 |   |
| Lighthouse(1)         |       | 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            |       | 2,769,864  |       | $                                | 2.64       |            | 11/14/2013 |   |
| Oxford(5)             |       | 12/31/2008     |       | Equipment financing          |       | Common Stock            |       | 8,547      |       | $                                | 2.34       |            | 12/31/2013 |   |
|                  |       |           |       |                         |       |                    |       | 3,126,828  |       |                             |       |            |       |

 

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(1)           Exercisable, inwhole or in part, anytime at the option of the holder or deemed to have beenautomatically exercised in full immediately prior to the expiration of thewarrant; expires at the earlier of (i) November 7, 2009 or (ii) theeffective date of a merger, as defined in the agreement.

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

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

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

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

 

Warrants topurchase our common stock may be exercised using the net exercise method. Underthis method, the number of shares issued upon exercise is reduced by an amountequal to the product of the number of shares subject to the exercise and theexercise price per share, divided by the fair market value of our common stock,as defined, on the date of the exercise. The number of shares issued uponexercise of the warrants, and the exercise price per share, are adjustable inthe event of stock splits, dividends and similar fundamental changes to ourcapitalization. During the three and nine months ended September 30, 2009,certain investors exercised their warrants on a net exercise basis whichresulted in the issuance of 49,381 shares of our common stock. No warrants wereexercised during the three and nine months ended September 30, 2008.

 

In June 2008, the FASB updated the ASC Topic 815 on *Determining Whether an Instrument (or Embedded Feature) is Indexed toan Entity’s Own Stock*.  Theupdate provides guidance on how to determine if certain instruments (orembedded features) are considered indexed to our own stock.  It 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 derivativeaccounting. Although this update is effective

 

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forfiscal years beginning after December 15, 2008, any outstanding instrumentat the date of adoption requires retrospective application of the accountingthrough a cumulative effect adjustment to retained earnings upon adoption. Theadoption of this update did not have an impact on our consolidated financialposition or results of operations.

 

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

 
| ** **                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended********September 30,** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                         | ** ** | **2009**                                   | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                         | ** ** | **(in thousands)**                         | ** ** |
| Lighthouse—Warrant 1          |       | $                                          | 13         |                                            | $          | 23 |   | $ | 40 |   | $ | 70 |   |
| Lighthouse—Warrant 2          |       | 13                                         |       | 16                                              |       | 39 |   | 184 |   |
| Lighthouse—Warrant 3          |       | 27                                         |       | —                                          |       | 81 |   | — |   |
| Oxford                             |       | 1                                          |       | —                                          |       | 4 |   | — |   |
| Total warrant amortization expense |       | $                                          | 54         |                                            | $          | 39 |   | $ | 164 |   | $ | 254 |   |

 

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

 

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

 
| ** **                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended********September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                              | ** ** | **2009**                                   | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                              | ** ** | **(in thousands)**                         | ** ** |
| *Research and development:*             |       |                                       |       |                                            |       |   |   |   |   |
| Officer compensation                    |       | $                                          | 71         |                                            | $          | 80 |   | $ | 215 |   | $ | 240 |   |
| Employee and consultant compensation    |       | 147                                        |       | 169                                             |       | 461 |   | 501 |   |
| *Selling, general and  administrative:* |       |                                       |       |                                            |       |   |   |   |   |
| Director and officer compensation       |       | 303                                        |       | 264                                             |       | 929 |   | 819 |   |
| Employee and consultant compensation    |       | 42                                         |       | 43                                              |       | 119 |   | 133 |   |
| Total stock-based compensation expense  |       | $                                          | 563        |                                            | $          | 556 |   | $ | 1,724 |   | $ | 1,693 |   |

 

Weissued an aggregate 59,069 shares of our common stock upon the exercise ofstock options and 24,128 shares of our common stock upon the conclusion of theinitial offering period under our 2007 Employee Stock Purchase Plan during thenine months ended September 30, 2009.

 

**7.  Subsequent Events**

 

On October 6, 2009,we entered into a committed equity line financing facility under which we may sell up to $35 million of ourcommon stock to Commerce Court Small Cap Value Fund, Ltd., or Commerce Court,over a 24-month period subject to a maximum of 5,380,090 shares of our common stock, which is equalto one share less than 20% of our outstanding shares of common stock on theclosing date of the financing arrangement, less the number of shares of commonstock we issued to Commerce Court on the closing date in payment of ourcommitment fee.  The agreement alsoprovides that in no event shall Commerce Court be obligated to purchase shares ofour common stock which would result in the aggregate beneficial ownership byCommerce Court of more than 9.9% of the then issued and outstanding shares ofour common stock.  Additionally, CommerceCourt is not obligated to purchase shares at a price below $1.50 pershare.  The agreement contains customaryrepresentations, warranties, covenants, closing conditions and terminationprovisions by, among and for the benefit of the parties.

 

Over the term of theagreement, and in our sole discretion, we may present Commerce Court with drawdown notices requiring Commerce Court to purchase either a specified dollaramount of shares of our common stock based on the price per share over 10consecutive trading days (the “Draw Down Period”), subject to certain agreed-uponlimitations based on the market price of our common stock at the time of thedraw down or a percentage of the daily trading volume of our common stockduring the Draw Down Period. We may present Commerce Court with up to 24 drawdown notices during the term of the agreement, with only one draw down noticeallowed per Draw Down Period and a required minimum of five trading dayselapsed between each Draw Down Period.

 

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Once presented with adraw down notice, Commerce Court is required to purchase a pro rata portion ofthe shares on each trading day during the trading period on which the dailyvolume weighted average price for our common stock exceeds a threshold pricedetermined by us for such draw down. The per share purchase price for theshares will be equal to the daily volume weighted average price of our commonstock on each date during the Draw Down Period on which shares are purchased,less a discount ranging from 4.2% to 7.0%, based on a minimum price wespecify. If the daily volume weighted average price of our common stock fallsbelow the threshold price on any trading day during a Draw Down Period, CommerceCourt will not be required to purchase any share of common stock on that day.

 

Weissued 114,200 shares of our common stock to Commerce Court upon the executionof the securities purchase agreement. In addition, we paid $50,000 of attorneys’ fees andexpenses (exclusive of disbursements and out-of-pocket expenses) incurred byCommerce Court in connection with this transaction. We have also agreed to payother reasonable fees and expenses incurred by Commerce Court related to theongoing administration of the equity line facility on a quarterly basis.Further, if we issue a draw down notice and fail to deliver the shares toCommerce Court on the applicable settlement date, and such failure continuesfor 10 trading days, we have agreed to pay Commerce Court, in addition to allother remedies available to Commerce Court under the securities purchaseagreement, an amount in cash equal to 2.0% of the purchase price of such sharesfor each 30-day period during which the shares are not delivered, plus accrued interest.

 

In connection with theequity line financing agreement, we entered into a registration rightsagreement with Commerce Court pursuant to which we agreed to use our bestefforts to prepare and file with the SEC one or more registration statements withthe initial registration statement to be filed within 60 days of the closingdate of the agreement. We also agreed to use our best efforts to cause theinitial registration statement and any additional registration statements to bedeclared effective by the SEC within a specified period of time.  If we fail to meet the filing oreffectiveness deadlines, or if we fail to keep any registration statementscontinuously effective, we may be obligated to pay to Commerce Court cashdamages plus accrued interest.

 

On October 29, 2009,we announced a restructuring of our operations which included a reduction inpersonnel from 73 employees to 56 employees. We expect to incur a charge ofless than $500,000 related to the restructuring during the fourth quarter of 2009.The staff reduction affected all functions within the company and wasaccompanied by changes within the organizational structure to improve theefficiency of our operations.

 

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

 

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

 

**Overview**

 

ARYx Therapeutics, Inc.,or ARYx, is a biopharmaceutical company focused on developing a portfolio ofinternally discovered product candidates designed to eliminate known safetyissues associated with well-established, commercially successful drugs. We useour RetroMetabolic Drug Design technology to design structurally uniquemolecules that retain the efficacy of these original drugs but are metabolizedthrough a potentially safer pathway to avoid specific adverse side effectsassociated with these compounds. Our product candidate portfolio includes: anoral antiarrhythmic agent, budiodarone (ATI-2042), designed to have theefficacy of amiodarone, in Phase 2b clinical development for the treatmentof atrial fibrillation, a form of irregular heartbeat; an oral anticoagulant,tecarfarin (ATI-5923), designed to have the same therapeutic benefits aswarfarin, in Phase 2/3 clinical development for the treatment of patientswho are at risk for the formation of dangerous blood clots; an oral prokineticagent, ATI-7505, designed to have the same therapeutic benefits as cisapride,in Phase 2b clinical development for the treatment of chronicconstipation, gastroparesis, functional dyspepsia, irritable bowel syndromewith constipation, and gastroesophageal reflux disease; and, a novel,next-generation atypical antipsychotic agent, ATI-9242, currently inPhase 1 clinical testing for the treatment of schizophrenia and otherpsychiatric disorders. Additionally, we have several product candidates inpreclinical development. Each of our product candidates is an orally available,patentable new chemical entity designed to address similar indications as thoseof the original drug upon which each is based. Our product candidates targetwhat we believe to be multi-billion dollar market opportunities.

 

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

 

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

 

We are engineering potentially safer oral product candidates thatretain the efficacy of commercially successful drugs for well-establishedchronic markets. We have established proof of concept with our three leadingproduct candidates, budiodarone, tecarfarin, and ATI-7505. The following is asummary of our product candidates that are currently in clinical development:

 

***Budiodarone***

 

Budiodarone is anoral antiarrhythmic agent in Phase 2 clinical development for thetreatment of patients with atrial fibrillation. Budiodarone was designed tohave the efficacy of amiodarone, a drug that has been used for many years,despite its adverse side effects, because physicians consider it to be the mosteffective drug for treating patients with atrial fibrillation. Amiodaroneaccumulates in many different organs and can only be metabolized by CYP450,potentially leading to serious side effects that are not immediately reversibleupon withdrawal of the drug. Since budiodarone is predominantly metabolizedthrough the esterase pathway, it should avoid accumulation in organs and havefewer drug-drug interactions. We 

 

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have completed aPhase 2 pilot study (CLN-208) with budiodarone involving six atrialfibrillation patients with implanted recordable pacemakers who did not respondto previous drug therapy. This pilot study suggested that the effect ofbudiodarone improved as the dose increased. Based upon the results of thispilot study, we conducted an additional Phase 2b clinical trial to furtherdemonstrate the efficacy of budiodarone in patients with atrial fibrillation.The clinical trial, which enrolled 72 patients, was a multi-centered,randomized, double blind, placebo-controlled study of the efficacy and safetyof budiodarone in patients with paroxysmal atrial fibrillation, or PAF. Allpatients entering this study had previously implanted permanent pacemakers withappropriate diagnostic and recording capabilities. In December 2008, weannounced successful top-line efficacy results from this Phase 2b clinicaltrial. By achieving statistical significance at the two highest doses of thethree tested, the results essentially mirrored the findings of the earlierPhase 2 pilot study also conducted in paroxysmal atrial fibrillationpatients. The Phase 2b study also demonstrated that patients in the studyquickly returned to their pre-treatment level of atrial fibrillation once thetreatment ended. We have also announced the complete safety resultsfrom this Phase 2b clinical trial which indicate that budiodarone isgenerally safe and well-tolerated, and appears to avoid the tissue accumulationevident with amiodarone. We are actively seeking a large pharmaceutical companypartner for the full development and eventual commercialization of budiodarone,in the event we obtain requisite regulatory approval.

 

***Tecarfarin***

 

Tecarfarinis an oral anticoagulant agent in Phase 2/3 clinical development for thetreatment of patients who are at risk for the formation of dangerous bloodclots, such as those with atrial fibrillation or those at risk of venousthromboembolism. Tecarfarin was designed to have the same therapeutic benefitsas the drug warfarin which for over 50 years has been the oralanticoagulant of choice. Despite its widespread use, warfarin has severalsignificant limitations. It is metabolized by CYP450 and has many drug-druginteractions that often lead to serious side effects. We designed tecarfarin tobe metabolized through the esterase pathway, eliminating metabolism throughCYP450 and avoiding drug-drug interactions. Warfarin also has a very steep doseresponse curve which means that a small change in dose may lead to a substantialchange in the anticoagulation status of the patient. These two factors cancreate significant challenges in maintaining therapeutic levels of warfarin andthis can put patients at risk for either life-threatening clotting or bleeding,especially in patients with compromised CYP clearance. In preclinical testingand in clinical testing to date, it appears that tecarfarin may be inherentlymore stable than warfarin due to its predictable metabolism through theesterase pathway that has a much larger capacity than CYP450. The rate ofanticoagulation for both warfarin and tecarfarin is measured by the standardassay known as International Normalized Ratio, or INR.

 

Wehave treated over 400 patients with tecarfarin measuring the drug’s ability tomaintain those patients within the target therapeutic range of INR of 2 to 3(2.5 to 3.5 for heart valve patients). Two of the clinical trials performedwere Phase 2 studies (CLN-504 and CLN-509) and the third was the recentlycompleted Phase 2/3 trial, EmbraceAC (CLN-505). The tecarfarin efficacy resultsin each were nearly identical, appearing to demonstrate tecarfarin’s ability tomaintain patients’ INR within the target therapeutic range during a consistentpercentage of the time treated: 71.5% (CLN-504); 73.9% (CLN-509); and 74%(EmbraceAC). Statistical significance was achieved in CLN-504 when comparingthe tecarfarin response to the same patients’ historical experience withwarfarin: 71.5% time within therapeutic range versus 59.3% time withintherapeutic range, respectively (p= 0.0009). However, statistical significancewas not achieved at the primary endpoint in the 607-patient EmbraceAC clinicaltrial, directly measuring the ability of tecarfarin to maintain patients withinthe target therapeutic range of INR as compared to warfarin patients. Theendpoint was missed due to the virtually unprecedented time within therapeuticrange in the warfarin-treated patients of 73.2% (p=0.506). We believe thewarfarin outcome resulted from the intense monitoring and dose control providedby the study’s central dosing methodology, executed in accord with ouragreement on the study design with the U.S. Food and Drug Administration, orFDA. We believe a second Phase 3 study must be conducted to seek regulatoryapproval, again directly comparing tecarfarin to warfarin but in a “real-world”setting in which all monitoring and dosing decisions will be made at the studysites. This will be similar to how tecarfarin was dosed in CLN-504 and howwarfarin is typically dosed and titrated in clinical practice. Similar studiesconducted in the past with warfarin have typically shown a time in therapeuticrange of 56% to 66%, considerably less than was seen in the EmbraceAC studywhich was highly controlled. Subsequent additional analyses of the datagenerated in the EmbraceAC trial, looking at specific subpopulations in thestudy, support our belief that a real-world study would demonstrate theimportance of warfarin’s dependence on CYP450 metabolism versus tecarfarin’savoidance of that metabolic pathway in maintaining patients within the targettherapeutic range of INR. Our belief that tecarfarin would continue to maintainpatients’ INR within the previously demonstrated target therapeutic range whentested in a real-world study is further supported by the results to date of thesafety extension phase of EmbraceAC. In this phase, 95 patients treated withtecarfarin remained on the drug for an additional period of up to one year oftotal treatment. To date, these tecarfarin treated patients are in therapeuticINR range 79% of the time treated. During this safety extension phase,monitoring and dose adjustments have occurred on an average of every threeweeks, similar to monitoring in a real-world study. In previous discussions,the FDA indicated that the ability to maintain patients within the targeted INRwill likely be an acceptable surrogate and primary endpoint for tecarfarin’sclinical development. Using INR maintenance as a surrogate and primary endpointshould reduce both the size of and time to

 

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complete our planned clinical trials for tecarfarin compared toclinical trials measuring survival rates or other outcomes. Based upon ourearlier discussions with the FDA, we believe the completed EmbraceAC clinicaltrial may qualify as a registration study. We are seeking FDA guidance on thecontinued development of tecarfarin and we expect to receive FDA feedbackwithin the fourth quarter of 2009. We are also continuing to actively seek apharmaceutical company partner for the full development and eventualcommercialization of tecarfarin, in the event we obtain requisite regulatoryapproval. This potential partner will be responsible for conducting therequired second Phase 3 study.

 

***ATI-7505***

 

ATI-7505 is an oral prokinetic drug that speeds up the motion ofcontents through the gut, which has successfully completed a series ofPhase 2 clinical trials for the treatment of multiple gastrointestinaldisorders including gastroesophageal reflux disease, or GERD, functionaldyspepsia and chronic idiopathic constipation. ATI-7505 was designed to havethe same therapeutic benefits as cisapride, a drug marketed by Johnson &Johnson as Propulsid in the United States. Launched in 1993, cisapride waswithdrawn from the market in 2000 due to serious cardiovascular side effects.These side effects occurred as blood levels of the drug rose significantly whenCYP450 clearance was inhibited because of the presence of other drugs clearedby the same metabolic pathway. We designed ATI-7505 to be metabolized throughthe esterase pathway, eliminating metabolism through CYP450 as well as theoff-target cardiovascular effects. More than 900 subjects have been treatedwith ATI-7505 as part of our clinical trial program, which includes fourPhase 2 trials to date. In June 2006, we entered into a collaborationagreement with Procter & Gamble Pharmaceuticals, Inc., orP&G, to develop and commercialize ATI-7505. On July 2, 2008, wereceived notice from P&G that it elected to exercise its option toterminate the collaboration agreement effective July 2, 2008. P&Gsubsequently announced that it is exiting pharmaceutical drug development. Upontermination of the collaboration agreement by P&G, all rights to ATI-7505reverted to ARYx. Also on July 2, 2008, we announced the overallsuccessful results of a Thorough QT study, or TQT study, on ATI-7505, which webelieve supports the agent’s favorable cardiac safety profile. In March 2009,we received written confirmation from the FDA that based on the FDA’s review ofresults from our TQT study of ATI-7505, the FDA concurs with our interpretationof the results that the findings were negative, meaning ATI-7505 does notsignificantly increase the QT interval at the proposed therapeutic orsupratherapeutic doses. Since the QT interval is an important measure ofcardiac safety, this result supports our belief that ATI-7505 does not lead tocardiac liabilities. On August 22, 2008, we announced the results of a Phase 2bclinical trial testing the safety and efficacy of ATI-7505 in patients withchronic idiopathic constipation. The clinical trial, conducted by P&G, wasdesigned to enroll 400 patients evaluating four doses of the agent compared toplacebo. As a result of the termination of the collaboration between ARYx andP&G, the study was terminated early after only 214 patients had beenenrolled. In spite of the early termination of the study, ATI-7505 achievedstatistical significance at the study’s primary endpoint in the 80 milligramtwice daily dose. In addition, all doses tested demonstrated a clinicallymeaningful and desired increase in spontaneous bowel movements over baselinecompared to placebo after one week of treatment. We are now actively seeking a newpharmaceutical company partner to complete the development and eventuallycommercialize ATI-7505, in the event we obtain requisite regulatory approval.

 

***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 designed to avoid certain drug-drug interactions by avoiding CYP450enzymes for metabolism and reduce certain metabolic problems associated withthis class of therapy, including weight gain and type 2 diabetes. The Phase 1single-dose clinical trial, testing the safety and tolerability of ATI-9242, isunderway and is expected to be completed as financial resources allow.

 

***Research and Development Expense***

 

Our research and development, or R&D,expense consists of expenses incurred in identifying, testing and developingour product candidates. These expenses consist primarily of fees paid tocontract research organizations and other third parties to assist us inmanaging, monitoring and analyzing our clinical trials, clinical trial costspaid to sites and investigators’ fees, costs of non-clinical studies includingtoxicity studies in animals, costs of contract manufacturing services, costs ofmaterials used in clinical trials and non-clinical studies, laboratory relatedexpenses, R&D support costs including certain regulatory, qualityassurance, project management and administration, allocated expenses such asfacilities and information technology that are used to support our research anddevelopment activities and related personnel expenses, including stock-basedcompensation. R&D costs are expensed as incurred.

 

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Clinical trial costs are a significantcomponent of our R&D expense. Currently, we conduct our clinical trialsprimarily through coordination with contract research organizations and otherthird-party service providers. We recognize research and development expensefor these activities based upon a variety of factors, including actual andestimated patient enrollment, clinical site initiation activities, directpass-through costs and other activity-based factors.

 

The following table summarizes our R&Dexpense for the three and nine months ended September 30, 2009 and 2008:

 
| ** **                                                          | ** ** | **Three Months Ended********September 30,** | ** ** | **Nine Months Ended********September 30,** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                          | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                          | ** ** | **(in thousands)**                               | ** ** |
| Direct R&D expense by product  candidate:                       |       |                                             |       |                                            |       |   |   |   |   |
| Budiodarone                                                         |       | $                                                | 141        |                                            | $          | 1,592 |   | $ | 847 |   | $ | 4,930 |   |
| Tecarfarin                                                          |       | 1,607                                            |       | 6,573                                           |       | 7,098 |   | 12,654 |   |
| ATI-7505                                                            |       | 19                                               |       | 93                                              |       | 135 |   | 226 |   |
| ATI-9242                                                            |       | 82                                               |       | 80                                              |       | 26 |   | 1,172 |   |
| Other research programs                                             |       | 78                                               |       | 148                                             |       | 178 |   | 796 |   |
| Total direct R&D expense                                        |       | 1,927                                            |       | 8,486                                           |       | 8,284 |   | 19,778 |   |
| R&D personnel, administrative and other  expense                |       | 3,067                                            |       | 3,230                                           |       | 9,770 |   | 9,468 |   |
| Less: R&D portion of the cost of  collaboration service revenue |       | —                                           |       | —                                          |       | — |   | (39 | ) |
| Total R&D expense                                               |       | $                                                | 4,994      |                                            | $          | 11,716 |   | $ | 18,054 |   | $ | 29,207 |   |

 

From our inception through September 30,2009, we estimate that approximately $25.1 million was incurred for ourbudiodarone product candidate, approximately $39.9 million of expense wasincurred for our tecarfarin product candidate, approximately $22.6 million wasincurred for our ATI-7505 product candidate, approximately $5.1 million wasincurred for our ATI-9242 product candidate, and approximately $67.9 millionwas incurred for costs related to our R&D personnel, administrative andother 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 “R&D personnel, administrative and otherexpense” in the above table. The portion of our R&D 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 productcandidates will be subject to future collaborations, when such arrangementswill be secured, if at all, and to what degree such arrangements would affectour development 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 time duringthe development and clinical trial process. In addition, the results from earlyclinical trials may not be predictive of results obtained in subsequent andlarger clinical trials, and product candidates in later stages of clinicaltrials may fail to show the desired safety and efficacy despite havingprogressed successfully through initial clinical testing. Although our approachto identifying and developing new product candidates is designed to mitigaterisk, the successful development of our product candidates is highly uncertain.Further, even if our product candidates are approved for sale, they may not besuccessfully commercialized and therefore the future revenue we anticipate maynot 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.

 

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**Critical Accounting Policies and Significant Estimates**

 

We haveprepared our consolidated financial statements in accordance with U.S.generally accepted accounting principles. Accordingly, we have had to makeestimates, assumptions and judgments that affect the amounts reported in ourconsolidated financial statements. These estimates, assumptions and judgmentsabout future events and their effects on our results cannot be determined withcertainty, and are made based upon our historical experience and on otherassumptions that are believed to be reasonable under the circumstances. Theseestimates may change as new events occur or additional information is obtained,and we may periodically be faced with uncertainties, the outcomes of which arenot within our control and may not be known for a prolonged 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 andnine months ended September 30, 2009.

 

**Results of Operations**

 

***Comparison of Three and Nine MonthsEnded September 30, 2009 and 2008***

 

***Revenue***

 
| ** **                    | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | **Nine Months Ended**  | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------|--------------|------------------------------|------------|------------|------------|------------------------|------------|------------|------------|------------|------------|
| ** **                    | ** **   | **September 30,**       | ** ** | **Change** | ** ** | **September 30,** | ** ** | **Change** | ** ** |
| ** **                    | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**                  | ** ** | **%**      | ** ** | **2009**   | ** ** | **2008** | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***                  | *** *** | **(In thousands, except %)** | ** ** |
| Collaboration service revenue |         | $                            | —     |       | $          | —                 |       | $          | —     |       | —     |   | $ | — |   | $ | 232 |   | $ | (232 | ) | (100 | )% |
| Technology license fees       |         | —                       |       | 17,544     |       | (17,544                | )          | (100       | )%         | —     |       | 19,492 |   | (19,492 | ) | (100 | )% |
| Total revenue                 |         | $                            | —     |       | $          | 17,544                 |       | $          | (17,544    | )          | (100       | )% | $ | — |   | $ | 19,724 |   | $ | (19,724 | ) | (100 | )% |

 

We generated no revenue for the three and nine months ended September 30,2009. Our only source of revenue in 2008 was in connection with our priorcollaboration agreement with P&G for the licensing of our ATI-7505 productcandidate and for providing pharmaceutical development and other services toP&G. The decreases in revenue for the three and nine months ended September 30,2009, as compared to the same periods in 2008, were due to the terminationof the collaboration agreement with P&G in July 2008.

 

***Cost ofCollaboration Service Revenue***

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

 

We incurred costs for certain servicesprovided in connection with our prior collaboration agreement with P&G,including costs for pharmaceutical development, patent filing and maintenanceand other activities related to the ATI-7505 product candidate. We did notgenerate any collaboration service revenue nor associated cost for the threeand nine months ended September 30, 2009, nor for the three months ended September 30,2008. The $232,000 decrease in cost of revenue for the nine months endedSeptember 30, 2009, ascompared to the same period in 2008, was the result of the termination of thecollaboration agreement with P&G in July 2008.

 

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***Researchand Development Expense***

 
| ** **                       | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **             | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|--------------|------------------------------|------------|------------|------------|------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| ** **                       | ** **   | **September 30,**       | ** ** | **Change** | ** ** | **September 30,** | ** ** | **Change**            | ** ** |
| ** **                       | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**                  | ** ** | **%**                 | ** ** | **2009**   | ** ** | **2008**   | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***                     | *** *** | **(In thousands, except %)** | ** ** |
| Research and development expense |         | $                            | 4,994      |       | $          | 11,716                 |       | $                     | (6,722     | )          | (57        | )%         | $          | 18,054 |   | $ | 29,207 |   | $ | (11,153 | ) | (38 | )% |
|                                  |              |                              |            |            |            |                        |            |                       |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

For the three months ended September 30, 2009, as compared to thesame period in 2008, our research and development expense decreased by$6.7 million, or 57%. The decrease was primarily due to:

 

·                  a $1.5 million reduction in expendituresas a result of the substantial completion of our budiodarone Phase 2b clinicalstudy in December 2008;

 

·                  a $3.6 million reduction in clinicalexpenditures as a result of the substantial completion of our Phase 2/3EmbraceAC study of tecarfarin and a $300,000 reduction in clinical expendituresas a result of the completion of a pilot clinical study of tecarfarin;

 

·                  a $1.1 million reduction in drugmanufacturing costs and non-clinical studies associated with our tecarfarinproduct candidate; and

 

·                  a $200,000 reduction in expenditures relatedto our other research and development programs.

 

For the nine months ended September 30, 2009, as compared to thesame period in 2008, our research and development expense decreased by$11.2 million, or 38%. The decrease was primarily due to:

 

·                  a $2.7 million reduction in clinicalexpenditures and a $400,000 reduction in drug manufacturing costs due to thesubstantial completion of our budiodarone Phase 2b clinical study in December 2008, in addition to a $900,000 reduction innon-clinical studies expenditures on our budiodarone product candidate;

 

·                  a $2.4 million reduction in drugmanufacturing costs and a $900,000 reduction in non-clinical studiesexpenditures associated with our tecarfarin product candidate;

 

·                  a $1.4 million reduction in clinicalexpenditures as a result of the completion of a pilot clinical study oftecarfarin and a $900,000 reduction in clinical expenditures related to thesubstantial completion of our tecarfarin Phase 2/3 EmbraceAC study;

 

·                  a $1.2 million reduction in expendituresrelated to the completion of five cohorts of a Phase 1 clinical study related to ourATI-9242 product candidate; and

 

·                  a $400,000 reduction in expenditures relatedto our other research programs.

 

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

*** ***
| ** **                                  | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **             | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------|--------------|------------------------------|------------|------------|------------|------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| ** **                                  | ** **   | **September 30,**       | ** ** | **Change** | ** ** | **September 30,** | ** ** | **Change**            | ** ** |
| ** **                                  | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**                  | ** ** | **%**                 | ** ** | **2009**   | ** ** | **2008**   | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***                                | *** *** | **(In thousands, except %)** | ** ** |
| Selling, general and administrative expense |         | $                            | 2,638      |       | $          | 2,415                  |       | $                     | 223        |       | 9          | %          | $          | 7,863 |   | $ | 8,166 |   | $ | (303 | ) | (4 | )% |
|                                             |              |                              |            |            |            |                        |            |                       |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

The higher selling, general and administrative expense for the threemonths ended September 30, 2009 as compared to the same period in 2008 wasprimarily due to Sarbanes-Oxley Section 404 compliance costs and patentmaintenance costs. The lower selling, general and administrative expense forthe nine months ended September 30, 2009 as compared to the same period in2008 was primarily due to a reduction in legal expenses in connection with theinitiation of our Phase 2/3 clinical trial on tecarfarin, partially offset byincreases in consulting costs.

 

***Interestand Other Income, Net***

*** ***
| ** **                     | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **             | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|--------------|------------------------------|------------|------------|------------|------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| ** **                     | ** **   | **September 30,**       | ** ** | **Change** | ** ** | **September 30,** | ** ** | **Change**            | ** ** |
| ** **                     | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**                  | ** ** | **%**                 | ** ** | **2009**   | ** ** | **2008**   | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***                   | *** *** | **(In thousands, except %)** | ** ** |
| Interest and other income, net |         | $                            | 1          |       | $          | 292                    |       | $                     | (291       | )          | (100       | )%         | $          | 66 |   | $ | 1,149 |   | $ | (1,083 | ) | (94 | )% |
|                                |              |                              |            |            |            |                        |            |                       |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Interest and otherincome, net of other expenses, consist primarily of interest income from ourinvestments in marketable securities reduced by certain expenses such as statefranchise and local business taxes. Lower interest income for the three andnine months ended September 30, 2009 as compared to the same periods in2008 was attributable tolower prevailing short-term interest rates and a lower cash balance in ourinvestment portfolio.

 

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***InterestExpense***

 
| ** **       | ** **   | **Three Months Ended**       | ** ** | ** ** | ** ** | **Nine Months Ended**  | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------|--------------|------------------------------|------------|------------|------------|------------------------|------------|------------|------------|------------|------------|
| ** **       | ** **   | **September 30,**       | ** ** | **Change** | ** ** | **September 30,** | ** ** | **Change** | ** ** |
| ** **       | ** **   | **2009**                     | ** ** | **2008**   | ** ** | **$**                  | ** ** | **%**      | ** ** | **2009**   | ** ** | **2008** | ** ** | **$** | ** ** | **%** | ** ** |
| *** ***     | *** *** | **(In thousands, except %)** | ** ** |
| Interest expense |         | $                            | 519        |       | $          | 474                    |       | $          | 46         |       | 10         | % | $ | 1,515 |   | $ | 1,437 |   | $ | 78 |   | 5 | % |
|                  |              |                              |            |            |            |                        |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase ininterest expense for the three and nine months ended September 30, 2009 ascompared to the same periods in 2008 was primarily due to additional equipmentfinancing provided to us by Oxford Finance Corporation in December 2008.

 

***Other-Than-TemporaryImpairment Loss***

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

 

There was no impairment loss related to ourauction rate security holding for the three months ended September 30,2009. For the nine months ended September 30, 2009, we recorded a $14,000impairment loss due to an estimated decline in the fair value of our remainingauction rate security that we determined to be other than temporary. As of September 30,2009, the carrying value of this instrument was $353,000.

 

**Liquidity and Capital Resources**

 
| ** **                  | ** **   | **Nine Months Ended**  | ** **   |
|-----------------------------|--------------|------------------------|--------------|
| ** **                  | ** **   | **September 30,** | ** **   |
| ** **                  | ** **   | **2009**               | ** **   | **2008** | ** ** |
| *** ***                | *** *** | **(In thousands)**     | *** *** |
| Cash (used in) provided by: |         |                   |         |   |   |
| Operating activities        |         | $                      | (28,882      | ) | $ | (34,574 | ) |
| Investing activities        |         | 1,149                  |         | (6,890 | ) |
| Financing activities        |         | (1,421                 | )            | 6,799 |   |
| Total cash (used) provided  |         | $                      | (29,154      | ) | $ | (34,665 | ) |

 

As of September 30, 2009, we had $14.2 million in cash, cashequivalents and marketable securities excluding our auction rate securityholding. While our cash resources as of September 30, 2009 are less thanthe amount needed for us to maintain our current operations for the next 12months, we believe that our cash, cash equivalents and marketable securities onhand will be sufficient to fund our operations through the end of the firstquarter of 2010. Subsequent to the end of our third quarter, on October 6,2009, we entered into a committed equity line financing facility under which we have an option to sell up to$35 million of our commonstock, subject to certain limitations, over a 24-month period. Since ourinception, we have incurred significant net operating losses and, as of September 30,2009, we had an accumulated deficit of $181.3 million. Our ability tocontinue operations is dependent upon our ability to obtain substantialadditional capital to continue our R&D programs and to bring any potentialfuture products to market. In order to satisfy our projected cash needs for atleast the next 12 months, we are considering various options that may beavailable to us, including entering into collaborative arrangements for one ormore of our product candidates, public or private equity financings, debtfinancing or a combination of the aforementioned. However, there is noassurance that we will be able to raise additional capital on terms acceptableto us or at all. Furthermore, any additional equity financings may be dilutiveto stockholders and debt financing, if available, may involve covenants thatplace substantial restrictions on our business. If we fail to raise sufficientcapital as and when needed, we have developed contingency plans that mayrequire us to delay, reduce the scope of, or eliminate one or more of ourR&D programs, partner one or more of our product candidates at an earlierstage of development than we might otherwise choose, or to reduce personnel andrelated costs and other discretionary expenditures that are within our control.

 

Due to adverse developments in globalfinancial markets, we have experienced reduced liquidity with respect to ourinvestment in a single auction rate instrument. If the need arose to liquidatethis 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.

 

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Net cash used in operating activities was $28.9 millionand $34.6 millionfor the nine months ended September 30, 2009 and 2008, respectively. Netcash used in each of these periods was primarily used towards the funding ofour operating costs and expenses in connection with the conduct of our research,development and administrative activities.

 

Cash provided by or used in investing activities primarily consists ofpurchases, sales and maturities of marketable securities, as well as changes inrestricted cash balances and purchases of property and equipment. Net cashprovided by sales and maturities of marketable securities was $1.1 millionduring the nine months ended September 30, 2009, as compared to $6.9million net cash used to invest in marketable securities for the same period in2008. Purchases of property and equipment were $97,000 for the ninemonths ended September 30, 2009, compared to $614,000 for the same periodin 2008. Cash provided by investing activities for the nine months ended September 30,2009 included a $200,000 release in restricted cash, as compared to a $300,000increase in restricted cash for the same period in 2008.

 

Net cash used in financing activities was$1.4 million for the nine months ended September 30, 2009, and net cashprovided by financing activities was $6.8 million for thenine months ended September 30, 2008. Net cash used in financingactivities for the nine months ended September 30, 2009 primarilyconsisted of principal payments on our long-term debt.  Net cash provided by financing activities forthe nine months ended September 30, 2008 was primarily due to theutilization of the $9.0 million loan facility extended to us by LighthouseCapital Partners, net of $1.5 millionprincipal payments on our long-term debt.

 

As of September 30, 2009, we have loancommitments outstanding with Lighthouse, GE, and Oxford. The total principalamount borrowed under the Lighthouse agreements was $19.0 millionand the total unpaid principal balance outstanding as of September 30,2009 was $10.8 million.We recorded interest expense related to the Lighthouse loan agreement,including amortization of expense related to the terminal payment and thewarrants issued under the agreement, of $488,000 and $456,000 for the threemonths ended September 30, 2009 and 2008, respectively, and $1.4 million and $1.4 million for the nine monthsended September 30, 2009 and 2008, respectively. The total principalamount borrowed under the GE agreements was $1.9 million and the total unpaid principal balance outstandingas of September 30, 2009 was $122,000. We recorded interest expenserelated to the GE loan agreements of $5,000 and $18,000 for the three monthsended September 30, 2009 and 2008, respectively, and $20,000 and $79,000for the nine months ended September 30, 2009 and 2008, respectively. Thetotal principal amount borrowed under the Oxford loan agreement was $1.0 million and the total unpaidprincipal balance outstanding as of September 30, 2009 was $781,000. Werecorded interest expense related to the Oxford loan agreement, including amortizationof expense related to the terminal payment and the warrant issued under theagreement, of $27,000 and zero for the three months ended September 30,2009 and 2008, respectively, and $87,000 and zero for the nine months ended September 30,2009 and 2008, respectively.

 

Our future funding requirements will dependupon many factors, including:

 

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

 

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

 

·                  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.

 

In order to provide for our long-termobjective of product commercialization and continued investment in our R&Dpipeline, we will need to raise additional funds to support our operations, andsuch funding may not be available to us on acceptable terms, or at all. If weare unable to raise additional funds when needed, we may not be able tocontinue 

 

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development of our product candidates or we could be required to delay,scale back or eliminate some or all of our R&D programs. We may seek toraise any necessary additional funds through public or private equity, debtfinancings, collaborative arrangements with corporate partners or othersources. If we raise additional funds through the issuance of debt securities,these securities could have rights that are senior to the holders of our commonstock and could contain covenants that restrict our operations. If we raiseadditional funds by issuing equity securities, dilution to our existingstockholders may result. In addition, if we raise additional funds through thesale of equity securities, new investors could have rights superior to ourexisting stockholders. To the extent that we raise additional capital throughlicensing arrangements or arrangements with collaborative partners, we may berequired to relinquish, on terms that are not favorable to us, rights to someof our technologies or product candidates that we would otherwise seek todevelop or commercialize ourselves for a higher profit margin. The terms offuture financings may restrict our ability to raise additional capital, whichcould delay or prevent the further development of our product candidates orcommercialization of our products. Our failure to raise capital when needed mayharm our business and operating results.

 

**Contractual Obligations**

 

There were no material changes to ourcontractual obligations from those disclosed in our annual report on Form 10-Kfor the year ended December 31, 2008, filed with the Securities and Exchange Commission on March 27, 2009, other than scheduledpayments made through September 30, 2009.

 

**Recent Accounting Pronouncements**

 

See Note 1 of the Notes to our Condensed Consolidated FinancialStatements included elsewhere in this report for recent accountingpronouncements that could have an effect on us.

 

**Off-Balance Sheet Arrangements**

 

Since inception, except for standard operating leases, we have notengaged in any off-balance sheet arrangements, including the use of structuredfinance, special purpose entities or variable interest entities.

 

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

 

There were no material changes to our market riskfrom those disclosed in our annual report on Form 10-K for the year ended December 31,2008, filed with the Securities and Exchange Commission on March 27, 2009.

 

**ITEM 4T. CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controlsand Procedures***

 

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

 

Asof September 30, 2009, we carried out an evaluation, under the supervisionand with the participation of our management, including our Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures.  Based on that evaluation, our Chief ExecutiveOfficer and Chief Financial Officer have concluded that, subject to thelimitations described below, our disclosure controls and procedures wereeffective as of September 30, 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, ifany, within the company have been detected. These inherent limitations includethe realities that judgments in decision-making can be faulty, and thatbreakdowns can occur because of 

 

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simple error or mistake. Additionally, controls can be circumvented bythe individual acts of some persons, by collusion of two or more people, or bymanagement override of the control. The design of any system of controls alsois based in part upon certain assumptions about the likelihood of futureevents, and there can be no assurance that any design will succeed in achievingits stated goals under all potential future conditions. Over time, control maybecome inadequate because of changes in conditions, or the degree of compliancewith the policies or procedures may deteriorate. Because of the inherentlimitations in a cost-effective control system, misstatements due to error orfraud may occur and not be detected.

 

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

 

No change was made in our internal control over financial reportingduring the quarter ended September 30, 2009 that has materially affected,or is reasonably likely to materially affect, our internal control overfinancial 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 an asterisk(*) those risks described below that reflect substantive changes from therisks described in our Annual Report on Form 10-K  for the year ended December 31, 2008,filed with the Securities and Exchange Commission on March 27, 2009. Inassessing these risks, you should also refer to the other information containedin this quarterly report on Form 10-Q, including our financial statementsand 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.****

 

As of September 30, 2009, we had $14.2 million in cash, cashequivalents and marketable securities on hand excluding our auction ratesecurity holding, which is less than the amount needed for us to maintain ourcurrent operations for the next 12 months. Our ability to continueoperations is dependent upon our ability to obtain substantial additionalcapital. Our operations have consumed substantial amounts of cash sinceinception. We expect to continue to spend substantial amounts of cash to fundour operations, including research and development expenses and costsassociated with the conduct of clinical trials for our product candidates. Itis our intention to enter into collaboration arrangements to commercialize ourproduct candidates. Within those arrangements, we may retain the commercialright to co-promote our products to selected physicians through a specialtysales force. However, should the collaboration arrangements fail to providesufficient revenue to fund our operations adequately, we will need to raiseadditional capital to fund our operations and complete development of ourproduct candidates. If any of our product candidates receive regulatoryapproval for commercial sale, we may need to raise additional capital to fundour portion of the commercialization efforts. Our future funding requirementswill depend on many factors, including:

 

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

 

·                  the scope, rate of progress, resultsand cost of our preclinical testing, clinical trials and other research anddevelopment activities;

 

·                  the cost, timing and outcomes ofregulatory approvals;

 

·                  the number and characteristics ofproduct candidates that we pursue;

 

·                  the cost and timing of establishingsales, marketing and distribution capabilities for our specialty sales force;

 

·                  the cost of establishing clinical andcommercial supplies of our product candidates and any products that we maydevelop;

 

·                  the timing, receipt and amount ofsales or royalties, if any, from our potential products;

 

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

 

·                  the extent to which we acquire orinvest in businesses, products or technologies, although we currently have nocommitments or agreements relating to any of these 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. Ifadequate funds are not available on a timely basis, we may:

 

·                  terminate or delay clinical trialsfor one or more of our product candidates;

 

·                  further reduce our headcount and capitalor operating expenditures;

 

·                  delay our establishment of sales andmarketing capabilities or other activities that may be necessary tocommercialize our product candidates; or

 

·                  curtail significant drug research anddevelopment programs that are designed to identify 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 September 30, 2009,we had an accumulated deficit of approximately $181.3 million.We expect our research and development expenses to continue to be a significantportion of our operating costs that may increase as we continue to expand ourdevelopment programs subject to adequate funding. Subject to regulatoryapproval for any of our product candidates, we expect to incur significantexpenses associated with the potential establishment of a North Americanspecialty sales force and increased manufacturing expenses. Although it is notexpected to occur in the next several years, the cost of establishing a smallNorth American specialty sales force will be substantial. As a result, weexpect to continue to incur substantial and increasing losses for theforeseeable future. These losses have had and will continue to have an adverseeffect 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 expense 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.

 

***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.

 

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

 

Currently, there remains much caution in theU.S. economy due to a global credit crisis that has resulted in tighteningcredit markets and rising liquidity concerns across most industries, includingthe banking and investments sector. While as of the date of this filing we arenot aware of any material losses, or other significant deterioration in thefair value of our cash equivalents or investments in marketable securitiessince September 30, 2009, no assurance can be given that furtherdeterioration in conditions of the global credit and financial markets wouldnot negatively impact our current portfolio of cash equivalents or investmentsin marketable securities or our ability to meet our financing objectives toallow us to continue our operations.

 

***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.***

 

We have three product candidates in latestage clinical development, with tecarfarin in Phase 2/3, and budiodarone andATI-7505 in Phase 2b. A fourth product candidate, ATI-9242, entered into aPhase 1 clinical trial in April 2008.******Ourability to generate product revenue in the future will depend heavily on thesuccessful development and commercialization of these product candidates. Ourother product candidates are in the discovery stage. Any of our productcandidates could be unsuccessful for a variety of reasons, including that they:

 

·                  may not demonstrate acceptable safetyand efficacy in preclinical studies or clinical trials or otherwise may notmeet applicable regulatory standards for approval;

 

·                  may not offer therapeutic, safety orother improvements over existing or future drugs used to treat the sameconditions;

 

·                  may not be capable of being producedin commercial quantities at acceptable costs; or

 

·                  may not be accepted in the medicalcommunity 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.

 

***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 collaborative arrangementswith third parties to develop and commercialize each of our lead productcandidates. Dependence on collaborative arrangements for development andcommercialization of our product candidates will subject us to a number ofrisks, including:

 

·                  we may not complete a collaborativearrangement in time to avoid delays in clinical development, if at all, and ifno collaborative arrangement is achieved, product development may be haltedaltogether;

 

·                  we may not be able to control theamount and timing of resources that our collaborators may devote to thedevelopment or commercialization of product candidates or to their marketingand distribution;

 

·                  collaborators may delay clinicaltrials, provide insufficient funding for a clinical trial program, stop aclinical trial or abandon a product candidate, repeat or conduct new clinicaltrials or require a new formulation of a product candidate for clinicaltesting;

 

·                  we may have limited control over ourclinical trial design;

 

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·                  disputes may arise between us and ourcollaborators that result in the delay or termination of the research,development or commercialization of our product candidates or that result incostly litigation or arbitration that diverts management’s attention andresources;

 

·                  our collaborators may experiencefinancial difficulties;

 

·                  collaborators may not properlymaintain or defend our intellectual property rights or may use our proprietaryinformation in such a way as to invite litigation that could jeopardize orinvalidate our proprietary information or expose us to potential litigation;

 

·                  business combinations or significantchanges in a collaborator’s business strategy may adversely affect acollaborator’s willingness or ability to fulfill its obligations under anyarrangement;

 

·                  a collaborator could independentlymove forward with a competing product candidate developed either independentlyor in collaboration with others, including our competitors; and

 

·                  any collaborative arrangement may beterminated or allowed to expire, which would delay the development and mayincrease the cost of developing our product candidates.

 

***Collaborative arrangementsdo not currently exist for any of our product candidates. If we do notestablish collaborations for each of our budiodarone, tecarfarin, ATI-7505 andATI-9242 product candidates or future product candidates, we may have to alterour 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 budiodarone, tecarfarin, 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 developproducts that compete with ours, or fail to commit sufficient resources to themarketing and distribution of our product candidates. The termination of acollaboration agreement may cause us to incur additional and unanticipatedcosts that may be material 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 product candidate(s) throughother collaborations and to generate future revenue from the sale of theproduct candidate(s) may be significantly reduced. If a conflict ofinterest arises between us and our collaboration partner(s), they may act intheir own self-interest and not in the interest of our company or ourstockholders. If a collaboration partner breaches or terminates theircollaboration agreement with us or otherwise fails to perform their obligationsthereunder in a timely manner, the clinical development or commercialization ofthe respective product candidate(s) could be delayed or terminated. Forexample, we experienced this when P&G terminated our collaborationagreement to develop and commercialize ATI-7505, and we may experience asimilar result with potential collaboration partners in the future with respectto any of our product candidates.

 

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***If we are not 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 each submittedproduct application may cause delays in the approval or rejection of anapplication. Even if the FDA or a foreign regulatory agency approves a productcandidate, the approval may impose significant restrictions on the indicateduses, conditions for use, labeling, advertising, promotion, marketing and/orproduction 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,including withdrawal of the medicine from the market. Each of the opportunitiesupon which we have chosen to focus is based upon our belief that ourRetroMetabolic Drug Design technology can be used to create a new product basedupon an existing product which is efficacious in treating a specific condition,but which has a known safety problem. Each of our four lead product candidatesis modeled on drugs which have significant safety problems. Budiodarone ismodeled on amiodarone which is used, but not approved, for atrial fibrillationin spite of known safety problems due to its accumulation in the body andinteraction with other drugs. Both amiodarone and budiodarone contain iodinewhich can accumulate in the thyroid and must be monitored for safety purposes.In addition, budiodarone is partially metabolized by CYP450 and, at certainlevels has 

 

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caused drug-drug interactions with warfarin, which increased INR andcould increase the risk of hemorrhage complications. Tecarfarin is modeled onwarfarin which is known to have safety risks because of its potential forbleeding and for interactions with numerous other drugs as listed on thepackage insert for the product. ATI-7505 is modeled on cisapride which waswithdrawn from the market due to fatal cardiac problems. ATI-9242 is modeled toretain certain of the positive features of the class of atypical antipsychoticdrugs while lessening certain of the safety issues that vary but exist withinthe class. The receptor profile which yields the positive and avoids thenegative features of this class of drugs is a matter of great debate. While wehave designed ATI-9242 to have an appropriate balance across a very complex setof receptors, we may have targeted an inappropriate profile or the profileattained may result in an unanticipated lack of efficacy or safety problems.Although we have designed our drugs to largely address each of the originaldrugs’ key safety problems, we will need to continue to demonstrate thisthrough continued clinical testing. It is possible that the FDA may imposeadditional requirements on the development or approval of our products becauseof its concern about the original drug’s safety problems. These potentialadditional barriers could delay, increase the cost of, or prevent thecommercialization 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 product candidatescould adversely affect the development of our product candidates. For example,the product withdrawals of Vioxx by Merck & Co., Inc. andBextra by Pfizer because of safety issues caused other drugs that have the sametherapeutic target, such as Celebrex from Pfizer, to receive additionalscrutiny from regulatory authorities. Another prokinetic, tegaserod marketed byNovartis Pharmaceuticals Corporation as Zelnorm, was temporarily withdrawn fromthe market and then reintroduced in a very limited manner due to certaincardiac effects reportedly related to its off-target effects. 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;

 

·                  delays in patient enrollment, whichwe previously experienced in certain trials, and variability in the number andtypes of patients available for clinical trials;

 

·                  difficulty in maintaining contactwith patients after treatment, resulting in incomplete data;

 

·                  poor effectiveness of productcandidates during clinical trials;

 

·                  poor patient compliance whileparticipating in one of our clinical trials;

 

·                  unforeseen safety issues or sideeffects; and

 

·                  governmental or regulatory delays andchanges in regulatory requirements, policies and guidelines.

 

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 clinical trialsin any of the markets in which our collaborators or we intend to sell thoseproduct candidates. Accordingly, our collaborators or we would not receive theregulatory approvals needed to market our product candidates, which wouldseverely 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 in the conduct of ourclinical trials. In addition, to date we have conducted our clinical trials atnumerous sites in North America and Europe. Nonetheless, we are responsible forconfirming that each of our clinical trials is conducted in accordance with itsgeneral investigational plan and protocol. Moreover, the FDA requires us tocomply with regulations and standards, commonly referred to as good clinicalpractices, for conducting and recording and reporting the results of clinicaltrials to assure that data and reported results are credible and accurate and thatthe trial participants are adequately protected. Our reliance on third partiesthat we do not control does not relieve us of these responsibilities andrequirements. If these third parties do not successfully carry out theircontractual duties or regulatory obligations or meet expected deadlines, if thethird parties need to be replaced or if the quality or accuracy of the datathey obtain is compromised owing to the failure to adhere to our clinicalprotocols or regulatory requirements or for other reasons, our clinical trialsmay be extended, delayed, suspended or terminated, and we may not be able toobtain regulatory approval for, or successfully commercialize, our productcandidates.

 

***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 not have been the first tomake the inventions covered by each of our pending patent applications andissued patents;

 

·                  we might not have been the first tofile patent applications for the disclosed inventions;

 

·                  others may independently developsimilar or alternative technologies or duplicate our technologies;

 

·                  it is possible that none of ourpending patent applications will result in issued patents;

 

·                  any patents issued to us or ourcollaborators may not provide protection for commercially viable products ormay be challenged by third parties;

 

·                  the patents of others may have anadverse effect on our ability to do business; or

 

·                  regulators or courts may retroactivelydiminish 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 drug wheremuch 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 affectour ability to obtain protection for our technologies, (b) increase ourcosts of obtaining and maintaining patents, (c) detrimentally affect ourability to enforce our existing patents, (d) narrow the scope of ourpatent protection, 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, non-infringing 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 affect 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 September 30, 2009, we held 45issued or allowed U.S. patents and had 17 patent applications pending beforethe USPTO. For some of our inventions, corresponding foreign patent protectionis pending. Of the 45 U.S. patents that we hold, 40 patents are compound andcomposition related, having expiration dates from 2013 to 2025. Our compositionof matter patent for budiodarone, our compound for the treatment of atrialfibrillation, issued in April 2002 and has an expiration date in 2020. Thecomposition of matter patent for tecarfarin, our compound for anticoagulation,issued in August 2007 and has an expiration date in 2025. The compositionof matter patent for ATI-7505, our compound for the treatment ofgastrointestinal disorders, issued in February 2007 and has an expirationdate in 2025. Our composition of matter patent applications for ATI-9242, ourproduct candidate for the treatment of schizophrenia and other psychiatricdisorders, are currently pending, one in the United States and two in foreignjurisdictions. Although third parties may challenge our rights to, or the scopeor validity of, our patents, to date we have not received any communicationsfrom third parties challenging our patents or patent applications covering ourclinical candidates.

 

While budiodarone, tecarfarin 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 2020, 2025 and 2025, respectively (assuming the validity andenforceability of the current composition of matter patents). We cannotguarantee that any patents will be issued from our pending or future patentapplications, and any patents that issue from such pending or future patentapplications would be subject to the same risks described herein for currentlyissued patents.

 

Our research and development 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. Our employees,consultants, contractors, outside scientific collaborators and other advisorsare 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 be forcedto litigate if an intellectual property dispute arises, and it is possible thatothers may choose to challenge our position and that a judge or jury willdisagree with our conclusions. We could incur substantial costs in litigationif we are required to defend against patent suits brought by third parties. Ifwe do not successfully defend an infringement action, are unable to haveinfringed patents declared invalid, and do not obtain a license to the patentedtechnology, we may,

 

·                  incur substantial monetary damages;

 

·                  encounter significant delays inmarketing our products; and

 

·                  be unable to conduct or participatein the manufacture, use or sale of our products 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 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 isunable 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 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 andCorum Inc. of Taiwan on an ongoing purchase order basis. ShouldChemShop BV or Corum Inc. be unable or unwilling to serve as thesupplier of tecarfarin, a delay in the development of tecarfarin could occur,impairing our ability to commercialize tecarfarin on our existing timeline.Tecarfarin’s active pharmaceutical ingredient is processed into 1 milligram, 2milligram, 5 milligram or 10 milligram tablets by QS Pharma of Boothwyn, PA.

 

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.

 

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.

 

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 

 

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alternative suppliers. Any inability to obtain qualified alternativesuppliers, including an inability to obtain or delay in obtaining approval ofan alternative supplier from the FDA, would delay or prevent the clinicaldevelopment and commercialization of these product candidates.

 

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 beenperformed by entities other than those that will likely manufacture theproducts for future clinical trials or commercial use. There is a possibilitythat analysis of future clinical trials will show that the results from ourearlier clinical trials have not been replicated. The failure to replicatethese earlier clinical trials would delay our clinical development timelines.New impurity profiles that occur as a result of changing manufacturers may leadto delays in clinical 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;

 

·                  terminate or choose not to renewmanufacturing agreements, based on their own business priorities, at a timethat is costly or inconvenient for us;

 

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

 

·                  breach or fail to perform as agreedunder 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 not ensurethat 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:

 

·                  regulators or institutional reviewboards may not authorize us to commence a clinical trial at a prospective trialsite;

 

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

 

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

 

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

 

·                  the effects of our product candidatesmay not be the desired effects or may include undesirable side effects; and

 

·                  our preclinical studies or clinicaltrials may show that our product candidates are not superior to the originaldrugs 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. For example, 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 ourclinical trials for budiodarone, and have a resulting adverse effect on our abilityto obtain requisite regulatory approval to market and sell budiodarone.Similarly, in the clinical testing of budiodarone in patients whose conditionalso required treatment with warfarin, dose adjustments of warfarin weresometimes required. As is common to most clinical trials, the potential fordrug-drug interactions will be monitored. As another example, due to the resultof our Phase 2/3 clinical trial of tecarfarin, additional clinical trials oftecarfarin will be necessary in order to demonstrate clinical superiority towarfarin. Even if we adequately demonstrate that tecarfarin is safe andeffective and obtain FDA approval, we may not be permitted to market it assuperior to warfarin. In a canine toxicology study of ATI-7505 performed by ourformer collaboration partner, P&G, six deaths occurred at doses that were10 and 20 times greater than doses currently being used in clinical trials. Ourclinical trials to date have indicated only mild to moderate side effects inhumans. However, further observation is warranted.

 

Even when our product candidates do not 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, in the EmbraceAC study, tecarfarin demonstratedefficacy essentially the same as in earlier Phase 2 studies but did not achievethe primary endpoint of superiority over warfarin, as measured by time intherapeutic range. ATI-7505 was tested in two Phase 2 clinical trials inwhich the primary endpoints were not met in comparison to placebo. Althoughthese studies did support ATI-7505’s efficacy against certain symptoms assecondary endpoints, if future studies show that ATI-7505 is not sufficientlyefficacious to justify its use as a therapy, our business and prospects may bematerially adversely affected. In addition, we may need to reformulate theATI-9242 drug product should we find in our on-going Phase 1 testing thatadequate blood levels are not achieved with our current formulation.

 

Unforeseen events could cause us 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 budiodarone, tecarfarin, ATI-7505 and ATI-9242, 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 effectiveproducts. For instance, at high doses our budiodarone product candidateinteracts with warfarin and causes prolonged INR which could increase the riskof hemorrhage complications.

 

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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:

 

·                  restrictions on the products,manufacturers or manufacturing processes;

 

·                  warning letters;

 

·                  civil or criminal penalties or fines;

 

·                  injunctions;

 

·                  product seizures, detentions orimport bans;

 

·                  voluntary or mandatory productrecalls and publicity requirements which could vary in foreign jurisdictions;

 

·                  suspension or withdrawal ofregulatory approvals;

 

·                  total or partial suspension ofproduction; and

 

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

 

***Because we have anumber of product candidates and are considering a variety of targetindications, we may expend our limited resources to pursue a particularcandidate or indication and fail to capitalize on candidates or indicationsthat may be more profitable or for which there is a greater likelihood ofsuccess.***

 

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:

 

·                  demonstration of efficacy and safetyin clinical trials;

 

·                  demonstration that we have adequatelyaddressed the specific safety problem of the original molecule;

 

·                  the prevalence and severity of anyside effects;

 

·                  potential or perceived advantagesover alternative treatments;

 

·                  perceptions about the relationship orsimilarity between our product candidates and the original drug upon which eachRetroMetabolic Drug Design candidate was based;

 

·                  advantage over other drugs may not besufficiently great enough to obtain premium pricing;

 

·                  the timing of market entry relativeto competitive treatments;

 

·                  the ability to offer our productcandidates for sale at competitive prices;

 

·                  relative convenience and ease ofadministration;

 

·                  the strength of marketing anddistribution support;

 

·                  sufficient third-party coverage orreimbursement; and

 

·                  the product labeling or productinsert required by the FDA or regulatory authorities 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 tocommercialize our product candidates. Additionally, in the event we enter intoany collaboration arrangements for any of our product candidates, we may retainthe right to co-promote the sales of any ultimate product(s) byestablishing a small specialty sales force to market such product(s) tospecific physician groups. There are risks involved with establishing our ownsales and marketing capabilities and entering into arrangements with thirdparties to perform these services. Developing an internal sales force isexpensive and time-consuming and could delay any product launch. On the otherhand, if we enter into arrangements with third parties to perform sales,marketing and distribution services, our product revenues are likely to belower than if we market 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:

 

·                  our inability to convince futurecorporate partners to allow us to retain commercialization rights for specificphysician groups;

 

·                  our inability to obtain financing toestablish the specialty sales force;

 

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

 

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·                  theinability of sales personnel to obtain access to or persuade adequate numbersof physicians to prescribe our products;

 

·                  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 onreimbursement and 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. In the case of ATI-7505,the original molecule, cisapride, was withdrawn from the market and no genericversion exists, but there are many competitive products which may limit theamount we can charge for this product candidate. 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 efficacyand safety 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. 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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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 in the UnitedStates. Amiodarone will continue to be used off-label in spite of its safetyproblems because of its generic pricing. Other generically available treatmentsfor atrial fibrillation, such as sotalol, flecainide, and propafenone, do nothave equivalent efficacy to amiodarone, but will continue to compete in theatrial fibrillation marketplace. Merck and Cardiome Pharma Corp. are believedto be in Phase 2b testing with an oral product, vernakalant (oral), for thetreatment of atrial fibrillation, as a follow-on therapy to vernakalant (IV),an intravenous formulation, for which a New Drug Application has been submittedto the FDA. Sanofi-aventis has obtained FDA approval to market in the UnitedStates their oral product, dronedarone (Multaq®), for the treatment of atrialfibrillation. Their Phase 3 clinical trial data demonstrated improved outcomesof reduction in the risk of cardiovascular related hospitalization or death forpatients suffering from atrial fibrillation. We believe a similar endpoint maybe required for budiodarone approval. However, based upon a recent meeting ofthe FDA advisory panel considering the regulatory approval of dronedarone, itappears that a superior mortality endpoint will not be required forbudiodarone.

 

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 and biotechnologyindustry. Most of these development programs are for non-monitored therapiesfalling into either the factor Xa or 2A direct thrombin inhibitor categories.We are aware of the following companies or collaborations each having a factorXa inhibitor in development or in review with the FDA for approval: Johnson &Johnson in collaboration with Bayer AG has a factor Xa before the FDA forapproval, Bristol-Myers Squibb Company in collaboration with Pfizer, Inc.has a factor Xa in development, and Portola Pharmaceuticals, Inc incollaboration with Merck Inc. has a factor Xa program in development. We areaware of a direct thrombin inhibitor program, dabigatran atBoehringer-Ingelheim GmbH, which recently presented results showing enhancedefficacy and or safety as compared to warfarin. Although we believe tecarfarin’smechanism of action (VKOR inhibition as with warfarin) and broadly availableinexpensive monitoring methodology (INR) provide an advantage, these factor Xaand 2a direct thrombin inhibitor programs will likely be significantcompetitive factors in this market. In addition, there may be other compoundsof which we are not aware at earlier stages of development that may competewith tecarfarin.

 

ATI-7505 has potential use in at least 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. ATI-7505 has demonstrated efficacy in aPhase 2 clinical trial for chronic idiopathic constipation. Products whichaffect the gastrointestinal system’s motility could be useful in the treatmentof each of these disorders including the approved products metaclopromide orerythromycin, but have limitations due to safety and or tachyphylaxis. Other prokineticsin development which may also compete with ATI-7505, include, TD-5108, which isbeing developed by Theravance and prucalopride which is being developed byMovetis, Inc. In constipation, substantial competition exists withapproved products prescription Amitiza and over-the-counter Miralax.  A product in development for chronicidiopathic constipation or IBS with constipation or I BS-c is linaclotide beingdeveloped by Ironwood in collaboration with Forest Pharmaceuticals Inc. Whilelinaclotide has a different pharmacological mechanism of action than ATI-7505,Ironwood recently announced positive results from two Phase 3 clinical trialstesting linaclotide in patients with chronic constipation. Tranzyme has an IVand oral grehlin agonist, TZD-101 and TZD 102 in Phase 2 development and hasobtained FDA fastrack designation for gastroparesis.

 

Competition for ATI-9242 will likely comefrom the five largest selling atypical antipsychotics: Risperdal by JanssenPharmaceutica, Seroquel by AstraZeneca Pharmaceuticals LP, Zyprexa by Eli Lillyand Company, Abilify by Bristol­Myers Squibb/Otsuka America Pharmaceutical, Inc.and Geodon by Pfizer Inc., which contributed to aggregate sales of $15.7billion in 2007. It is likely that virtually all of these products will be soldas generic products by the time ATI-9242 could come to market. Otherantipsychotics are in development which may also be competitive to ATI-9242.

 

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 andretaining qualified scientific and management personnel, establishing clinicaltrial sites and patient registration for clinical trials, as well as inacquiring technologies and technology licenses complementary to our programs oradvantageous to our business. Accordingly, our competitors may succeed inobtaining patent protection, receiving FDA approval or discovering, developingand commercializing medicines before we do. We are also aware of othercompanies that may currently be engaged in the discovery of medicines that willcompete with the product candidates that we are developing. In addition, in themarkets that we are targeting, we expect to compete against currentmarket-leading medicines. If we are not able to compete effectively against ourcurrent and future competitors, our business will not grow and our financialcondition will suffer.

 

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***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.

 

***Our workforce reduction in October 2009 andany future workforce and expense reductions may have an adverse impact on ourinternal programs, our ability to hire and retain key personnel and may bedistracting to management.***

 

InOctober 2009, our board of directors committed to a restructuring planthat will result in a reduction in force affecting 17 employees in orderto improve operational efficiencies.  In light of our continued need forfunding and expense control, we may be required to implement further workforceand expense reductions in the future. Further workforce and expense reductionscould result in reduced progress on our internal programs. In addition,employees, whether or not directly affected by a reduction, may seek futureemployment with our business partners or competitors. Although our employeesare required to sign a confidentiality agreement at the time of hire, theconfidential nature of certain proprietary information may not be maintained inthe course of any such future employment. Further, we believe that our futuresuccess will depend in large part upon our ability to attract and retain highlyskilled personnel. We may have difficulty retaining and attracting suchpersonnel as a result of a perceived risk of future workforce and expensereductions. In addition, the implementation of the restructuring program mayresult in the diversion of efforts of our executive management team and otherkey employees, which could adversely affect our business.

 

***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 maybe required 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:

 

·                  decreased demand for any productcandidates or products that we may develop;

 

·                  injury to our reputation;

 

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·                  withdrawal of clinical trialparticipants;

 

·                  costs to defend the relatedlitigation;

 

·                  increased demands on management’sattention in defending the related litigation;

 

·                  substantial monetary awards toclinical trial participants or patients;

 

·                  loss of revenue; and

 

·                  the inability to commercialize anyproducts 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 our productcandidates 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 accounting rules.Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and otherrequirements will increase our costs and require additional managementresources. We continuously work to enhance our finance and accounting systems,procedures and controls and may need to implement additional finance andaccounting systems, procedures and controls as we grow our business andorganization and to satisfy new reporting requirements. Compliance with Section 404first applied to our annual report on Form 10-K for our year ended December 31,2008, to be followed by a requirement for attestation by our independentauditors as to our compliance as of December 31, 2010. 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, 2010, 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.

 

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***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.

 

**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 operating performanceof the companies represented by such stocks. Some of the factors that may causethe market price of our common stock to fluctuate include:

 

·                  adverse results or delays in ourclinical trials;

 

·                  the timing or delay of achievement ofour clinical, regulatory, partnering and other milestones, such as thecommencement of clinical development, the completion of a clinical trial, thereceipt of regulatory approval or the establishment or termination of acommercial partnership for one or more of our product candidates;

 

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

 

·                  actions taken by regulatory agencieswith respect to our product candidates, our clinical trials or our sales andmarketing activities;

 

·                  the commercial success of any productapproved by the FDA or its foreign counterparts;

 

·                  regulatory developments in the UnitedStates and foreign countries;

 

·                  changes in the structure ofhealthcare payment systems;

 

·                  any intellectual propertyinfringement lawsuit involving us;

 

·                  announcements of technologicalinnovations or new products by us or our competitors;

 

·                  market conditions for thebiotechnology or pharmaceutical industries in general;

 

·                  changes in financial estimates orrecommendations by securities analysts;

 

·                  sales of large blocks of our commonstock;

 

·                  sales of our common stock by ourexecutive officers, directors and significant stockholders;

 

·                  restatements of our financial resultsand/or material weaknesses in our internal controls; and

 

·                  the loss of any of our key scientificor management personnel.

 

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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 ordisproportionate to the operating performance of particular companies. Thesebroad market and industry factors may seriously harm the market price of ourcommon stock, regardless of our operating performance. In the past, classaction litigation has often been instituted against companies whose securitieshave experienced periods of volatility in market price. Any such litigationbrought against us could result in substantial costs, which would hurt ourfinancial condition and results of operations, divert management’s attentionand resources, and possibly delay our clinical trials or commercializationefforts.

 

***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:

 

·                  adverse results or delays in ourclinical trials;

 

·                  the timing or delay of achievement ofour clinical, regulatory, partnering and other milestones, such as thecommencement of clinical development, the completion of a clinical trial, thereceipt of regulatory approval or the establishment or termination of acommercial partnership for one or more of our product candidates;

 

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

 

·                  actions taken by regulatory agencieswith respect to our product candidates, our clinical trials or our sales andmarketing activities;

 

·                  the commercial success of any productapproved by the FDA or its foreign counterparts;

 

·                  regulatory developments in the UnitedStates and foreign countries;

 

·                  changes in the structure ofhealthcare payment systems;

 

·                  any intellectual propertyinfringement lawsuit involving us; and

 

·                  announcements of technologicalinnovations 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.

 

***If we fail to continue to complywith the listing requirements of The NASDAQ Global Market, the price of ourcommon stock and our ability to access the capital markets could be negativelyimpacted.****

 

Ourcommon stock is currently listed on The NASDAQ Global Market. To maintain thelisting of our common stock on The NASDAQ Global Market we are required to meetcertain listing requirements, including a minimum closing bid price of $1.00per share, a market value of publicly held shares (excluding shares held by ourexecutive officers, directors and 10% or more stockholders) of at least$5 million and stockholders’ equity of at least $10 million. As of September 30,2009, our stockholders’ equity was $1.8 million.  As a result,we do not meet The NASDAQ Global Market’s stockholders’ equity listing requirementas of September 30, 2009.  In the event we receive sufficientadditional capital in the near term from a potential collaboration arrangementinvolving any of our lead product candidates or through an equity financing,our stockholders’ equity could be in excess of $10 million, which may forestallour delisting from The NASDAQ Global Market.

 

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Ifwe fail to comply with the listing standards of The NASDAQ Global Market, wemay consider transferring to The NASDAQ Capital Market, provided we met thetransfer criteria, which is a lower tier market, or our common stock may bedelisted and traded on the over-the-counter bulletin board network. Moving ourlisting to The NASDAQ Capital Market could adversely affect the liquidity ofour common stock.  If our common stock were to be delisted by NASDAQ,we could face significant material adverse consequences, including:

 

·                  a limited availability of marketquotations for our common stock;

 

·                  a reduced amount of news and analystcoverage for us;

 

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

 

·                  reduced liquidity for ourstockholders;

 

·                  potential loss of confidence bycollaboration partners and employees; and

 

·                  loss of institutional investorinterest and fewer business development opportunities.

 

***If we sell shares of our common stock underour existing committed equity line financing facility, our existingstockholders will experience immediate dilution and, as a result, our stockprice may go down.****

 

InOctober 2009, we entered into a committed equity line financing facility,or financing arrangement, under which we may sell up to $35.0 million of ourcommon stock to Commerce Court Small Cap Value Fund, Ltd., or Commerce Court,over a 24-month period subject to a maximum of 5,494,290 shares of our commonstock, including the 114,200 shares of common stock we issued to Commerce Courton the closing date in payment of our commitment fee.  The sale of shares of our common stockpursuant to the financing arrangement will have a dilutive impact on ourexisting stockholders.  Commerce Courtmay resell some or all of the shares we issue to them under the financingarrangement and such sales could cause the market price of our common stock todecline significantly with advances under the financing arrangement.  To the extent of any such decline, anysubsequent advances would require us to issue a greater number of shares ofcommon stock to Commerce Court in exchange for each dollar of the advance.  Under these circumstances, our existingstockholders would experience greater dilution. Although Commerce Court is precluded from short sales of shares acquiredpursuant to advances under the financing arrangement, the sale of our commonstock under the financing arrangement could encourage short sales by thirdparties, which could contribute to the further decline of our stock price.

 

***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 September 30,2009 (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 61% 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, a changein our management or other changes that stockholders may consider favorable.These provisions include:

 

·                  a classified board of directors;

 

·                  a prohibition on actions by ourstockholders by written consent;

 

·                  the ability of our board of directorsto issue preferred stock without stockholder approval, which could be used toadopt a stockholders’ rights plan that would make it difficult for a thirdparty to acquire us;

 

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

 

·                  limitations on the removal ofdirectors.

 

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.

 

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

 

Sales of a substantial number of shares of ourcommon 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.

 

              Asof September 30, 2009, we had 27,471,455 shares of common stockoutstanding, which excludes any shares of common stock issuable upon exerciseof warrants and options outstanding as of such date. The shares outstanding arefreely tradable without restriction in the public market unless held by anaffiliate of ours. Shares held by our affiliates are eligible for sale in thepublic market either in accordance with an effective resale registrationstatement with the Securities and Exchange Commission or pursuant to the volumelimitations and manner of sale requirements under Rule 144. Any commonstock that is either subject to outstanding options or warrants or reserved forfuture issuance under our 2001 Equity Incentive Plan, 2007 Equity IncentivePlan, 2007 Non-Employee Directors’ Stock Option Plan and 2007 Employee StockPurchase Plan could also become eligible for sale in the public market to theextent permitted by the provisions of various vesting agreements, and Rules 144and 701 under the Securities Act of 1933, as amended. If these additionalshares are sold, or if it is perceived that they will be sold, in the publicmarket, the trading price of our common stock could decline.

 

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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 September 30, 2009, we have filed three registrationstatements on Form S-8 under the Securities Act of 1933, as amended, toregister up to an aggregate of 5,005,132 shares of our common stock forissuance under our stock option and employee stock purchase plans, and intendto file additional registration statements on Form S-8 to register theshares automatically added each year to the share reserves under these plans.

 

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

 

In July 2009, we issued 49,381 shares ofour common stock to three accredited investors pursuant to the cashlessexercise of an outstanding warrant.  Theissuance of the common stock was deemed to be exempt from registration underthe Securities Act in reliance on Section 4(2) of the Securities Actand Regulation D promulgated thereunder as a transaction by an issuer notinvolving a public offering. The recipients of the common stock acquired thecommon stock for investment only and not with a view to or for sale inconnection with any distribution thereof and appropriate legends were affixedto the securities issued in these transactions. Each of the recipients of thecommon stock was an accredited or sophisticated person and had adequate access,through their employment, business or other relationships, to information aboutus.

 

**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.

 

45

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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:November 13, 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.                                                         |
|                |       |                                                                                                                                                                             |
| 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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(1)          Previously filed as thelike numbered exhibit to registrant’s Registration Statement on Form S-1 (No. 333-145813),initially filed with the Securities and Exchange Commission on August 30,2007, as amended, and incorporated by reference herein.

 

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

 

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

 

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

 

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