**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

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| **(Mark  One)**                                                                                                                                                                                              |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                         |
| **x**                                                                                                                                                                                                        | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES** |
| ** **                                                                                                                                                                                                   | **EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                         |
| **For the quarterly period ended June 30, 2006**                                                                                                                                                        |
|                                                                                                                                                                                                         |
| **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 000-51134**

 

**Favrille, Inc.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                    | ** ** | **33-0892797**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **10421  Pacific Center Court, San Diego, CA**                  | ** ** | **92121**                             |
| (Address of principal  executive offices)                       |       | (Zip Code)                            |

 

**(858) 526-8000**

(Registrant’s telephone number, including areacode)

 

**N/A**

(Former name, former address and former fiscalyear if changed since last report)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  YES  x    NO  o

 

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

 
| Large Accelerated Filer  o |   | Accelerated Filer  o |   | Non-Accelerated Filer  x |
|--------------------------------------|--------|--------------------------------|--------|------------------------------------|

 

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

 

Thenumber of shares of the Registrant’s common stock outstanding as of August 8,2006 was 28,967,245.

 

 

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**FAVRILLE, INC.**

 

**QUARTERLYREPORT ON FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 2006TABLE OF CONTENTS**

 
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                                                                                                     |   |
|-------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.           | Financial Statements                                                                                                                                                                          |   |
|              | Balance  Sheets as of June 30, 2006 (Unaudited) and December 31, 2005                                                                                                               |   |
|              | Statements of Operations (Unaudited) for  the three and six months ended June 30, 2006 and 2005 and the period  from January 21, 2000 (inception) to June 30, 2006 (Unaudited) |   |
|              | Statements of Cash Flows (Unaudited) for  the six months ended June 30, 2006 and 2005 and the period from January 21,  2000 (inception) to June 30, 2006 Unaudited)            |   |
|              | Notes to Condensed Financial Statements (Unaudited)                                                                                                                                           |   |
| Item 2.           | Management’s Discussion and Analysis of Financial Condition and  Results of Operations                                                                                                   |   |
| Item 3.           | Quantitative and Qualitative Disclosures  About Market Risk                                                                                                                                   |   |
| Item 4.           | Controls and Procedures                                                                                                                                                                       |   |
|              |                                                                                                                                                                                          |   |
| **PART II.** | **OTHER INFORMATION**                                                                                                                                                                         |   |
| Item 1.           | Legal Proceedings                                                                                                                                                                             |   |
| Item 1A.          | Risk Factors                                                                                                                                                                                  |   |
| Item 2.           | Unregistered Sales of Equity Securities and  Use of Proceeds                                                                                                                                  |   |
| Item 4.           | Submission of Matters to a Vote of Security  Holders                                                                                                                                          |   |
| Item 6.           | Exhibits                                                                                                                                                                                      |   |
|              |                                                                                                                                                                                          |   |
| SIGNATURES        |                                                                                                                                                                                          |

 

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**PART I— FINANCIAL INFORMATION**

 

**Item 1. FinancialStatements.**

 

**FAVRILLE, INC.**

**(adevelopment stage company)**

**BALANCESHEETS**

**(inthousands, except share and per share data)**

 
| ** **                                                                                                                                                                                           | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                           | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                           |       |                    |       |                        |       |
| Current  assets:                                                                                                                                                                                     |       |                    |       |                        |       |
| Cash and  cash equivalents                                                                                                                                                                           |       | $                       | 28,817     |                        | $          | 12,065 |   |
| Short-term  investments                                                                                                                                                                              |       | 32,835                  |       | 22,427                      |       |
| Receivables                                                                                                                                                                                          |       | 351                     |       | 372                         |       |
| Prepaid  expenses and other current assets                                                                                                                                                           |       | 737                     |       | 563                         |       |
| Total  current assets                                                                                                                                                                                |       | 62,740                  |       | 35,427                      |       |
| Property and  equipment, net                                                                                                                                                                         |       | 10,987                  |       | 9,430                       |       |
| Restricted  cash                                                                                                                                                                                     |       | 3,451                   |       | 1,550                       |       |
| Other assets                                                                                                                                                                                         |       | 640                     |       | 600                         |       |
| Total assets                                                                                                                                                                                         |       | $                       | 77,818     |                        | $          | 47,007 |   |
| **Liabilities  and stockholders’ equity**                                                                                                                                                       |       |                    |       |                        |       |
| Current  liabilities:                                                                                                                                                                                |       |                    |       |                        |       |
| Accounts  payable and accrued liabilities                                                                                                                                                            |       | $                       | 5,439      |                        | $          | 3,888 |   |
| Current  portion of debt                                                                                                                                                                             |       | 3,676                   |       | 2,553                       |       |
| Total  current liabilities                                                                                                                                                                           |       | 9,115                   |       | 6,441                       |       |
| Debt, less  current portion                                                                                                                                                                          |       | 4,575                   |       | 3,532                       |       |
| Deferred  rent                                                                                                                                                                                       |       | 2,013                   |       | 1,320                       |       |
| Commitments  and contingencies                                                                                                                                                                       |       |                    |       |                        |       |
| Stockholders’  equity:                                                                                                                                                                          |       |                    |       |                        |       |
| Preferred  stock, $0.001 par value 5,000,000 shares authorized at June 30, 2006 and  December 31, 2005; no shares issued and outstanding at June 30,  2006 and December 31, 2005 |       | —                  |       | —                      |       |
| Common  stock, $0.001 par value:                                                                                                                                                                     |       |                    |       |                        |       |
| Authorized  shares, 75,000,000 at June 30, 2006 and December 31, 2005;                                                                                                                     |       |                    |       |                        |       |
| Issued and  outstanding shares— 28,916,355 and 20,329,046 at June 30, 2006 and December 31,  2005, respectively                                                                       |       | 29                      |       | 20                          |       |
| Additional  paid-in capital                                                                                                                                                                          |       | 198,164                 |       | 156,882                     |       |
| Deferred  stock-based compensation                                                                                                                                                                   |       | —                  |       | (5,655                      | )          |
| Note  receivable from stockholder                                                                                                                                                                    |       | —                  |       | (96                         | )          |
| Accumulated  other comprehensive loss                                                                                                                                                                |       | (15                     | )          | (54                         | )          |
| Deficit  accumulated during the development stage                                                                                                                                                    |       | (136,063                | )          | (115,383                    | )          |
| Total  stockholders’ equity                                                                                                                                                                     |       | 62,115                  |       | 35,714                      |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                     |       | $                       | 77,818     |                        | $          | 47,007 |   |

 

See accompanying notes.

 

1

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**FAVRILLE, INC.(a development stage company)**

 

**STATEMENTSOF OPERATIONS(in thousands, except share and per share data)**

**Unaudited**

 
| ** **                                                                                               | ** ** | **Three Months ended  June 30,** | ** ** | **Six Months ended  June 30,** | ** ** | **Period from  January 21, 2000  (inception) to  June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006**                                                                             | ** ** | **2005** | ** ** | **2006** | ** ** |
| Operating  expenses:                                                                                     |       |                                            |       |                                          |       |                                                                                 |       |   |   |   |   |
| Research and  development                                                                                |       | $                                               | 7,462      |                                          | $          | 7,909                                                                                |       | $ | 15,883 |   | $ | 14,737 |   | $ | 84,739 |   |
| General and  administrative                                                                              |       | 2,919                                           |       | 1,681                                         |       | 5,620                                                                                |       | 3,345 |   | 24,113 |   |
| Total  operating expenses                                                                                |       | 10,381                                          |       | 9,590                                         |       | 21,503                                                                               |       | 18,082 |   | 108,852 |   |
| Interest  income                                                                                         |       | 798                                             |       | 409                                           |       | 1,231                                                                                |       | 705 |   | 3,640 |   |
| Interest  expense                                                                                        |       | (213                                            | )          | (181                                          | )          | (379                                                                                 | )          | (389 | ) | (2,386 | ) |
| Other  expense                                                                                           |       | (29                                             | )          | (11                                           | )          | (29                                                                                  | )          | (12 | ) | (15 | ) |
| Loss on  extinguishment of debt                                                                          |       | —                                          |       | —                                        |       | —                                                                               |       | — |   | (290 | ) |
| Total other  income, net                                                                                 |       | 556                                             |       | 217                                           |       | 823                                                                                  |       | 304 |   | 949 |   |
| Net loss                                                                                                 |       | (9,825                                          | )          | (9,373                                        | )          | (20,680                                                                              | )          | (17,778 | ) | (107,903 | ) |
| Deemed  dividend-beneficial conversion feature for Series C redeemable  convertible preferred stock |       | —                                          |       | —                                        |       | —                                                                               |       | — |   | (28,103 | ) |
| Accretion of  Series C redeemable convertible preferred stock issuance costs                        |       | —                                          |       | —                                        |       | —                                                                               |       | (6 | ) | (57 | ) |
| Net loss  applicable to common stockholders                                                              |       | $                                               | (9,825     | )                                             | $          | (9,373                                                                               | )          | $ | (20,680 | ) | $ | (17,784 | ) | $ | (136,063 | ) |
| Historical  net loss per share:                                                                          |       |                                            |       |                                          |       |                                                                                 |       |   |   |   |   |
| Basic and  diluted                                                                                       |       | $                                               | (0.34      | )                                             | $          | (0.47                                                                                | )          | $ | (0.81 | ) | $ | (1.10 | ) |   |   |
| Weighted-average  shares-basic and diluted                                                               |       | 28,708,766                                      |       | 19,810,409                                    |       | 25,597,762                                                                           |       | 16,118,557 |   |   |   |

 

See accompanying notes.

 

2

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**FAVRILLE, INC.(a development stage company)**

 

**STATEMENTSOF CASH FLOWS(in thousands)**

**Unaudited**

 
| ** **                                                                              | ** ** | ** **                     | ** ** | ** **              | ** ** | **Period from** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------|------------|-------------------------|------------|----------------------|------------|
| ** **                                                                              | ** ** | ** **                     | ** ** | ** **              | ** ** | **January 21,** | ** ** |
| ** **                                                                              | ** ** | ** **                     | ** ** | ** **              | ** ** | **2000**             | ** ** |
| ** **                                                                              | ** ** | **Six Months ended** | ** ** | **(inception) to** | ** ** |
| ** **                                                                              | ** ** | **June 30,**              | ** ** | **June 30,**       | ** ** |
| ** **                                                                              | ** ** | **2006**                       | ** ** | **2005**                | ** ** | **2006**             | ** ** |
| **Operating  activities**                                                               |       |                           |       |                    |       |                 |       |
| Net loss                                                                                |       | $                              | (20,680    | )                       | $          | (17,778              | )          | $ | (107,903 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities:            |       |                           |       |                    |       |                 |       |
| Depreciation  and amortization                                                          |       | 1,010                          |       | 884                     |       | 5,368                |       |
| Loss on  disposal of fixed assets                                                       |       | 29                             |       | —                  |       | 29                   |       |
| Issuance of  options and warrant related to consulting agreements                       |       | —                         |       | —                  |       | 186                  |       |
| Stock-based  compensation                                                               |       | 1,864                          |       | 1,454                   |       | 7,314                |       |
| Non-cash  interest expense                                                              |       | 100                            |       | 22                      |       | 272                  |       |
| Loss on  extinguishment of debt                                                         |       | —                         |       | —                  |       | (290                 | )          |
| Issuance of  restricted common stock for license                                        |       | —                         |       | —                  |       | 24                   |       |
| Deferred  rent                                                                          |       | 693                            |       | 272                     |       | 2,013                |       |
| Amortization  of premium/discount on short-term investments                             |       | (162                           | )          | (3                      | )          | (157                 | )          |
| Accrued  interest on short-term investments                                             |       | 140                            |       | (21                     | )          | (174                 | )          |
| Unrealized  loss on cash and cash equivalents                                           |       | —                         |       | 1                       |       | (1                   | )          |
| Changes in  operating assets and liabilities:                                           |       |                           |       |                    |       |                 |       |
| Receivables                                                                             |       | (119                           | )          | (7                      | )          | (177                 | )          |
| Prepaid  expenses and other assets                                                      |       | (214                           | )          | 41                      |       | (1,079               | )          |
| Accounts  payable and accrued liabilities                                               |       | 1,551                          |       | 344                     |       | 5,439                |       |
| Net cash  used in operating activities                                                  |       | (15,788                        | )          | (14,791                 | )          | (89,136              | )          |
| **Investing  activities**                                                               |       |                           |       |                    |       |                 |       |
| Purchases of  property and equipment                                                    |       | (2,595                         | )          | (371                    | )          | (16,353              | )          |
| Purchases of  short-term investments                                                    |       | (32,055                        | )          | (4,267                  | )          | (66,543              | )          |
| Maturities  of short-term investments                                                   |       | 21,848                         |       | —                  |       | 33,851               |       |
| Other assets                                                                            |       | —                         |       | —                  |       | (70                  | )          |
| Restricted  cash                                                                        |       | (1,901                         | )          | —                  |       | (3,611               | )          |
| Sale of  restricted cash                                                                |       | —                         |       | —                  |       | 160                  |       |
| Net cash used  in investing activities                                                  |       | (14,703                        | )          | (4,638                  | )          | (52,566              | )          |
| **Financing  activities**                                                               |       |                           |       |                    |       |                 |       |
| Proceeds  from debt                                                                     |       | 3,315                          |       | 1,427                   |       | 18,722               |       |
| Payments on  debt                                                                       |       | (1,249                         | )          | (1,237                  | )          | (10,332              | )          |
| Issuance of  preferred stock, net                                                       |       | —                         |       | —                  |       | 76,144               |       |
| Proceeds  from issuance of convertible promissory note                                  |       | —                         |       | —                  |       | 650                  |       |
| Issuance of  common stock and warrants                                                  |       | 45,183                         |       | 39,456                  |       | 85,378               |       |
| Repurchase  of restricted common stock                                                  |       | (6                             | )          | (7                      | )          | (43                  | )          |
| Net cash  provided by financing activities                                              |       | 47,243                         |       | 39,639                  |       | 170,519              |       |
| Net decrease  increase in cash and cash equivalents                                     |       | 16,752                         |       | 20,210                  |       | 28,817               |       |
| Cash and  cash equivalents at beginning of period                                       |       | 12,065                         |       | 25,065                  |       | —               |       |
| Cash and  cash equivalents at end of period                                             |       | $                              | 28,817     |                    | $          | 45,275               |       | $ | 28,817 |   |
|                                                                                    |       |                           |       |                    |       |                 |       |
| **Supplemental  schedule of non-cash investing and financing activities:**         |       |                           |       |                    |       |                 |       |
| Conversion  of convertible preferred stock to common stock upon initial public offering |       | $                              | —     |                    | $          | 43,678               |       | $ | 43,678 |   |

 

See accompanying notes.

 

3

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**FAVRILLE, INC.NOTES TO CONDENSED FINANCIAL STATEMENTSJUNE 30, 2006UNAUDITED**

 

**1. Basis of Presentation**

 

The accompanying unaudited interim financial statements have beenprepared in accordance with U.S. generally accepted accounting principles andwith the rules and regulations of the Securities and Exchange Commissionrelated to a quarterly report on Form 10-Q. Accordingly, they do notinclude all of the information and disclosures required by U.S. generallyaccepted accounting principles for complete financial statements. The balancesheet at December 31, 2005 has been derived from the audited financialstatements at that date but does not include all information and footnotesrequired by U.S. generally accepted accounting principles for completefinancial statements. The interim financial statements reflect all adjustmentswhich, in the opinion of management, are necessary for a fair presentation ofthe financial condition and results of operations for the periods presented.Except as otherwise disclosed, all such adjustments are of a normal recurringnature.

 

Operating results for the three and six months ended June 30, 2006are not necessarily indicative of the results that may be expected for theyear ending December 31, 2006. Thesefinancial statements should be read in conjunction with the financialstatements included in the Company’s Annual Report on Form 10-K for theyear ended December 31, 2005 and management’s discussion and analysis offinancial condition and results of operations included elsewhere herein.

 

The preparation of financial statements in conformity with U.S.generally accepted accounting principles requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities aswell as expenses during the reporting period. Actual results could differ fromthose estimates. On an ongoing basis, we review our estimates based oninformation currently available, and changes in facts and circumstances may causeus to revise these estimates.

 

Certain reclassifications have been made to prior periods’ financialstatements in order to conform to the current period’s presentation. The threeand six months ended June 30, 2005 Statement of Operations includes stock-basedcompensation expense in the applicable research and development and marketing, generaland administrative amounts in a manner consistent with the three and six monthsended June 30, 2006 Statement of Operations presentation.

 

***Stock-BasedCompensation***

 

***Adoption of SFAS123(R)***

 

Favrille has its Amended and Restated 2001Equity Incentive Plan (the Equity Incentive Plan), its 2005 Non-Employee Directors’Stock Option Plan (the Directors’ Plan) and its 2005 Employee Stock PurchasePlan (the Stock Purchase Plan) that are described more fully in Note 5 to theFinancial Statements included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005.

 

Effective January 1, 2006, the Company adopted Statement ofFinancial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment,” (SFAS 123(R)). SFAS 123(R) requires the recognition of the fair valueof stock-based compensation in net income. The Company recognizes thestock-based compensation expense over the requisite service period of theindividual grantees on a straight-line basis over the vesting period, which isgenerally four years. Prior to January 1, 2006, the Company recordedcompensation expense for stock options based upon their intrinsic value on thedate of grant pursuant to Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees (APB 25)*.Prior to the Company’s initial public offering (IPO), the Company establishedthe exercise price based on the fair value of the Company’s stock at the dateof grant as determined by the Board of Directors (the Board). Therefore, theoptions had no intrinsic value upon grant and no expense was recorded uponissuance. With respect to certain options granted during 2005 and 2004, theCompany had recorded deferred compensation of $350,000 and $9.4 million,respectively, for the incremental difference at the grant date between the fairvalue per share determined by the Board and the deemed fair value per sharedetermined solely for financial reporting purposes.

 

The Company has elected the modified prospective transition method foradopting SFAS 123(R). Under this method, the provisions of SFAS 123(R) apply toall awards granted or modified after the date of adoption. The deferredstock-based compensation balance of $5.7 million as of December 31, 2005,which was accounted for under APB 25, was reclassified as a reduction ofadditional paid-in capital upon the adoption of SFAS 123(R). In addition, theunrecognized expense of awards not yet vested at the date of adoption will berecognized in net income or loss in the periods after the date of adoptionusing

 

4

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the same Black-Scholes valuation method and assumptions determinedunder the original provisions of SFAS 123, “Accounting for Stock-BasedCompensation,” as disclosed in our previous quarterly and annual reports. Thecumulative effect of the change in accounting principle from APB 25 to SFAS123(R) was not material, because the amortization of expense related to optionsgranted prior to the adoption was based on the single-option approach.

 

***Determining FairValue***

 

The Companyestimates the fair value of each stock-based award on the grant date using theBlack-Scholes valuation model. To facilitate the adoption of SFAS 123(R), theCompany applied provisions of Staff Accounting Bulletin (SAB) 107 in developingour methodologies to estimate our Black-Scholes valuation model inputs. Optionvaluation models, including Black-Scholes, require the input of highlysubjective assumptions, and changes in the assumptions used can materiallyaffect the grant date fair value of an award. Below is a summary of themethodologies the Company utilized to estimate the assumptions:

 

*Valuation and AmortizationMethod –*The Company estimates the fair value of stockoptions granted using the Black-Scholes option-pricing formula and asingle-option award approach. This fair value is then amortized on astraight-line basis over the requisite service period, which is generally thevesting period.

 

*Expected Term-* The Company’sexpected term represents the period that the Company’s stock-based awards areexpected to be outstanding and is determined based on the SAB 107 simplifiedmethod, since the company does not have adequate history of exercises of itsstock-based awards since its IPO in February 2005.

 

*ExpectedVolatility-*The Company estimates its volatility factor byusing the historical average volatility, over a period equal to the expectedterm, of comparable companies since it does not have adequate stock pricehistory of its own stock to determine volatility.

 

*ExpectedDividend -*The Black-Scholes valuation model calls for asingle expected dividend yield as an input. The dividend yield of zero is basedon the fact that the Company has never paid cash dividends and has no presentintention to pay cash dividends in the future.

 

*Risk-FreeInterest Rate –*The Company bases the risk-free interest rateused in the Black-Scholes valuation model on the implied yield currentlyavailable on the U.S. Treasury zero-coupon issues with an equivalent remainingterm. Where the expected term of the Company’s stock-based awards does notcorrespond with the terms for which interest rates are quoted, the Companyperforms a straight-line interpolation to determine the rate from the availablematurities.

 

*Estimated Forfeitures–*When estimating forfeitures, the Company considers voluntarytermination behavior as well as an analysis of actual option forfeitures. Asstock-based compensation expense recognized in the Statement of Operations forthe three and six months ended June 30, 2006 is based on awards ultimatelyexpected to vest, it should be reduced for estimated forfeitures.SFAS 123(R) requires forfeitures to be estimated at the time of grant andrevised, if necessary, in subsequent periods if actual forfeitures differ fromthose estimates. Pre-vesting forfeitures were estimated based on historicalexperience. In the Company’s pro forma information required under SFAS 123 forthe periods prior to January 1, 2006, the Company accounted forforfeitures as they occurred.

 

*Fair Value –*The fair value ofthe Company’s stock options granted to employees and non-employee directors forthe three and six months ended June 30, 2006 and 2005 and employee stockpurchase plan offerings in the six months ended June 30, 2006 and 2005 wasestimated using the following assumptions:

 
| ** **                                | ** ** | **Stock Option Plan**                     | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **Three Months ended June 30,** | ** ** |
| ** **                                | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                                | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Expected  term (in years)                 |       | 6.25                                                |       | 4.0 |   |
| Volatility                                |       | 61.8                                                | %          | 70 | % |
| Expected  dividend                        |       | 0                                                   |       | 0 |   |
| Weighted  average risk-free interest rate |       | 5.04                                                | %          | 3.87 | % |
| Estimated  forfeitures                    |       | 4.0                                                 | %          | — |   |
| Weighted-average  fair value              |       | $                                                   | 2.93       |   | $ | 2.16 |   |
|                                           |            |                                                     |            |  |  |  |  |

 

5

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| ** **                                | ** ** | **Stock Option Plan**                   | ** ** | **Employee Stock Purchase Plan**   | ** ** |
|-------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **Six Months ended June 30,** | ** ** | **Six Months ended June 30,** | ** ** |
| ** **                                | ** ** | **2006**                                          | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                | ** ** | ** **                                        | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Expected  term (in years)                 |       | 6.25                                              |       | 4.0                                               |       | 1.25 |   | 1.25 |   |
| Volatility                                |       | 61.8                                              | %          | 70                                                | %          | 57.6 | % | 70 | % |
| Expected  dividend                        |       | 0                                                 |       | 0                                                 |       | 0 |   | 0 |   |
| Weighted  average risk-free interest rate |       | 4.76                                              | %          | 4.26                                              | %          | 4.71 | % | 3.02 | % |
| Estimated  forfeitures                    |       | 4.0                                               | %          | —                                            |       | 4.0 | % | — |   |
| Weighted-average  fair value              |       | $                                                 | 4.14       |                                              | $          | 3.23 |   | $ | 3.01 |   | $ | 3.18 |   |
|                                           |            |                                                   |            |                                                   |            |  |  |  |  |  |  |  |  |

 

***Stock-Based Compensation Expense***

 

Under provisions of SFAS 123(R), the Company recorded approximately $984,000and $1.9 million of stock-based compensation expense in our Statement of Operationsfor the three and six months ended June 30, 2006, respectively. TheCompany utilized the Black-Scholes valuation model for estimating the fairvalue of the stock-based compensation granted both before and after theadoption of SFAS 123(R). Prior to the adoption of SFAS 123(R), the Companyrecorded approximately $700,000 and $1.5 million of stock-based compensation forcertain options granted during 2004 and 2005 in our Statement of Operations forthe three and six months ended June 30, 2005, respectively, under theprovisions of APB 25 based upon their intrinsic value. Total stock-basedcompensation expense recognized for the three and six months ended June 30,2006 and 2005 was as follows (in thousands, except per share data):

 
| ** **                                              | ** ** | **Three Months  ended  June 30,** | ** ** | **Three Months  ended  June 30,** | ** ** | **Six Months  ended  June 30,** | ** ** | **Six Months  ended  June 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                              | ** ** | **2006**                                    | ** ** | **2005**                                    | ** ** | **2006**                                  | ** ** | **2005**                                  | ** ** |
| Research and  development                               |       | $                                           | 485        |                                        | $          | 349                                       |       | $                                         | 918        |   | $ | 716 |   |
| General and  administrative                             |       | 499                                         |       | 358                                         |       | 946                                       |       | 738                                       |       |
| Stock-based  compensation expense                       |       | $                                           | 984        |                                        | $          | 707                                       |       | $                                         | 1,864      |   | $ | 1,454 |   |
|                                                    |       |                                        |       |                                        |       |                                      |       |                                      |       |
| Net  stock-based compensation expense, per common share |       |                                        |       |                                        |       |                                      |       |                                      |       |
|                                                    |       |                                        |       |                                        |       |                                      |       |                                      |       |
| Basic and  diluted                                      |       | $                                           | 0.03       |                                        | $          | 0.04                                      |       | $                                         | 0.07       |   | $ | 0.09 |   |

 

At June 30, 2006, the total compensation cost related to unvestedstock-based awards granted to employees under the Company’s stock award plansbut not yet recognized was approximately $8.1 million, net of estimatedforfeitures of approximately $500,000. This cost will be amortized on astraight-line basis over a weighted-average period of approximately 2.8 yearsand will be adjusted for subsequent changes in estimated forfeitures.

 

6

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***Pro-forma Disclosures***

 

SFAS 123(R) requires the Company to present pro forma information forthe comparative period prior to adoption as if it had accounted for all ourstock options under the fair value method of the original SFAS 123. Thefollowing table illustrates the effect on net income and earnings per share ifwe had applied the fair value recognition provisions of SFAS 123 to stock-basedemployee compensation to the same period in the prior year:

 
| ** **                                                                                            | ** ** | **Three Months  ended  June 30,** | ** ** | **Six Months  ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2005**                                    | ** ** | **2005**                                  | ** ** |
| Net loss  applicable to common stockholders as reported                                               |       | $                                           | (9,373     | )                                         | $          | (17,784 | ) |
| Add:  Stock-based employee compensation expense included in net loss                                  |       | 707                                         |       | 1,454                                     |       |
|                                                                                                  |       |                                        |       |                                      |       |
| Deduct:  Stock-based employee compensation expense determined under fair value method  for all awards |       | (814                                        | )          | (1,539                                    | )          |
|                                                                                                  |       |                                        |       |                                      |       |
| Pro forma  net loss applicable to common stockholder                                                  |       | $                                           | (9,480     | )                                         | $          | (17,869 | ) |
| Net loss per  share:                                                                                  |       |                                        |       |                                      |       |
| As  reported—Basic and Diluted                                                                   |       | $                                           | (0.47      | )                                         | $          | (1.10 | ) |
| Pro  forma—Basic and Diluted                                                                     |       | $                                           | (0.48      | )                                         | $          | (1.11 | ) |

 

As a resultof adopting SFAS 123(R), the Company’s net loss for the three and six monthsended June 30, 2006 is approximately $300,000 and $500,000 larger,respectively, than if the Company had continued to account for stock-basedcompensation under APB 25. Basic and diluted net loss per share are $0.01 and$0.02 higher, respectively, than if the Company had continued to account for stock-basedcompensation under APB 25.

 

***Stock Option Activity***

 

The Company issues new shares of common stock upon exercise of stockoptions. The following is a summary of option activity for the Equity IncentivePlans:

 
| ** **                                         | ** ** | **Shares**              | ** ** | **Approximate  Weighted-  average  exercise price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|----------------------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                         | ** ** | **(in thousands)** | ** ** | ** **                                               | ** ** | ** **                                           | ** ** | **(in thousands)**             | ** ** |
| Outstanding  at December 31, 2005             |       | 1,682                   |       | $                                                        | 2.50       |                                                 |       |                                |       |   |
| Granted                                            |       | 835                     |       | $                                                        | 6.65       |                                                 |       |                                |       |   |
| Exercised                                          |       | (4                      | )          | $                                                        | 0.71       |                                                 |       |                                |       |   |
| Forfeited                                          |       | (125                    | )          | $                                                        | 4.42       |                                                 |       |                                |       |   |
| Outstanding  at June 30, 2006                 |       | 2,388                   |       | $                                                        | 3.86       |                                                 | 8.75       |                                | $          | 3,846 |   |
|                                               |       |                    |       |                                                     |       |                                                 |       |                                |       |
| Vested and  expected to vest at June 30, 2006 |       | 2,299                   |       | $                                                        | 3.81       |                                                 | 8.73       |                                | $          | 3,777 |   |
|                                               |       |                    |       |                                                     |       |                                                 |       |                                |       |
| Exercisable  at June 30, 2006                 |       | 1,090                   |       | $                                                        | 1.53       |                                                 | 7.89       |                                | $          | 3,584 |   |

 

Shares available for future stock option grants under the EquityIncentive Plan and the Directors’ Plan were 396,028 and 297,500, respectively, atJune 30, 2006. Aggregate intrinsic value is calculated as the differencebetween the exercise price of the underlying awards and the quoted price of theCompany’s common stock for the 1.3 million options that were in-the-money as ofJune 30, 2006.

 

***Stock Purchase Plan Information***

 

During the three months ended June 30, 2006 no shares were issued.During the six months ended June 30, 2006, 36,070 shares were issued at apurchase price of $3.93. At June 30, 2006, approximately 160,000 shareswere reserved for future issuance and the aggregate intrinsic value of thesereserved shares outstanding under the Company’s Stock Purchase Plan was $100,000.

 

7

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***Net Loss per CommonShare***

 

Net loss per share is calculated in accordance with SFAS No. 128, *Earnings Per Share,* and SAB No. 98.Basic loss per share is calculated using the weighted average number of commonshares outstanding during each period, without consideration for common stockequivalents. Diluted loss per share includes the dilutive effect of commonequivalent shares outstanding for the period determined using thetreasury-stock method. For purposes of this calculation, common stock subjectto repurchase by the Company, preferred stock, options and warrants areconsidered to be common stock equivalents and are only included in thecalculation of diluted earnings per share when their effect is dilutive.

 

The pro forma shares used to compute basic and diluted net loss pershare below represent the weighted-average common shares outstanding, reducedby the weighted-average unvested common shares subject to repurchase, andinclude the assumed automatic conversion of all outstanding shares of preferredstock that automatically converted into shares of common stock upon the closingof our IPO, in February 2005, using the as-if converted method as of January 1,2005 or the date of issuance, if later.

 
| ** **                                                                                                    | ** ** | **Three Months ended**                                                       | ** ** | **Six Months ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                    | ** ** | **June 30,**                                                                      | ** ** | **June 30**               | ** ** |
| ** **                                                                                                    | ** ** | **2006**                                                                               | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                                    | ** ** | **(in thousands, except share and per share data)** | ** ** |
| **Historical:**                                                                                               |       |                                                                                   |       |                           |       |   |   |   |   |
| Numerator:                                                                                                    |       |                                                                                   |       |                           |       |   |   |   |   |
| Net loss                                                                                                      |       | $                                                                                      | (9,825     | )                              | $          | (9,373 | ) | $ | (20,680 | ) | $ | (17,778 | ) |
| Deemed  dividend—beneficial conversion feature for Series C redeemable  convertible preferred stock |       | —                                                                                 |       | —                         |       | — |   | — |   |
| Accretion of  Series C redeemable convertible stock issuance costs                                       |       | —                                                                                 |       | —                         |       | — |   | (6 | ) |
| Net loss  applicable to common stockholders                                                                   |       | $                                                                                      | (9,825     | )                              | $          | (9,373 | ) | $ | (20,680 | ) | $ | (17,784 | ) |
| Denominator:                                                                                                  |       |                                                                                   |       |                           |       |   |   |   |   |
| Weighted-average  common shares                                                                               |       | 28,918,782                                                                             |       | 20,299,889                     |       | 25,832,433 |   | 16,648,144 |   |
| Weighted-average  unvested common shares subject to repurchase                                                |       | (210,016                                                                               | )          | (489,480                       | )          | (234,671 | ) | (529,587 | ) |
| Denominator  for basic and diluted earnings per share                                                         |       | 28,708,766                                                                             |       | 19,810,409                     |       | 25,597,762 |   | 16,118,557 |   |
|                                                                                                          |       |                                                                                   |       |                           |       |   |   |   |   |
| Basic and  diluted net loss per share                                                                         |       | $                                                                                      | (0.34      | )                              | $          | (0.47 | ) | $ | (0.81 | ) | $ | (1.10 | ) |
| **Pro  forma:**                                                                                               |       |                                                                                   |       |                           |       |   |   |   |   |
| Net loss  applicable to common stockholders                                                                   |       | $                                                                                      | (9,825     | )                              | $          | (9,373 | ) | $ | (20,680 | ) | $ | (17,784 | ) |
|                                                                                                          |       |                                                                                   |       |                           |       |   |   |   |   |
| Pro forma  basic and diluted net loss per share                                                               |       | $                                                                                      | (0.34      | )                              | $          | (0.47 | ) | $ | (0.81 | ) | $ | (0.96 | ) |
|                                                                                                          |       |                                                                                   |       |                           |       |   |   |   |   |
| Shares used  above                                                                                            |       | 28,708,766                                                                             |       | 19,810,409                     |       | 25,597,762 |   | 16,118,557 |   |
| Pro forma  adjustments to reflect weighted-average affect of conversion of preferred  stock                   |       | —                                                                                 |       | —                         |       | — |   | 2,489,291 |   |
| Pro forma  shares used to compute basic and diluted net loss per share                                        |       | 28,708,766                                                                             |       | 19,810,409                     |       | 25,597,762 |   | 18,607,848 |   |

 
| ** **                                                                                                   | ** ** | **As of June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                   | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| ** **                                                                                                   | ** ** | **(in thousands)**           | ** ** |
| **Historical  outstanding antidilutive securities not included in diluted net loss per  share calculation:** |       |                              |       |   |   |
| Common stock  equivalents:                                                                                   |       |                              |       |   |   |
| Redeemable  convertible preferred stock                                                                      |       | —                            |       | — |   |
| Convertible  preferred stock                                                                                 |       | —                            |       | — |   |
| Stock  warrants                                                                                              |       | 3,122                             |       | 30 |   |
| Options to  purchase common stock                                                                            |       | 2,388                             |       | 1,464 |   |
| Common stock  subject to repurchase                                                                          |       | 185                               |       | 444 |   |
|                                                                                                         |       | 5,695                             |       | 1,938 |   |

 

8

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**2. Comprehensive Loss**

 

Components of comprehensive loss were asfollows (in thousands):

 
| ** **                                                  | ** ** | **Three Months ended June 30,** | ** ** | **Six Months ended June 30,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                        |       |                                                |       |                                              |       |   |   |   |   |
| Net loss                                                    |       | $                                                   | (9,825     | )                                                 | $          | (9,373 | ) | $ | (20,680 | ) | $ | (17,778 | ) |
| Change in  unrealized gain/(loss) on short-term investments |       | (9                                                  | )          | 5                                                 |       | 38 |   | (12 | ) |
| Comprehensive  loss                                         |       | $                                                   | (9,834     | )                                                 | $          | (9,368 | ) | $ | (20,642 | ) | $ | (17,790 | ) |

 

Accumulated other comprehensive loss totaled $15,000and $54,000 at June 30, 2006 and December 31, 2005, respectively, andwas attributed to unrealized losses on short-term investments.

 

**3. Stockholders’ Equity**

 

*Registration Statement*

 

OnJune 20, 2006, the Company filed a shelf registration statement with theSecurities Exchange Commission on Form S-3. The shelf registrationstatement on Form S-3 permits the Company to sell, in one or more publicofferings, shares of its common stock, debt securities or warrants, or anycombination of such securities, for proceeds in an aggregate amount of up to$60 million. On July 11, 2006, the Securities Exchange Commissiondeclared the Form S-3 effective. To date no securities have been issuedpursuant to this registration statement.

 

*Private Placement of Common Stock andWarrants*

 

OnMarch 6, 2006, the Company entered into a securities purchase agreementrelating to a private placement in which the Company issued and sold to certaininvestors, for an aggregate purchase price of approximately $45.4 million, 8.6million shares of its common stock and warrants to purchase up to 3million shares of its common stock at an exercise price of $5.26 per share.At the closing, investors in the private placement paid $5.26 per share ofcommon stock and an additional purchase price equal to $0.125 per warrant.

 

Certain of the Company’s existing stockholders, including two membersof our board of directors, Ivor Royston, M.D. and Fred Middleton, and fundsaffiliated with Forward Ventures, Sanderling Ventures, Alloy Ventures andWilliam Blair Capital Partners, invested in the private placement. Dr. Royston,Mr. Middleton, Doug Kelly, M.D. and Arda Minocherhomjee, Ph.D., members ofour board of directors on March 6, 2006, are associated with ForwardVentures, Sanderling Ventures, Alloy Ventures and William Blair CapitalPartners, respectively.

 

The Company filed a registration statement with the Securities andExchange Commission on March 31, 2006 covering the resale of the shares ofcommon stock issued in the private placement and the shares of common stockissuable upon exercise of the warrants issued in the private placement. On April 12,2006, the Securities and Exchange Commission declared the registrationstatement effective.

 

*Initial Public Offering*

 

On February 7, 2005, the Company completed an initial closing ofits IPO in which it sold 6 million shares of common stock for proceeds of $37.7million, net of underwriting discounts and commissions and $1.4 million ofoffering expenses. In addition, on March 7, 2005, the Company completed anadditional closing of its IPO in which it sold an additional 285,000 shares ofcommon stock pursuant to the partial exercise by the underwriters of anover-allotment option which resulted in proceeds of $1.8 million, net ofunderwriting discounts and commissions.

 

9

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**Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

 

**Cautionary Note Regarding Forward-LookingStatements**

 

*This Form 10-Q contains certain forward-looking statementsincluding expectations of market conditions, challenges and plans, within themeaning of Section 21E of the Securities Exchange Act of 1934, as amended,and is subject to the Safe Harbor provisions created by that statute. The words“anticipate”, “expect”, “believe”, “plan”, “intend”, and similar expressionsare intended to identify such statements. Although the forward-lookingstatements in this Form 10-Q reflect the good faith judgment of ourmanagement, such statements are subject to various risks and uncertainties,including but not limited to those discussed herein and, in particular, therisks described in Item 1A of Part II and throughout our Annual Report on Form 10-Kfor the year ended December 31, 2005. Actual results and the timing ofselected events may differ materially from those anticipated in theseforward-looking statements. Except as required by applicable law, we disclaimany duty to update any forward-looking statement to reflect events orcircumstances that occur after the date on which such statement is made.*

 

**Overview**

 

We are abiopharmaceutical company focused on the development and commercialization oftargeted immunotherapies for the treatment of cancer and other diseases of theimmune system. We have developed a proprietary technology that enables us tomanufacture active immunotherapy products that are designed to stimulate apatient’s immune system to mount a specific and sustained response to disease.Our lead product candidate, FavId, is an active immunotherapy for the treatmentof B-cell non-Hodgkin’s lymphoma, or NHL. FavId entered a pivotal Phase 3clinical trial in follicular B-cell NHL in July 2004 and completed patientenrollment in January 2006 with 347 patients randomized into the trial. Inaddition, FavId has been evaluated in several multi-center, open-labelPhase 2 clinical trials involving more than 130 patients.

 

We believeFavId may be effective in treating other types of B-cell NHL. Four additionalPhase 2 clinical trials and one additional Phase 3 clinical trial of FavId areongoing. One of these clinical trials is being conducted under a separatephysician-sponsored Investigational New Drug, or IND, application in the UnitedStates. A second of these is being conducted as a physician-sponsored clinicaltrial in Switzerland. Moreover, we believe our active immunotherapy expertiseand proprietary manufacturing technology may enable us to developadditional product candidates for other oncology indications, such as T-celllymphoma, and for autoimmune diseases, with an initial focus on multiplesclerosis. In June 2006, we received an allowance from the FDA for an INDfor our second product candidate, FAV-201, for the treatment of cutaneous T-celllymphoma. We have retained exclusive worldwide commercialization rights to allof our product candidates.

 

We were incorporated in Delaware in January 2000. As of June 30,2006, we had not generated any revenues, and we had financed our operations andinternal growth through private placements of our common stock and warrants,equipment and leasehold debt financings and the sale of common stock in ourinitial public offering or IPO in February 2005. We are a developmentstage company and have incurred significant losses since our inception in 2000,as we have devoted substantially all of our efforts to research and developmentactivities, including clinical trials. As of June 30, 2006, our deficitaccumulated during the development stage was approximately $136.1 million. Weexpect to incur substantial and increasing losses for the next several years aswe:

 

•continue to develop and prepare for the commercialization of our lead productcandidate, FavId;

•expand our research and development programs;

•expand our current manufacturing capabilities to support commercialmanufacturing of FavId; and

•acquire or in-license oncology products that are complementary to our own.

 

10

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**Financial Operations Overview**

 

***Research andDevelopment Expense.***Research and developmentexpense consists primarily of costs associated with clinical trials of ourproduct candidates, including the costs of manufacturing our productcandidates, compensation and other expenses related to research and developmentpersonnel, facilities costs and depreciation. We charge all research anddevelopment expenses to operations as they are incurred. Our research anddevelopment activities are primarily focused on the development of FavId. Wehave completed enrollment in two Phase 2 clinical trials and continue toevaluate the results. We initiated our pivotal Phase 3 clinical trial of FavIdfollowing Rituxan in patients with follicular B-cell NHL in July 2004 andcompleted patient enrollment in the trial in January 2006. In addition,four additional Phase 2 clinical trials and one additional Phase 3 clinicaltrial of FavId are ongoing.

 

From inception through June 30, 2006, weincurred costs of approximately $84.7 million associated with the researchand development of FavId, which represents substantially all of our researchand development costs to date. We expect our research and development costs toincrease as we advance FavId and new product candidates into later stages ofclinical development. While difficult to predict, we estimate that research anddevelopment costs required to complete the development of and file a BiologicsLicensing Application, or BLA, for FavId will be an additional$50 million. We are unable to estimate with any certainty the costs wewill incur in the continued development of other product candidates forcommercialization. On an ongoing basis, we expect to expand our research anddevelopment activities to include clinical development of FAV-201 andpreclinical research of treatments for autoimmune diseases, primarily multiplesclerosis.

 

Clinicaldevelopment timelines, likelihood of success and total costs vary widely.Although we are currently focused primarily on FavId, we anticipate that wewill make determinations as to which research and development projects topursue and how much funding to direct toward each project on an ongoing basisin response to the scientific and clinical success of each product candidate.

 

At this time,due to the risks inherent in the clinical trial process, clinical trial completiondates and costs vary significantly for each product candidate and are difficultto estimate. The lengthy process of seeking regulatory approvals and thesubsequent compliance with applicable regulations require the expenditure ofsubstantial resources. Any failure by us to obtain, or any delay in obtaining,regulatory approvals for our product candidates could cause our research anddevelopment expenditures to increase and, in turn, have a material adverseeffect on our results of operations. We cannot be certain when any cash flowsfrom our current product candidates will commence.

 

***Marketing, Generaland Administrative Expense.***  Marketing,general and administrative expenses consist primarily of compensation and otherexpenses related to our marketing and corporate general and administrativeemployees, legal fees and other professional services expenses. We anticipateincreases in marketing, general and administrative expenses as we add personneland continue to develop and prepare for commercialization of our productcandidates.

 

***Interest Income***    Interestincome primarily consists of interest earned on our cash reserves, cashinvested in money market funds, government securities, corporate notes andbonds and certificates of deposit.

 

***Interest Expense.***  Interestexpense represents interest on our debt, including capital leases.

 

**Critical Accounting Policies and Estimates**

 

Thediscussion and analysis of our financial condition and results of operationsare based on our financial statements, which have been prepared in accordancewith U.S. generally accepted accounting principles. The preparation offinancial statements requires us to make estimates and assumptions that affectthe reported amounts of assets, liabilities, expenses and related disclosures.Actual results could differ materially from those estimates. While oursignificant accounting policies are described in more detail in Note 1 ofthe Notes to Financial Statements included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005, we believe the following accountingpolicies to be critical to the judgments and estimates used in the preparationof our financial statements:

 

***Deferred Tax Asset Valuation Allowance.***  Ourestimate for the valuation allowance for deferred tax assets requires us tomake significant estimates and judgments about our future operating results.Our ability to realize the deferred tax assets depends on our future taxableincome as well as limitations on utilization. A deferred tax asset must bereduced by a valuation allowance if it is more likely than not that someportion or all of the deferred tax asset will not be realized prior to itsexpiration. The projections of our operating results on which the establishmentof a valuation allowance is based involve

 

11

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significantestimates regarding future demand for our products, competitive conditions,product development efforts, approvals of regulatory agencies and product cost.We have recorded a full valuation allowance on our net deferred tax assets asof June 30, 2006 and December 31, 2005, due to uncertainties relatedto our ability to utilize our deferred tax assets in the foreseeable future.These deferred tax assets primarily consist of certain net operating losscarryforwards and research and development tax credits.

 

***Stock-BasedCompensation.***  We grant options to purchase our common stock to our employees anddirectors under our stock option plans. Eligible employees can also purchaseshares of our common stock at 85% of the lower of the fair market value on thefirst day of an offering period or the last day of each six-month purchase periodduring a twenty-four month offering under our employee stock purchase plan. Thebenefits provided under these plans are stock-based payments subject to theprovisions of SFAS 123(R). EffectiveJanuary 1, 2006, we use the fair value method to apply the provisions ofSFAS 123(R) with a modified prospective transition method**,**whichprovides for certain changes to the method for valuing stock-basedcompensation. The valuation provisions of SFAS 123(R) apply to new awards andto awards that are outstanding on the effective date and subsequently modifiedor cancelled. Under the modified prospective transition method, prior periodsare not revised for comparative purposes. Prior to the adoption SFAS123(R), we recorded compensation expense for these plans based upon theirintrinsic value on the date of grant pursuant to Accounting Principles BoardOpinion No. 25, *Accounting for StockIssued to Employees (APB 25)*. Prior to our IPO, we established theexercise price based on the fair value of the Company’s stock at the date ofgrant as determined by the Board of Directors (the Board). Therefore, theoptions had no intrinsic value upon grant and no expense was recorded uponissuance. With respect to certain options granted during 2005 and 2004, we hadrecorded deferred compensation of $350,000 and $9.4 million, respectively,for the incremental difference at the grant date between the fair value pershare determined by the Board and the deemed fair value per share determinedsolely for financial reporting purposes. The deferred stock-based compensationbalance of $5.7 million as of December 31, 2005, which was accounted forunder APB 25, was reclassified as a reduction of additional paid-in capitalupon the adoption ofSFAS 123(R) and the unrecognized expense of awards not yet vested at the dateof adoption will be recognized in net income or loss in the periods after thedate of adoption using the same Black-Scholes valuation model and assumptionsdetermined under the original provisions of SFAS 123, “Accounting forStock-Based Compensation,” as disclosed in our previous quarterly and annualreports. The cumulative effect of the change in accounting principle from APB25 to SFAS 123(R) was not material, because the amortization of expense relatedto options granted prior to the adoption was based on the single-optionapproach. Stock-based compensationexpense recognized under SFAS 123(R) for the three and six months ended June 30,2006 was approximately $984,000 and $1.9 million, respectively. At June 30,2006, total unrecognized estimated compensation expense related to unvestedstock options granted prior to that date was $8.1 million, net ofestimated forfeitures of $500,000, which is expected to be recognized over aweighted-average period of 2.8 years.

 

Uponadoption of SFAS 123(R), we estimated the value of stock-based awards on thedate of grant using a Black-Scholes valuation model. The determinationof the fair value of stock-based payment awards on the date of grant using anoption-pricing model is affected by our stock price as well as assumptionsregarding a number of complex and subjective variables. These variablesinclude, but are not limited to, our expected stock price volatility over theterm of the awards, risk-free interest rate and expected dividends.

 

 If factors change andwe employ different assumptions in the application of SFAS 123(R) in futureperiods, the compensation expense that we record under SFAS 123(R) may differsignificantly from what we have recorded in the current period. Therefore, webelieve it is important for investors to be aware of the high degree ofsubjectivity involved when using option pricing models to estimate stock-basedcompensation under SFAS 123(R). Option-pricing models were developed for use inestimating the value of traded options that have no vesting or hedgingrestrictions, are fully transferable and do not cause dilution. Because our stock-basedpayments have characteristics significantly different from those of freelytraded options, and because changes in the subjective input assumptions canmaterially affect our estimates of fair values, in our opinion, existingvaluation models, including the Black-Scholes and lattice binomial models, may notprovide reliable measures of the fair values of our stock-based compensation.Consequently, there is a risk that our estimates of the fair values of our stock-basedcompensation awards on the grant dates may bear little resemblance to theactual values realized upon the exercise, expiration, early termination orforfeiture of those stock-based payments in the future. Certain stock-basedpayments, such as employee stock options, may expire worthless orotherwise result in zero intrinsic value as compared to the fair valuesoriginally estimated on the grant date and reported in our financialstatements. Alternatively, value may be realized from these instrumentsthat is significantly in excess of the fair values originally estimated on thegrant date and reported in our financial statements. There is currently nomarket-based mechanism or other practical application to verify the reliabilityand accuracy of the estimates stemming from these valuation models, nor isthere a means to compare and adjust the estimates to actual values. Althoughthe fair value of stock-based awards is determined in accordance with SFAS123(R) and the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107(SAB 107) using an option-pricing model, that value may not be indicativeof the fair value observed in a willing buyer/willing seller markettransaction.

 

12

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***Clinical Trial Accruals****.*In the normal course of business, we contract with numerous third-partyclinical trial centers to perform various clinical trial activities in theon-going development of FavId. The financial terms of these agreements aresubject to negotiation and variation from contract to contract may resultin uneven payment flows. Payment under the contracts depends on factors such asthe completion of individual patients’ treatments and the related requireddocumentation. We record expenses forcontracted clinical trial costs based upon patient enrollment and the datesthat they receive treatment. These costs are a significant component ofresearch and development expenses. The objective of our accrual policyis to match the recording of expenses in our financial statements to the actualservices received and efforts expended. However,our estimates may not match the timing of actual services performed by theclinical trial centers, which may result in adjustments to our researchand development expenses in future periods.

 

***Short- Term Investments.***  Weclassify all of our short-term investments as available-for-sale. We carrythese investments at fair value, based on quoted market prices, and unrealizedgains and losses are included in accumulated other comprehensive income whichis reflected as a separate component of stockholders’ equity. The amortizedcost of securities in this category is adjusted for amortization of premiumsand accretions of discounts to maturity. Such amortization is included ininterest income. Realized gains and losses are recorded in our statement ofoperations. If we believe that an other-than-temporary decline exists, it isour policy to record a write-down to reduce the investments to fair value andrecord the related charge as a realized loss.

 

Managementhas discussed the development and selection of these critical accountingpolicies with the Audit Committee of our Board of Directors and the AuditCommittee has reviewed the disclosures presented above relating to them.

 

**Results of Operations**

 

***Comparison of the Three Months Ended June 30, 2006and 2005***

 

***Research and Development****.   *Research and development expense decreased from approximately $7.9million for the three months ended June 30, 2005 to $7.5 million for thethree months ended June 30, 2006. The decrease of approximately $400,000,or 5%, was due primarily to an increase of approximately $450,000 incompensation expenses related to additional personnel and the accrual of the2006 merit bonus program; an increase of approximately $150,000 in operatingexpenses related to our manufacturing facility to support the production ofFavId; an increase of approximately $150,000 in stock-based compensationcosts due to the implementation of SFAS123(R); an increase of approximately $100,000 in third-party consultingservices to assist in developing the IT infrastructure to support the clinicaldevelopment and marketing approval of FavId; offset by a decrease of approximately $700,000 in expenses forclinical trial site costs and other third-party vendors supporting the pivotalPhase 3 clinical trial and a decrease of approximately $600,000 of rawmaterials and supplies for the manufacture of FavId due to the completion ofpatient enrollment in the first quarter of 2006.

 

***Marketing, Generaland Administrative****.  *Marketing, generaland administrative expense increased from approximately $1.7 million for thethree months ended June 30, 2005 to $2.9 million for the three monthsended June 30, 2006. The increase of $1.2 million, or 71%, primarily reflectsan increase of approximately $500,000 in personnel and outside services relatedto strategic marketing programs; an increase of approximately $200,000 associatedwith an increase in general and administrative personnel from 15 employees to 23 employees and the accrualof the 2006 merit bonus program; an increase of approximately $200,000 for third-partyservices to assist in developing the IT infrastructure in preparation for thecommercialization of FavId and an increase of approximately $150,000 in stock-basedcompensation costs due to implementation of SFAS 123(R).

 

***Interest Income****.* Interest income increased from approximately $400,000 for the threemonths ended June 30, 2005 to approximately $800,000 for the three monthsended June 30, 2006. The increase of $400,000, or 100%, was a result of risinginterest rates during the past year and an average balance of approximately $64.0million compared to approximately $53.0 million over the same period in 2005.

 

***Comparison of the Six Months Ended June 30, 2006and 2005***

 

***Research and Development****.   *Research and development expense increased from approximately $14.7million for the six months ended June 30, 2005 to $15.9 million for the sixmonths ended June 30, 2006. The increase of $1.2 million, or 8%, was dueprimarily to an increase of approximately $1.5 million due to compensationcosts of additional personnel and the accrual of the 2006 merit bonus program; anincrease of approximately $650,000 of operating expenses related to ourmanufacturing facility to support the production of FavId; an increase ofapproximately $200,000 in stock-based compensation costs due to theimplementation of SFAS 123(R); offsetby a decrease of approximately $1.4 million of raw

 

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materials and supplies for themanufacture of FavId due to the completion of patient enrollment in the firstquarter of 2006.

 

***Marketing, Generaland Administrative****. *Marketing, generaland administrative expense increased from approximately $3.3 million for the sixmonths ended June 30, 2005 to $5.6 million for the six months ended June 30,2006. The increase of approximately $2.3 million, or 70%, primarily reflects anincrease of approximately $700,000 in personnel and outside services related tostrategic marketing programs; an increase of approximately $500,000 incompensation costs associated with an increase in administrative personnelfrom 15 employees to 23 employees andthe accrual of the 2006 merit bonus program; an increase of approximately $500,000in legal and audit fees and other public company expenses; an increase ofapproximately $200,000 in stock-based compensation due to the implementation ofSFAS 123(R); and an increase of approximately $200,000 to assist in thebuilding of the IT infrastructure for the commercialization of FavId.

 

***Interest Income****.  *Interest income increased from approximately $700,000for the six months ended June 30, 2005 to approximately $1.2 million forthe six months ended June 30, 2006. The increase of approximately $500,000,or 71%, was a result of rising interest rates during the past year.

 

**Liquidity and Capital Resources**

 

***Sources of Liquidity***

 

We have historically funded our operations primarily through the saleof our equity securities and equipment and leasehold debt financing. As of June 30,2006, we had received proceeds of approximately $76.1 million, net ofstock issuance costs of approximately $686,000, from the sale of preferredstock which was converted to common stock immediately preceding our IPO; proceedsfrom the sale of common stock in our IPO of approximately $39.5 million, net ofunderwriters’ discounts and commissions of approximately $3.1 million andoffering expenses of approximately $1.4 million; and proceeds of approximately$45.0 million from the sale of common stock and warrants to purchase commonstock to certain investors, in a private placement, net of offering expenses ofapproximately $400,000.

 

As of June 30, 2006 we had financed the purchase of equipment andleasehold improvements through debt totaling approximately $15.7 million. Totaldebt of $8.3 million was outstanding at that date. These obligations aresecured by our existing and future assets excluding intellectual property andare due in monthly installments through January 2010. They bear interestat stated rates ranging from approximately 9.34% to 11.54%. The debt agreementssubject us to certain financial and non-financial covenants. As of June 30,2006, we were in compliance with the terms of the debt agreements.

 

***Cash Flows***

 

As of June 30,2006, cash, cash equivalents and short-term investments were approximately $61.7 millionas compared to $34.5 million at December 31, 2005, an increase ofapproximately $27.2 million. The increase primarily is due to the$45.4 million in gross proceeds received from our private placement duringthe first quarter of 2006, partially offset by net cash used to fund ongoingoperations.

 

Net cash usedin operating activities was approximately $15.8 million for the six monthsended June 30, 2006 compared to $14.8 million for the same period in 2005.The increase of $1.0 million is primarily due to increased operating expensesrelated to additional personnel and other expenses related to the continuingclinical development and preparation for commercialization of FavId.

 

Net cash usedin investing activities was approximately $14.7 million for the six monthsended June 30, 2006 compared to net cash used in investing activities of $4.6million for the same period in 2005. The increase of $10.1 million is due to $32.1million in short-term investment purchases offset by increases of $21.8 millionin short term investment maturities, $2.6 million in property and equipmentpurchases and the increase of $1.9 million in restricted cash to collateralize theletter of credit which has been increased to $3.5 million as required by ourfacility lease agreement.

 

Net cashprovided by financing activities for the six months ended June 30, 2006totaled $47.2 million, reflecting primarily the net proceeds from our private placement ofcommon stock and warrants in March 2006 of approximately $45.0 million. Netcash provided by financing activities for the same period in 2005 totaled $39.6million, reflecting primarily the net proceeds from our IPO of $39.5 million inFebruary 2005.

 

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***Funding Requirements***

 

Our futurecapital uses and requirements depend on numerous forward-looking factors. Thesefactors include but are not limited to the following:

 

•magnitude and cost of our product development efforts and other research anddevelopment activities;

 

•rate of progress toward obtaining regulatory approval for our productcandidates;

 

•costs of filing, prosecuting, defending and enforcing our patent claims andother intellectual property rights;

 

•our ability to establish and maintain collaborative, licensing or otherarrangements for the development, sale, marketing or distribution of ourproduct candidates and the terms of those arrangements;

 

•effects of competing technological and market developments;

 

• the costof expansion of our current facility for commercial production or theconstruction of a large separate commercial-scale production facility; and

 

• thesuccess of the commercialization of FavId.

 

Until we cangenerate significant cash from our operations, we expect to continue to fundour operations with existing cash resources that were primarily generated fromthe proceeds of offerings of our equity securities and from equipment andleasehold improvement debt financing. In addition, we may finance futurecash needs through the sale of other equity securities, strategic collaborationagreements and debt financing. However, we may not be successful inobtaining collaboration agreements, or in receiving milestone or royaltypayments under those agreements. In addition, we cannot be sure that ourexisting cash, cash equivalents and short-term investments will be adequate orthat additional financing will be available when needed or that, if available,financing will be obtained on terms favorable to us or our stockholders. Havinginsufficient funds may require us to delay, scale back or eliminate someor all of our research or development programs or to relinquish rights toproduct candidates at an earlier stage of development or on less favorableterms than we would otherwise choose. Failure to obtain adequate financing may alsoadversely affect our ability to operate as a going concern. If we raiseadditional funds by issuing equity securities, substantial dilution to existingstockholders would likely result. If we raise additional funds by incurringdebt financing, the terms of the debt may involve significant cash paymentobligations as well as covenants and specific financial ratios that may restrictour ability to operate our business.

 

**Off-Balance Sheet Arrangements**

 

As of June 30, 2006, we have not invested in any variable interestentities. We do not have any relationships with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance or special purpose entities, which would have been established for thepurpose of facilitating off-balance sheet arrangements or other contractuallynarrow or limited purposes. In addition, we do not engage in trading activitiesinvolving non-exchange traded contracts. As such, we are not materially exposedto any financing, liquidity, market or credit risk that could arise if we hadengaged in these relationships.

 

**Item 3. Quantitativeand Qualitative Disclosures about Market Risk.**

 

The primary objective of our investment activities is to preserveprincipal while maximizing income without significantly increasing risk. Someof the securities in which we invest may be subject to market risk. Thismeans that a change in prevailing interest rates may cause the marketvalue of the investment to fluctuate. To minimize this risk, we may maintainour portfolio of cash equivalents and short-term investments in a variety ofsecurities, including commercial paper, money market funds and direct orguaranteed obligations of the United States government. The risk associatedwith fluctuating interest rates is limited to our investment portfolio and wedo not believe that a 1% change in interest rates would have a significantimpact on our interest income. As of June 30, 2006, all of our short-terminvestments were government agency securities, corporate notes and bonds, andour cash equivalents were held in checking accounts and money market funds.

 

**Item 4. Controls andProcedures.**

 

As of the end of the period covered by this report, we carried out anevaluation, under the supervision and with the

 

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participation of our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of our disclosure controls and procedurespursuant to Rule 13a-15 of the Securities Exchange Act of 1934, asamended, or Exchange Act. Based upon that evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that, as of the end of the periodcovered by this report, our disclosure controls and procedures were effectiveto cause material information required to be disclosed by the Company in thereports that we file or submit under the Exchange Act to be recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms. We believe that acontrol system, no matter how well designed and operated, is based in part uponcertain assumptions about the likelihood of future events, and, therefore, canonly provide reasonable, not absolute, assurance that the objectives of thecontrols system are met, and no evaluation of controls can provide absoluteassurance that all control issues and instances of fraud, if any, within acompany will be detected.

 

During the three months ended June 30, 2006, there were no changesin our internal control over financial reporting which materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

**PART II - OTHERINFORMATION.**

 

**Item 1. LegalProceedings.**

 

Weare currently not a party to any material legal proceeding. We may besubject to various claims and legal actions arising in the ordinary course ofbusiness from time to time.

 

**Item 1A. Risk Factors**

 

*You should consider carefully the riskfactors described below, together with the other information contained in thisreport. If any of the following risks actually occur, our business, financialcondition, results of operations and future growth prospects would likely bematerially and adversely affected. In these circumstances, the market price ofour common stock could decline, and you may lose all or part of yourinvestment in our common stock.*

 

*We have marked with an asteriskthose risk factors that reflect substantive changes from the risk factorsincluded in our Annual Report on Form 10-K for the year ended December 31,2005.*

 

**RisksRelated to the Development of Our Product Candidates**

 

***We are dependent on the success of our leadproduct candidate, FavId, and we cannot be certain that it will be commercialized.**

 

We have expended significant time, money and effort in the developmentof our lead product candidate, FavId, which is still in clinical development,has not yet received regulatory approval and may never be commercialized.In order to commercialize FavId, we will need to demonstrate to the FDA andother regulatory agencies that it satisfies rigorous standards of safety andeffectiveness. We completed patient enrollment in a pivotal Phase 3 clinicaltrial of FavId following Rituxan for the treatment of follicular B-cell NHL in January 2006.

 

We are also evaluating FavId for use in other B-cell NHL indications.However, even if we were to receive regulatory approval of FavId for thetreatment of follicular B-cell NHL or the other indications we are exploring,our ability to successfully commercialize FavId could be jeopardized by theemergence of a competitive product that exhibits greater efficacy, longerduration of response or other benefits. In addition, because our initialregulatory and marketing strategy contemplates the administration of FavId topatients following treatment with Rituxan, the commercial opportunity for FavIdmay be limited by the degree to which oncologists continue to use Rituxanto treat indolent B-cell NHL. Furthermore, to the extent FavId fails to gainmarket acceptance for its initial indication, it may be more difficult forus to generate sufficient credibility with physicians and patients tocommercialize FavId for other indications.

 

Other than FavId, we have only two other product development programs,which are at significantly earlier stages of development. In June 2006, wereceived an allowance from the FDA for an IND for a product candidate, FAV-201,from one of these programs in patients with cutaneous T-cell lymphoma. We haveongoing preclinical studies to assess the applicability of our technology toautoimmune diseases, with an initial focus on multiple sclerosis. We cannot becertain that we will be able to successfully develop any product candidate fromthese development programs. We cannot be certain that the clinical developmentof FavId or any other product candidate in preclinical testing or clinicaltrials will be successful, that it will receive the regulatory approvalsrequired to commercialize it, or that any of our other research programs willyield a product candidate suitable for entry into clinical trials. If we areunable to commercialize FavId or our other product

 

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candidates, we may be unable to generate sufficient revenues toattain or maintain profitability, our ability to raise additional capital willbe impaired and our stock price may be negatively affected.

 

**Failure to obtain product approvals by theFDA could harm our business.**

 

We are subject to rigorous and extensive regulation by the FDA. In theUnited States, our biologic product candidates, currently in the preclinicaland clinical stages of development, cannot be marketed until they are approvedby the FDA. Obtaining FDA approval involves the submission of the results ofpreclinical studies and clinical trials, among other information, of theproduct candidates. We may not be able to obtain FDA approval, and, evenif we are able to do so, the approval process typically takes many years andrequires the commitment of substantial effort and financial resources. The FDAcan delay, limit or deny approval of a biologic product candidate for manyreasons, including:

 

• the FDA may notfind that the biologic product candidate is sufficiently safe or effective;

 

• FDAofficials may interpret data from preclinical testing and clinical trialsdifferently than we do; and

 

• the FDA may notfind our manufacturing processes or facilities satisfactory.

 

In addition, the specific active immunotherapy technology on whichFavId is based is a relatively new form of cancer therapy that presentsnovel issues for the FDA to consider, which may make the regulatoryprocess especially difficult.

 

We cannot assure you that any of our product candidates in developmentwill be approved in the United States in a timely fashion, or at all. Failureto obtain regulatory approval of our product candidates in a timely fashionwould prevent or delay us from marketing or selling any products and,therefore, from generating revenues from their sale. If this occurs, we may beunable to generate sufficient revenues to attain or maintain profitability, ourability to raise additional capital will be impaired and our stock price may benegatively affected. In addition, both before and after approval, we aresubject to numerous FDA requirements covering, among other things, testing,manufacturing, quality control, labeling, advertising, promotion and export ofbiologics. Failure to comply with the law, including statutes and regulations,administered by the FDA, could result in, among others, any of the followingactions:

 

• warningletters;

 

• fines andother civil penalties;

 

•unanticipated expenditures;

 

• delays inapproving or refusal to approve a product candidate;

 

• productrecall or seizure;

 

•interruption of production;

 

• operatingrestrictions;

 

•injunctions; and

 

• criminalprosecution.

 

***Before we can seek regulatory approval ofany of our product candidates, we must successfully complete clinical trials,which are uncertain.**

 

Conducting clinical trials is a lengthy, time-consuming and expensiveprocess, and the results of these trials are inherently uncertain. We havecompleted enrollment of patients in several Phase 2 clinical trials of FavIdinvolving over 130 indolent B-cell NHL patients and are currently conductingfollow-up evaluation of those patients. We completed enrollment of patients ina pivotal Phase 3 clinical trial of FavId for the treatment of follicularB-cell NHL in January 2006 and anticipate an analysis of the secondaryendpoint, response improvement, during the fourth quarter of 2006 and a finalanalysis of the primary endpoint, TTP, during the second half of 2007. Fouradditional Phase 2 clinical trials and one additional Phase 3 clinicaltrial of FavId are ongoing. One of these clinical trials is being conductedunder a separate physician-sponsored IND in the United States. A second ofthese is being conducted as a physician-sponsored clinical trial inSwitzerland. In June

 

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2006, we received an allowance from the FDA for an IND for our secondproduct candidate, FAV-201, for the treatment of cutaneous T-cell lymphoma.

 

We have received a Special Protocol Assessment, or SPA, from the FDAfor our pivotal Phase 3 clinical trial of FavId. In the SPA process, the FDAreviewed the design, size and planned analysis of our Phase 3 clinical trialand provided comments regarding the trial’s adequacy to form a basis withrespect to effectiveness for approval of a Biologics Licensing Application, orBLA, if the trial meets its predetermined objectives. We cannot assure you thatwe will be able to file a BLA for FavId until after we receive an analysis ofthe primary endpoint, TTP, of our ongoing pivotal Phase 3 clinical trial(assuming the TTP data is positive), which analysis is anticipated in thesecond half of 2007, or at all. The FDA’s written agreement is binding, exceptin limited circumstances, such as when a substantial scientific issue essentialto determining the safety or effectiveness of a product candidate is identifiedafter the Phase 3 clinical trial is commenced. Despite having received an SPA,we may be required to conduct an additional Phase 3 clinical trial ofFavId for the treatment of indolent B-cell NHL before we can apply forregulatory approval. Although the FDA typically requires successful results intwo Phase 3 clinical trials to support marketing approval, the FDA has, onseveral occasions, approved products based on a single Phase 3 clinical trialthat demonstrates a high level of statistical significance where there is anunmet need for a life-threatening condition. We currently plan to seek FDAapproval of FavId based on our ongoing pivotal Phase 3 clinical trialalone. In the event that the FDA requires the results of a second Phase 3clinical trial before accepting a BLA or before granting marketing approval ofFavId, our launch of FavId would be delayed, possibly by several years, and wewould incur significant costs in conducting the additional trial.

 

Completion of necessary clinical trials may take several years ormore. Our commencement and rate of completion of clinical trials may bedelayed by many factors, including:

 

•ineffectiveness of the product candidate, or perceptions by physicians that theproduct candidate is not safe or effective for a particular indication;

 

• inabilityto manufacture sufficient quantities of the product candidate for use inclinical trials;

 

• delay orfailure in obtaining approval of our clinical trial protocols from the FDA;

 

• slowerthan expected rate of patient recruitment and enrollment;

 

• inabilityto adequately follow and monitor patients after treatment;

 

•difficulty in managing multiple clinical sites;

 

•unforeseen safety issues; and

 

• governmentor regulatory delays.

 

Even if we achieve positive interim results in clinical trials, theseresults do not necessarily predict final results, and positive results in earlytrials may not be indicative of success in later trials. A number ofcompanies in the pharmaceutical industry have suffered significant setbacks inadvanced clinical trials, even after promising results in earlier trials.Negative or inconclusive results or adverse medical events during a clinicaltrial could cause us to repeat or terminate a clinical trial or require us toconduct additional trials. Our clinical trials may be suspended at anytime for a variety of reasons, including if the FDA or we believe the patientsparticipating in our trials are exposed to unacceptable health risks or if theFDA finds deficiencies in the conduct of these trials.

 

Failures or perceived failures in our clinical trials will directlydelay our product development and regulatory approval process, damage ourbusiness prospects, make it difficult for us to establish collaboration andpartnership relationships, and negatively affect our reputation and competitiveposition in the pharmaceutical community.

 

**Failure to enroll patients in our clinicaltrials may cause delays in developing FavId or any other productcandidate.**

 

We may encounter delays in development and commercialization, orfail to obtain marketing approval, of FavId or any other product candidate thatwe may develop if we are unable to enroll enough patients to completeclinical trials. Our ability to enroll sufficient numbers of patients in ourclinical trials depends on many factors, including the size of the patientpopulation, the nature of the protocol, the proximity of patients to clinicalsites, the eligibility criteria for the trial and competing clinical trials.Although we completed patient enrollment in our pivotal Phase 3 clinical trialof FavId in January 2006, we have from time to time experiencedslower-than-expected patient enrollment in our clinical trials and may doso in

 

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the future if additional clinical trials of FavId are required or if weclinically develop any of our other product candidates. Delays in plannedpatient enrollment may result in increased costs and harm our ability tocomplete our clinical trials and obtain regulatory approval.

 

**The development of FavId requires thecontinued availability of two FDA-approved drugs: GM-CSF and Rituxan.**

 

Administration of FavId requires an adjuvant, which is a substance thatis used to enhance the immune response. We use a white blood cell growth factorknown as GM-CSF, which is commercially available solely from BerlexLaboratories, Inc., as an adjuvant for FavId. We currently rely onpurchase orders to purchase GM-CSF for use in our clinical trials and do nothave a supply agreement with Berlex. GM-CSF is an FDA-approved and commerciallyavailable drug that may be purchased by physicians. Our current strategyfor the initial commercialization of FavId involves the administration of FavIdfollowing treatment with Rituxan. Rituxan is a passive immunotherapy forpatients with NHL, which is also FDA-approved and is commercially availablesolely from Genentech, Inc. and Biogen Idec Inc. We currently rely onphysicians to order and administer Rituxan to patients prior to theadministration of FavId in our registration trial. If GM-CSF or Rituxan were tobecome unavailable as a result of regulatory actions, supply constraints orother reasons, our ability to continue the clinical development of FavId wouldbe jeopardized.

 

**RisksRelated to Our Financial Results and Need for Financing**

 

***We have incurred significant operatinglosses since inception and anticipate that we will continue to incursubstantial losses and negative cash flow from operations for the foreseeablefuture.**

 

We are a development stage company with a limited operating history. Wehave financed our operations through private placements of stock and warrants,an initial public offering of our common stock and equipment and leasehold debtfinancing. We have incurred losses in each year since our inception in 2000. Netlosses were $9.8 million and $20.7 million for the three and six months ended June 30,2006, respectively, and $9.4 million and $17.8 million for the three and sixmonths ended June 30 2005, respectively. As of June 30, 2006, we hadan accumulated deficit of $136.1 million. These losses, among other things,have had and will continue to have an adverse effect on our stockholders’equity and working capital. We expect to incur substantial operating losses forat least the next several years. This is due primarily to the expansion of ourclinical trials and research and development programs, preparations tomanufacture FavId on a commercial scale, and, to a lesser extent, general andadministrative expenses. We also have substantial lease and debt obligationsrelated to our new manufacturing and headquarters facilities impacting ouroperating expenses. We expect that our losses will fluctuate from quarter to quarterand that these fluctuations may be substantial. We cannot guarantee thatwe will successfully develop, manufacture, commercialize or market anyproducts. As a result, we cannot guarantee that we will ever achieve or sustainproduct revenues or profitability.

 

**We currently have no source of revenue and may neverbecome profitable.**

 

Our ability to become profitable will depend upon our ability togenerate revenue. To date, FavId has not generated any revenue, and we do notknow when or if FavId will generate revenue. Our ability to generate revenuedepends on a number of factors, including our ability to:

 

•successfully complete clinical trials for FavId;

 

• obtainregulatory approval for FavId, including regulatory approval for our commercialscale manufacturing facility and process;

 

•manufacture commercial quantities of FavId at acceptable cost levels; and

 

•successfully market and sell FavId.

 

We do not anticipate that we will generate revenues until 2008, at theearliest. Further, we do not expect to achieve profitability for at leastseveral years after generating material revenues. If we are unable to generaterevenue, we will not become profitable, and we may be unable to continueour operations.

 

***We will need substantial additional funds tocontinue operations, which we may not be able to raise on favorable terms,or at all.**

 

We will need substantial additional funds for existing and plannedpreclinical studies and clinical trials, to continue research and developmentactivities, for lease and debt obligations related to our manufacturing andheadquarter facilities, and to establish manufacturing and marketingcapabilities for any products we may develop. In addition, because we donot expect

 

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to generate revenues from the sale of our product candidates forseveral years, if at all, we will also need to raise additional capital to fundour operations.

 

We believe that our existing cash, cash equivalents and short-terminvestments, together with interest thereon, will be sufficient to meet ourprojected operating requirements through fiscal 2007. We will need to raiseadditional funds in order to commercialize FavId, including the completion ofthe expansion and qualification of our manufacturing facility forcommercial-scale production. Our forecast of the period of time through whichour financial resources will be adequate to support our operations is aforward-looking statement and involves risks and uncertainties, and actualresults could vary as a result of a number of factors, including the factorsdiscussed elsewhere in this report. We have based this estimate on assumptionsthat may prove to be wrong, and we could utilize our available capitalresources sooner than we currently expect.

 

Our future capital requirements or the adequacy of our available fundswill depend on many factors, including, but not limited to:

 

• magnitudeand cost of our product development efforts and other research and developmentactivities;

 

• rate ofprogress toward obtaining regulatory approval for our product candidates;

 

• costs offiling, prosecuting, defending and enforcing our patent claims and otherintellectual property rights;

 

• ourability to establish and maintain collaborative, licensing or other arrangementsfor the development, sale, marketing or distribution of our product candidatesand the terms of those arrangements;

 

• effectsof competing technological and market developments;

 

• the costof expansion of our current facility for commercial production or theconstruction of a large separate commercial-scale production facility; and

 

• thesuccess of the commercialization of FavId.

 

Future capital requirements will also depend on the extent to which weacquire or invest in businesses, products and technologies, but we currentlyhave no commitments or agreements relating to any of these types oftransactions.

 

To that end, on June 20, 2006, we filed a shelf registrationstatement with the SEC on Form S-3 pursuant to which we may periodicallysell up to $60 million in debt securities, common stock or warrants to purchasedebt securities or common stock. We may seek to access the public orprivate equity markets whenever conditions are favorable, even if we do nothave an immediate need for additional capital at that time. Additional funding may notbe available to us, and, if available, may not be on acceptable terms. Ifwe raise additional funds by issuing equity securities, stockholders will incurimmediate dilution. If adequate funds are not available to us, we may berequired to delay, reduce the scope of, or eliminate one or more of ourresearch, development and clinical activities. Alternatively, we may needto seek funds through arrangements with collaborative partners or others thatrequire us to relinquish rights to technologies or product candidates that wewould otherwise seek to develop or commercialize ourselves. Any of these eventscould have a material adverse effect on our business, results of operations,financial condition or cash flow.

 

***Futurechanges in financial accounting standards or practices or existing taxation rules orpractices may cause adverse unexpected revenue or expense fluctuations andaffect our reported results of operations.**

 

Achange in accounting standards or practices or a change in existing taxation rules orpractices can have a significant effect on our reported results and may evenaffect our reporting of transactions completed before the change is effective.New accounting pronouncements and taxation rules and varyinginterpretations of accounting pronouncements and taxation practice haveoccurred and may occur in the future. Changes to existing rules orthe questioning of current practices may adversely affect our reportedfinancial results or the way we conduct our business. For example, in December 2004,the FASB issued SFAS No. 123(R), “Share-Based Payment,” which is arevision of SFAS No. 123, “Accounting for Stock-Based Compensation.”In April 2005, the SEC approved a vote that effectively required us toadopt this statement on January 1, 2006. This statement eliminates theability to account for stock-based compensation using the intrinsic valuemethod allowed under APB 25 and requires these transactions to berecognized as compensation expense in the statement of operations based on thefair values on the date of grant, with the compensation expense recognized overthe period in which an employee or director is required to provide service inexchange for the stock award. This new requirement will result in an increasein our stock-based compensation expense, which may increase our netlosses. For example, as a result of adopting

 

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SFAS123(R), the Company’s net loss for the three and six months ended June 30,2006 is approximately $300,000 and $500,000 larger, respectively, than if theCompany had continued to account for stock-based compensation under APB 25. Basicand diluted net loss per share for the three and six months ended June 30,2006 are $0.01 and $0.02 higher, respectively, than if the Company hadcontinued to account for stock-based compensation under APB25.

 

**OtherRisks Related to Our Business and Industry**

 

**We currently depend on single sourcesuppliers for critical raw materials for manufacturing. The loss of thesesuppliers could delay our clinical trials or prevent or delay commercializationof FavId.**

 

We currently depend on single source suppliers for critical rawmaterials used in the manufacture of FavId. In particular, our manufacturingprocess for FavId requires a foreign protein derived from shellfish that isknown as keyhole limpet hemocyanin, or KLH. We purchase KLH from biosynArzneimittel GmbH, or biosyn, which is currently the only supplier of KLH thathas submitted the required filing, known as a drug master file, to the FDA. In November 2004,we entered into an eight-year supply and license agreement with biosyn underwhich biosyn has agreed to supply us with KLH and we have committed to annualKLH purchase requirements during the commercialization of FavId. An additionalaggregate of up to $300,000 will be due upon the achievement of certainmilestones, the timing of which is not known at this time. Either party may terminatethe supply agreement upon a breach by the other party that is not cured within60 days or other events relating to insolvency or bankruptcy. If weidentify another supplier of KLH of suitable quality for our purposes, we willnot be able to use the supplier as a second source of KLH for the commercialmanufacture of FavId unless the KLH is tested to be comparable to the existingKLH.

 

In addition, we depend on a single source supplier for the cell growthmedia we use to produce FavId. We purchase this material from ExpressionSystems LLC, which in turn obtains several of the components used in the cellgrowth media from sole suppliers. We currently rely on purchase orders toobtain this material and do not have a supply agreement with ExpressionSystems. We intend to qualify a second source for the cell growth media ormanufacture the cell growth media in house from commercially available rawmaterials but may not be able to do so.

 

Establishing additional or replacement suppliers for these materials may takea substantial amount of time. In addition, we may have difficultyobtaining similar materials from other suppliers that are acceptable to theFDA. If we have to switch to a replacement supplier, we may faceadditional regulatory delays and the manufacture and delivery of FavId, or anyother product candidates that we may develop, could be interrupted for anextended period of time, which may delay completion of our clinical trialsor commercialization. If we are unable to obtain adequate amounts of thesematerials, our clinical trials will be delayed. In addition, we will berequired to obtain regulatory clearance from the FDA to use different materialsthat may not be as safe or as effective. As a result, regulatory approvalof FavId, or any other product candidates that we may develop, may notbe received at all.

 

***We rely on third parties to conduct ourclinical trials. If these third parties do not successfully carry out theircontractual duties or meet expected deadlines, we may be delayed or may notbe able to obtain regulatory approval for or commercialize FavId or any otherproduct candidates that we may develop.**

 

Our pivotal Phase 3 clinical trial of FavId for the treatment offollicular B-cell NHL is being conducted at 67 centers in the United States andwill require long-term follow up of the 347 patients randomized into the trial.Two clinical trials of FavId are being conducted under the direction of aphysician sponsor, rather than under our supervision. We do not have theability to independently conduct clinical trials for FavId, or any otherproduct candidate that we may develop, and we must rely on third parties,such as medical institutions and clinical investigators, including physiciansponsors, to conduct our clinical trials. In particular, we will rely on theseparties to recruit and enroll patients in our clinical trials. We also rely onthird-party couriers to transport patient tissue samples and FavId. If any ofthe third parties upon whom we rely to conduct our clinical trials or transportpatient tissue samples and immunotherapies do not comply with applicable laws,successfully carry out their obligations or meet expected deadlines, and needto be replaced, our clinical trials may be extended, delayed orterminated.

 

If the quality or accuracy of the clinical data obtained by medicalinstitutions and clinical investigators, including physician sponsors and otherthird-party vendors involved in data management, is compromised due to theirfailure to adhere to applicable laws or our clinical protocols or for otherreasons, we may not be able to obtain regulatory approval for orsuccessfully commercialize FavId, or any other product candidates that we may develop.If any of our relationships with any of these organizations or individualsterminates, we believe that we would be able to enter into arrangements withalternative third parties. However, replacing any of these third parties woulddelay our clinical trials and could jeopardize our ability to commercializeFavId and our other product candidates on a timely basis, or at all.

 

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**Even if we obtain regulatory approval, wewill continue to be subject to extensive government regulation that may causeus to delay the introduction of our products or withdraw our products from themarket.**

 

Even if we obtain regulatory approval for FavId or our other productcandidates, we will still be subject to extensive regulation. These regulationswill impact many aspects of our operations, including production, recordkeeping, quality control, adverse event reporting, storage, labeling,advertising, promotion and personnel. In addition, the later discovery ofpreviously unknown problems may result in restrictions of the productcandidates, including their withdrawal from the market. Furthermore, regulatoryapproval may subject us to ongoing requirements for post-marketingstudies. If we or any third party that we involve in our operations fail tocomply with any continuing regulations, we may be subject to, among otherthings, product seizures, recalls, fines or other civil penalties, injunctions,suspensions or revocations of marketing licenses, operating restrictions andcriminal prosecution.

 

***Before we can obtain marketing approval foror commercially distribute FavId, we must have a commercial-scale facility forthe manufacture of FavId. In addition, the FDA and the California Department ofHealth Services must find our manufacturing facility and process satisfactory.**

 

Our manufacturing methods, equipment and processes must comply with theFDA’s current Good Manufacturing Practices, or cGMP, requirements. We may alsoneed to perform extensive audits of vendors, contract laboratories andsuppliers. The cGMP requirements govern, among other things, record keeping,production processes and controls, personnel and quality control. We have onlyundertaken initial steps towards achieving compliance with these regulatoryrequirements. Additional steps will require expenditure of significant time,money and effort. We cannot predict the likelihood that the FDA will find ourfacility satisfactory, even if we believe that we have taken the necessarysteps to achieve compliance. If we fail to comply with these requirements orfail to pass a pre-approval inspection of our manufacturing facility inconnection with an application to obtain marketing approval for FavId oranother product candidate, we would not receive regulatory approval, and wewould be subject to possible regulatory action.

 

We manufacture FavId for our ongoing pivotal Phase 3 and for theplanned and ongoing Phase 1/2/3 clinical trials at our facility in San Diego.We currently lease approximately 80,000 square feet of space in a facility inSan Diego, California under a long-term lease agreement. This space is used forour corporate headquarters and manufacturing and laboratory facilities. Ourmanufacturing facility consists of approximately 26,000 square feet of space inthe facility. Our manufacturing facility is subject to the licensingrequirements of the California Department of Health Services. Our facility wasinspected and licensed by the California Department of Health Services. Ourfacility is subject to re-inspection at any time. Failure to maintain a licensefrom the California Department of Health Services or to meet the inspectioncriteria of the California Department of Health Services would disrupt ourmanufacturing processes and prevent us from supplying FavId to patients. If aninspection by the California Department of Health Services indicates that thereare deficiencies in our manufacturing process, we could be required to takeremedial actions at potentially significant expense, and our facility may betemporarily or permanently closed.

 

We will need to either expand and qualify our current facility orconstruct and qualify a commercial scale manufacturing facility in order tocommercialize FavId or any other product candidates that we may develop.We believe our current facility could be used to manufacture FavId for initialcommercial launch, and we began construction to expand this facility during thesecond quarter of 2006. We cannot assure you that we would be able to meetcommercial demand for FavId in this facility. Additionally, we may requirea larger production facility to meet the demand for FavId if it is approved. Wewould need to raise additional debt or equity capital to finance constructionof the larger facility. Such financing may not be available or, ifavailable, may not be obtained on terms favorable to us or ourstockholders.

 

Preparing a facility for commercial manufacturing may involveunanticipated delays and the costs of complying with FDA regulations may besignificant. In addition, any material changes we make to the manufacturingprocess after approval may require approval by the FDA and stateregulatory authorities. Obtaining these approvals is a lengthy, involvedprocess, and we may experience delays that could limit our ability tomanufacture commercial quantities, increase our costs and adversely affect ourbusiness.

 

**We may experience difficulties inmanufacturing FavId or any other product candidates that we may develop,which could prevent us from completing our ongoing clinical trials andcommercializing these product candidates.**

 

Manufacturing FavId is a complex, multi-step process that requires usto expend significant time, money and effort in production, record keeping andquality systems to assure that FavId will meet product specifications and otherregulatory requirements. To date, we have manufactured FavId only for use inPhase 2 and Phase 3 clinical trials and have no experience in manufacturingFavId for the commercial quantities that might be required if we receiveregulatory approval. In particular, we cannot be sure that we will be able tomanufacture FavId at a cost that would enable commercial use. We may experience

 

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any of the following problems in our efforts to manufacture our productcandidates for our expanding clinical trials or on a commercial scale:

 

• failureto obtain a sufficient supply of key raw materials;

 

•difficulties in completing the development and validation of the specializedassays required to ensure the consistency of our product candidates, includingFavId;

 

•difficulties in obtaining adequate tumor samples from treating physicians andhospitals;

 

•difficulties in manufacturing FavId for multiple patients simultaneously;

 

•difficulties in the timely shipping of tumor samples to us or in the shippingof FavId to the treating physicians due to errors by third-party couriers, transportationrestrictions or other reasons;

 

• failureto ensure adequate quality control and assurance in the manufacturing processas we increase the production quantities of FavId;

 

•difficulties in establishing and effectively managing a commercial-scalemanufacturing facility;

 

• failureto comply with regulatory requirements, such as FDA regulations andenvironmental laws;

 

•significant changes in regulatory requirements;

 

• damage toor destruction of our manufacturing facility or equipment;

 

• difficultyin qualifying a second-source supplier for certain critical equipment; and

 

• shortagesof qualified personnel.

 

In addition, because our manufacturing process only begins upon ourreceipt of a patient’s tumor biopsy, we cannot produce inventory reserves ofour product candidate to be stored in anticipation of any of these potentialmanufacturing problems. The failure to produce an adequate supply of FavIdcould delay our clinical trials and, in turn, delay submission of a BLA forFavId and commercial launch. Similarly, any difficulties we experience in themanufacture and supply of other product candidates, such as FAV-201, woulddelay the clinical trials of those product candidates.

 

**If our manufacturing facility is damaged ordestroyed, our ability to manufacture products will be significantly affected,which could delay or prevent completion of our clinical trials andcommercialization of FavId or any other product candidates that we may develop.**

 

We currently rely on the availability and condition of ourmanufacturing facility in San Diego to manufacture FavId. We lease the propertywhere this facility is located under a lease agreement that expires June 30,2025, but may be extended at our option for two additional five-yearperiods. After that time, we may not be able to negotiate a new lease forour facility. If the facility or our equipment in the facility is damaged ordestroyed, we will not be able to quickly or inexpensively replace ourmanufacturing capacity. This would significantly affect our ability to completeclinical trials of, and to manufacture and commercialize, FavId, or any otherproduct candidates that we may develop.

 

In addition, our facilities have been subject to electrical blackoutsas a result of a shortage of available electrical power. Although we haveback-up emergency power generators to cover energy needs for key supportsystems, a lengthy outage could disrupt the operations of our facilities andclinical trials. While we carry business interruption insurance, this insurancemay not be adequate. Any significant business interruption could causedelays in our product development and harm our business.

 

**If we do not develop a sufficient sales andmarketing force or enter into agreements with third parties to sell and marketFavId, we may not be able to successfully commercialize our products,which would limit our ability to earn product revenues.**

 

We plan to retain exclusive worldwide rights to FavId for oncologyindications at least through the completion of our BLA filing with the FDA forapproval to market FavId in the United States. If we are successful inobtaining BLA approval or foreign marketing approval for FavId, we will need toestablish sales and marketing capabilities. In the United States, we plan

 

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to do this either by establishing our own sales force or by enteringinto a co-promotion arrangement with a sales and distribution partner. Outsideof the United States, we plan to establish strategic collaborations for thedevelopment and marketing of FavId.

 

We do not presently possess the resources or experience necessary tomarket FavId or our other product candidates ourselves, and we currently haveno arrangements for the promotion or distribution of our product candidates.Our future commercial success will depend on our ability to establish our ownsales and marketing infrastructure or to collaborate with third parties thathave greater sales and marketing experience and resources. Developing effectiveinternal sales and marketing capabilities, which would include the hiring of asales force, would require a significant amount of our financial resources andtime.

 

We may be unable to establish and manage an effective sales forcein a timely or cost-effective manner, or at all, and any sales force we doestablish may not be capable of generating demand for FavId or any otherproduct candidate we may develop. In addition, if we cannot enter intoco-promotion arrangements in the United States, or other strategic collaborationsfor the development and marketing of FavId in other countries, in a timelymanner and on acceptable terms, we may not be able to successfullycommercialize FavId or any other product candidate that we may develop.

 

To the extent that we enter into arrangements with third parties to perform sales,marketing and distribution services, our product revenues are likely to belower than if we directly marketed and sold FavId, or any other productcandidates that we may develop. If we are unable to establish adequatesales, marketing and distribution capabilities, independently or with others,we will not be able to generate product revenue and will not become profitable.

 

**If physicians and patients do not use any ofour products that may be approved, our ability to generate revenue in thefuture will be limited.**

 

If approved, FavId and other product candidates that we may developmay not gain market acceptance among physicians, healthcare payors,patients and the medical community. Demand for any approved product that we may developwill depend on many factors, including:

 

• ourability to provide acceptable evidence of safety and efficacy;

 

•convenience and ease of administration;

 

•availability of alternative treatments;

 

• costeffectiveness;

 

• continuingwidespread use of Rituxan to treat our initial target disease market;

 

•effectiveness of our regulatory and marketing strategies;

 

•prevalence and severity of adverse side effects;

 

• publicityconcerning our products or competitive products; and

 

• ourability to obtain third-party coverage or reimbursement.

 

Furthermore, to the extent FavId fails to gain market acceptance forits initial indication, it may be more difficult for us to generatesufficient credibility with physicians and patients to commercialize FavId forother indications.

 

**If we are unable to obtain acceptable pricesor adequate coverage and reimbursement from third-party payors for FavId, orany other product candidates that we may develop, our revenues andprospects for profitability will suffer.**

 

Our ability to commercialize FavId, or any other product candidatesthat we may develop, depends on the extent to which coverage andreimbursement for FavId, or any other product candidates that we may develop,will be available from:

 

•governmental payors, such as Medicare and Medicaid;

 

• privatehealth insurers, including managed care organizations; and

 

• otherthird-party payors.

 

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Many patients will not be capable of paying for FavId, or any otherproduct candidates that we may develop, themselves and will rely onthird-party payors to pay for their medical needs. The federal and stategovernments, insurance companies, managed care organizations and otherthird-party payors are actively seeking to contain or reduce costs of healthcare in the United States and exert increasing influence on decisions regardingthe use of, and reimbursement levels for, particular treatments. Suchthird-party payors, including Medicare, are scrutinizing newly approved medicalproducts and services and may not cover or may limit coverage andreimbursement for our product candidates. In particular, third-party payors may limitthe indications for which they will reimburse patients who use FavId, or anyother product candidates that we may develop. Cost-control initiativescould cause us to decrease the price we might establish for FavId, or any otherproduct candidates that we may develop, which would result in lowerproduct revenues. If the prices for FavId, or any other product candidates thatwe may develop, decrease or if governmental and other third-party payorsdo not provide adequate coverage and reimbursement levels for FavId, or anyother product candidates that we may develop, our revenue and prospectsfor profitability will suffer.

 

**If we are unable to establish or managestrategic collaborations in the future, our revenue and product development may belimited.**

 

Our strategy may include reliance on strategic collaborations forco-promotion of FavId in the United States. In addition, we expect to rely onstrategic collaborators for commercialization of FavId outside of the UnitedStates and, to an even greater extent, for worldwide development andcommercialization of product candidates and programs for chronic autoimmunediseases, such as multiple sclerosis. To date, we have not entered into anyagreements with third parties for any of these services and do not plan toestablish a collaboration for FavId in the United States until at least completionof a BLA filing.

 

Establishing strategic collaborations is difficult and time-consuming.Our discussions with potential collaborators may not lead to theestablishment of new collaborations on favorable terms, or at all. For example,potential partners may reject collaborations based upon their assessmentof our financial, regulatory or intellectual property position. If wesuccessfully establish new collaborations, these relationships may neverresult in the successful development or commercialization of our productcandidates or the generation of sales revenue. To the extent that we enter intoco-promotion or other collaborative arrangements, our product revenues arelikely to be lower than if we directly marketed and sold any products that we may develop.

 

Management of any collaborative relationship we may establish inthe future will require:

 

•significant time and effort from our management team;

 

•coordination of our research and development programs with the research anddevelopment priorities of our collaborators; and

 

• effectiveallocation of our resources to multiple projects.

 

If we enter into development or commercialization collaborations, oursuccess will in part depend on the performance of our corporatecollaborators. We will not directly control the amount or timing of resourcesdevoted by our corporate collaborators to activities related to our productcandidates. Our corporate collaborators may not commit sufficientresources to our research and development programs or the commercialization,marketing or distribution of our product candidates. If any corporatecollaborator fails to commit sufficient resources, our preclinical or clinicaldevelopment related to the collaboration could be delayed or terminated. Also,our collaborators may pursue development or commercialization of otherproducts, product candidates or alternative technologies in preference to ourproduct candidates. Finally, our collaborators may terminate ourrelationships, and we may be unable to establish additional corporatecollaborations in the future on acceptable terms, or at all.

 

**Our efforts to discover, develop andcommercialize new product candidates beyond FavId are at an early stage and aresubject to a high risk of failure.**

 

Our strategy is focused on the research, development andcommercialization of targeted immunotherapies for the treatment of cancer andother diseases of the immune system. The process of successfully developingproduct candidates is very time-consuming, expensive and unpredictable. We haveonly recently begun to direct significant effort toward the development ofproduct candidates in addition to FavId, such as FAV-201 for T-cell lymphomaand a preclinical product candidate for the treatment of multiple sclerosis. Wedo not know whether our planned preclinical studies or clinical trials forthese other product candidates will begin on time or be completed on schedule,or at all. In addition, we do not know whether these clinical trials willresult in marketable products. Typically, there is a high rate of attrition forproduct candidates in preclinical and clinical trials. We do not anticipatethat any of our product candidates will reach the market for at least severalyears.

 

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We may not identify, develop or commercialize any additional newproduct candidates from our proprietary active immunotherapy technology. Ourability to develop successfully any of these product candidates depends on ourability to demonstrate safety and efficacy in humans through extensivepreclinical testing and clinical trials and to obtain regulatory approval fromthe FDA and other regulatory authorities. Development of our product candidateswill also depend substantially upon the availability of funding for ourresearch and development programs.

 

**If our competitors develop and marketproducts that are more effective than our existing product candidates or otherswe may develop, or obtain marketing approval before we do, our commercialopportunity may be reduced or eliminated.**

 

The development and commercialization of new pharmaceutical productsfor the treatment of cancer and autoimmune diseases is competitive, and we willface competition from numerous sources, including major pharmaceuticalcompanies, specialty pharmaceutical companies and biotechnology companiesworldwide. Many of our competitors have substantially greater financial andtechnical resources and development, production and marketing capabilities thanwe do. In addition, many of these companies have more experience than we do inpreclinical testing, clinical trials and manufacturing of biologictherapeutics, as well as in obtaining FDA and foreign regulatory approvals. Wewill also compete with academic institutions, governmental agencies and privateorganizations that are conducting research in the fields of cancer andautoimmune disease. Competition among these entities to recruit and retainhighly qualified scientific, technical and professional personnel andconsultants is also intense.

 

We are aware of a number of companies that are developing activeimmunotherapies to treat B-cell NHL. Genitope Corporation is evaluating itsidiotype immunotherapy product candidate in a Phase 3 clinical trial inpatients with follicular B-cell NHL who are in remission following priortreatment with chemotherapy. Antigenics, Inc. completed a Phase 2 clinicaltrial evaluating its active immunotherapy candidate in indolent NHL patients.The NCI is also conducting a Phase 3 clinical trial of an active idiotype immunotherapyin collaboration with Accentia Biopharmaceuticals.

 

Several companies are engaged in the development and commercializationof passive immunotherapy products for the treatment of B-cell NHL that may competewith FavId. Genentech and Biogen Idec are co-marketing Rituxan for thetreatment of relapsed or refractory, indolent B-cell NHL. Biogen Idec has alsoreceived FDA approval to market Zevalin, its passive radioimmunotherapyproduct. GlaxoSmithKline plc has received FDA approval to market Bexxar, a passiveradioimmunotherapy product.

 

The most recent advances in the treatment of B-cell NHL have involvedthe combination of existing products and changes to approved schedules anddoses, particularly for Rituxan. Numerous clinical trials reported in recentyears have indicated that additional doses of Rituxan and maintenance dosing ofRituxan can improve TTP in patients who respond to therapy. Combinationtherapies involving chemotherapeutic or immunostimulatory drugs in combinationwith Rituxan at various doses and schedules may provide patients with anincrease in TTP over that expected with Rituxan alone. Accordingly, we may facecompetition as a result of developments in this area.

 

We expect that our ability to compete effectively will depend upon ourability to:

 

•successfully and rapidly complete clinical trials and obtain all requisiteregulatory approvals in a cost-effective manner;

 

• reliablyand cost-effectively manufacture sufficient quantities of our products;

 

• maintaina proprietary position for our manufacturing process and other technology;

 

• price ourproducts competitively;

 

• obtainappropriate reimbursement approvals for our products;

 

• establishan adequate sales and marketing force for our products; and

 

• attractand retain key personnel.

 

In addition, our ability to compete effectively will depend on therelative efficacy and safety of other active immunotherapy products approvedfor sale as compared to our own products.

 

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**We are subject to new legislation, regulatoryproposals and managed care initiatives that may increase our costs ofcompliance and adversely affect our ability to market our products, obtaincollaborators and raise capital.**

 

There have been a number of legislative and regulatory proposals aimedat changing the healthcare system and pharmaceutical industry, includingreductions in the cost of prescription products and changes in the levels atwhich consumers and healthcare providers are reimbursed for purchases ofpharmaceutical products. For example, the Prescription Drug and MedicareImprovement Act of 2003 was recently enacted. This legislation provides a newMedicare prescription drug benefit beginning in 2006 and mandates otherreforms. Although we cannot predict the full effects on our business of theimplementation of this new legislation, it is possible that the new benefit,which will be managed by private health insurers, pharmacy benefit managers andother managed care organizations, will result in decreased reimbursement forprescription drugs, which may further exacerbate industry-wide pressure toreduce the prices charged for prescription drugs. This could harm our abilityto market our products and generate revenues.

 

**We depend on attracting and retaining keyscientific and management personnel to advance our technology, and the loss ofthese personnel could impair the development of our products.**

 

Our success depends on our continued ability to attract, retain andmotivate highly qualified management, clinical and scientific personnel and onour ability to develop and maintain important relationships with leadingacademic institutions, clinicians and scientists. We are highly dependent uponour senior management and scientific staff, particularly John P. Longenecker,Ph.D., our President and Chief Executive Officer, and Daniel P. Gold, Ph.D.,one of our co-founders and our Chief Scientific Officer. The loss of servicesof Dr. Longenecker or Dr. Gold, or one or more of our other membersof senior management, could delay or prevent the successful completion of ourpivotal Phase 3 clinical trial or the commercialization of FavId. Although wehave employment agreements with each of our executives, their employment withus is “at will,” and each executive can terminate his or her agreement with usat any time. We do not carry “key person” insurance covering members of seniormanagement, other than Drs. Longenecker and Gold. This insurance may notcontinue to be available on commercially reasonable terms and may proveinadequate to compensate us for the loss of their services.

 

The competition for qualified personnel in the biotechnology field isintense. In particular, our manufacturing process depends on our ability toattract and retain qualified manufacturing and quality control personnel. Wewill need to hire additional personnel as we continue to expand ourmanufacturing, research and development activities. We may not be able toattract and retain quality personnel on acceptable terms given the competition forsuch personnel among biotechnology, pharmaceutical and other companies. We arenot aware of any key personnel planning to retire or terminate their employmentin the near future.

 

***We will need to increase the size of ourorganization, and we may experience difficulties in managing growth.**

 

As of June 30, 2006, we had 147 employees. Of these, 115 employeeswere in research and development comprised of 80 in manufacturing, qualitycontrol and quality assurance, 31 in research and process development, and fourmembers of senior management. Of the remaining employees, three were members ofsenior management and 29 were in marketing, general and administration. We willneed to expand our financial, managerial, operational and other resources inorder to continue our clinical trials and commercialize FavId, FAV-201, or anyother product candidates that we may develop. Future growth would imposesignificant added responsibilities on our management team, including the needto identify, recruit, maintain and integrate additional employees. Our abilityto commercialize FavId, FAV-201, or any other product candidates that we may develop,and our future financial performance in general, will depend in part onour ability to manage any future growth effectively. In order to meet thesechallenges, we would need to:

 

• manageour clinical trials effectively;

 

• manageour research and development efforts effectively;

 

• developour administrative, accounting and management information systems and controls;and

 

• hire, trainand integrate additional management, administrative, manufacturing and salesand marketing personnel.

 

We may not be able to accomplish these tasks, and our failure toaccomplish any of them could harm our business or future prospects.

 

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**If we use biological and hazardous materialsin a manner that causes injury or violates laws, we may be liable fordamages.**

 

Our research and development and manufacturing activities involve theuse of biological and hazardous materials that could be dangerous to humanhealth, safety or the environment. Although we believe our safety proceduresfor handling and disposing of these materials comply with federal, state andlocal laws and regulations, we cannot entirely eliminate the risk of accidentalinjury or contamination from the use, storage, handling or disposal of thesematerials. In the event of contamination or injury, we could be held liable forany resulting damages, and any liability could exceed our resources. Wecurrently maintain property and casualty insurance coverage which coversliability for hazardous and controlled materials. However, this insurancecoverage may not be sufficient to cover our liability and we may notbe able to obtain sufficient coverage in the future at a reasonable cost. Inaddition, we may incur significant costs complying with both existing andfuture environmental laws and regulations. In particular, we are subject toregulation by the Occupational Safety and Health Administration, or OSHA, andthe Environmental Protection Agency, or EPA, and to regulation under the ToxicSubstances Control Act and the Resource Conservation and Recovery Act. OSHA,the EPA or other agencies may adopt regulations that adversely affect ourresearch and development programs.

 

**We face a risk of product liability claimsand may not be able to obtain adequate insurance.**

 

Our business exposes us to potential liability risks that may arisefrom the clinical testing of our product candidates and the manufacture andsale of any approved products. These risks will exist even with respect tothose product candidates that are approved for commercial sale by the FDA andmanufactured in facilities regulated by the FDA. Any product liability claim orseries of claims brought against us could significantly harm our businessby, among other things, reducing demand for our products, injuring ourreputation and creating significant adverse media attention and costlylitigation. Plaintiffs have received substantial damage awards in somejurisdictions against pharmaceutical companies based upon claims for injuriesallegedly caused by the use of their products. Any judgment against us that isin excess of our insurance policy limits would have to be paid from our cashreserves, which would reduce our capital resources. We currently maintainclinical trial insurance. Although we believe our current insurance coverage isadequate, we cannot be certain that it will be sufficient. Furthermore, wecannot be certain that our current insurance coverage will continue to beavailable, or that increased coverage, which will be necessary if we are ableto commercialize our products, will be available in the future on reasonableterms, or at all. Further, we may not have sufficient capital resources topay a judgment, in which case our creditors could levy claims against ourassets, including our intellectual property.

 

**We could be negatively impacted by futureinterpretation or implementation of federal and state fraud and abuse laws,including anti-kickback laws and other federal and state anti-referral laws.**

 

If we are able to commercialize FavId or any other product candidatesthat we may develop, we will be subject to various federal and state lawspertaining to healthcare fraud and abuse, including anti-kickback laws andphysician self-referral laws. Violations of these laws are punishable bycriminal and civil sanctions, including, in some instances, imprisonment andexclusion from participation in federal and state healthcare programs, includingMedicare, Medicaid and Veterans Administration health programs. Because of thefar-reaching nature of these laws, we may be required to alter one or moreof our practices to be in compliance with these laws. Healthcare fraud andabuse regulations are complex, and even minor, inadvertent irregularities canpotentially give rise to claims that a statute or prohibition has beenviolated. Any violations of these laws, or any action against us for violationof these laws, even if we successfully defend against it, could result in amaterial adverse effect on our business, financial condition and results ofoperations. If there is a change in law, regulation or administrative orjudicial interpretations, we may have to change our business practices orour existing business practices could be challenged as unlawful, which couldhave a material adverse effect on our business, financial condition and resultsof operations. In addition, some allegations under these laws have been claimedto violate the False Claims Act, discussed in more detail below.

 

In addition, if we are able to commercialize FavId or any other productcandidates that we may develop, we could become subject to false claimslitigation under federal statutes, which can lead to civil money penalties,criminal fines and imprisonment, and exclusion from participation in Medicare,Medicaid and other federal and state healthcare programs. These false claimsstatutes include the False Claims Act, which allows any person to bring suit onbehalf of the federal government alleging the submission of false or fraudulentclaims, or causing to present such false or fraudulent claims, under federalprograms or contracts claims or other violations of the statute and to share inany amounts paid by the entity to the government in fines or settlement. Thesesuits against biotechnology companies have increased significantly in recentyears and have increased the risk that a healthcare company will have to defenda false claim action, pay fines or be excluded from the Medicare, Medicaid orother federal and state healthcare programs as a result of an investigationarising out of such action. We cannot assure you that we will not becomesubject to such litigation or, if we are not successful in defending against suchactions, that such actions will not have a material adverse effect on ourbusiness, financial condition and results

 

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of operations. In addition, we cannot assure you that the costs ofdefending claims or allegations under the False Claims Act will not have amaterial adverse effect on our business, financial condition and results ofoperations.

 

**RisksRelated to Our Intellectual Property and Potential Litigation**

 

***If we are unable to obtain and maintain protectionfor our intellectual property, the value of our technology and products may beadversely affected.**

 

Our business and competitive positions are dependent upon our abilityto protect our proprietary technology. Our success will depend in large part onour ability to obtain and maintain patent protection for our product andtechnologies, preserve trade secrets and operate without infringing theintellectual property right of others. Because of the substantial length oftime and expense associated with development of new products, we, along withthe rest of the biopharmaceutical industry, place considerable importance onobtaining and maintaining patent protection for new technologies, products andprocesses. The patent positions of pharmaceutical, biopharmaceutical andbiotechnology companies, including us, are generally uncertain and involvecomplex legal and factual questions. Our patent applications may notprotect our technologies and products because, among other things:

 

• there isno guarantee that any of our pending patent applications will result in issuedpatents;

 

• we may developadditional proprietary technologies that are not patentable;

 

• there isno guarantee that any patents issued to us, our collaborators or our licensorswill provide a basis for a commercially viable product;

 

• there isno guarantee that any patents issued to us or our collaborators or ourlicensors will provide us with any competitive advantage;

 

• there isno guarantee that any patents issued to us or our collaborators or ourlicensors will not be challenged, circumvented or invalidated by third parties;and

 

• there isno guarantee that any patents previously issued to others or issued in thefuture will not have an adverse effect on our ability to do business.

 

We attempt to protect our intellectual property position by filingUnited States patent applications related to our proprietary technology,inventions and improvements that are important to the development of ourbusiness. Currently we own U.S. Patent No. 6,911,204 concerning thetreatment of NHL with our technology together with four pending United Statespatent applications covering methods of treating immune system diseases,including B-cell and T-cell lymphomas, using our proprietary immunotherapy productionmethods, as well as methods for combining the idiotype immunotherapies withother therapies that are used to treat diseases of the immune system.

 

We also have four issued patents, two applications for which we havereceived notices indicating that patents will issue, and twenty-four patentapplications pending outside of the United States. Limitations on patentprotection in some countries outside the United States, and the differences inwhat constitutes patentable subject matter in these countries, may limitthe protection we have under patents issued to us outside of the United States.In addition, laws of foreign countries may not protect our intellectualproperty to the same extent as would laws of the United States. In determiningwhether or not to seek a patent or to license any patent in a particularforeign country, we weigh the relevant costs and benefits, and consider, amongother things, the market potential of our product candidates in thejurisdiction, and the scope and enforceability of patent protection afforded bythe law of the jurisdiction. Failure to obtain adequate patent protection forour proprietary product candidates and technology would impair our ability tobe commercially competitive in these markets.

 

Although we believe our issued patents, as well as our patentapplications if they issue as patents, will provide a competitive advantage, wemay not be able to develop additional patentable products or processes. Further,we may not be able to obtain patents from any of the pending applications.Even if patent claims are allowed, the claims may not issue, or in theevent of issuance, may not be sufficient to protect our technology. Inaddition, any patents or patent rights we obtain may be circumvented,challenged or invalidated by our competitors.

 

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**We are not able to prevent others, includingpotential competitors, from using certain types of patient-specific idiotypeprotein-KLH conjugates, like those we use in our lead product candidate, FavId,for the treatment of indolent B-cell NHL.**

 

Certain types of patient-specific idiotype-KLH conjugates, comprisingsingle idiotype proteins, and their use for the treatment of indolent B-cellNHL are in the public domain and therefore cannot be patented. Consequently, wemay only be able to seek patent protection for methods of treating immunesystem diseases, including B-cell and T-cell lymphomas, using our proprietaryimmunotherapy production methods for making idiotype protein conjugates andcompositions comprising such conjugates, as well as methods for combining theidiotype or T-cell receptor-based immunotherapies with other therapies that areused to treat diseases of the immune system. As a result, we may not beable to prevent other companies using different manufacturing processes fromdeveloping active immunotherapies that directly compete with FavId.

 

**We may have to engage in costlylitigation to enforce our proprietary rights or to defend challenges to ourintellectual property by our competitors, which may harm our business,results of operations, financial condition and cash flow.**

 

The pharmaceutical field is characterized by a large number of patentfilings involving complex legal and factual questions, and, therefore, we cannotpredict with certainty whether our patents will be enforceable. Competitors may havefiled applications for or have been issued patents and may obtainadditional patents and proprietary rights related to products or processes thatcompete with or are similar to ours. We may not be aware of all of thepatents potentially adverse to our interests that may have been issued toothers. Litigation may be necessary to protect our patent position, and wecannot be certain that we will have the required resources to pursue litigationor otherwise to protect our patent rights. In addition, our efforts to protectour patents may not be successful.

 

**Our ability to market our products may beimpaired by the intellectual property rights of third parties.**

 

Our commercial success will depend in part on not infringing thepatents or proprietary rights of third parties. We are aware of competingintellectual property relating to active idiotype immunotherapies for cancer.Competitors or third parties may be issued, or may currently hold,patents that may cover subject matter that we use in developing thetechnology required to bring our product candidates to market, that we use inproducing our product candidates, or that we use in treating patients with ourproduct candidates. In addition, from time to time we receive correspondenceinviting us to license patents from third parties. While we currently believewe have freedom to operate in our area, others may challenge our positionin the future. There has been, and we believe that there will continue to be,significant litigation in the pharmaceutical industry regarding patent andother intellectual property rights.

 

While we believe that our pre-commercialization activities fall withinthe scope of an available exemption against patent infringement provided by35 U.S.C. §271(e), and that our subsequent manufacture of our commercialproducts will also not require the license of any patents, claims may bebrought against us in the future based on these or other patents held by others.As our product candidates progress toward commercialization, competitors orother parties may assert that we infringe on their patents or proprietaryrights.

 

In particular, we are aware of the following third party patents:

 

•              Genentechand City of Hope National Medical Center hold patent rights related to theexpression of recombinant antibodies;

 

•              Genitopeholds patent rights relating to immunotherapy using idiotype proteins producedusing T-lymphoid cells for the treatment of B-Cell lymphoma; and

 

•              ScheringCorp. holds patent rights relating to the use of GM-CSF as a vaccine adjuvantfor use against infectious diseases.

 

The first patent listed above was issued to Genentech in 2001. We donot believe that this patent covers our technology, and we note that in May 2005,a third party filed a request for reexamination of this patent with the U.S.Patent and Trademark Office, requesting that the claims of this patent bereexamined as to their patentability. If this patent reissues and we decide to attemptto obtain a license for this patent, we cannot guarantee that we would be ableto obtain such a license on commercially reasonable terms, or at all.

 

Additionally, because patent prosecution can proceed in secret prior toissuance of a patent, third parties may obtain other patents with claimsof unknown scope relating to our product candidates, which they could attemptto assert against us. Further, as we develop our products, we may infringethe current patents of third parties or patents that may issue in thefuture. Third parties could bring legal actions against us claiming damages andseeking to enjoin clinical testing,

 

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manufacturing and marketing of the affected product or products. If webecome involved in any litigation, it could consume a substantial portion ofour resources, regardless of the outcome of the litigation. If any of theseactions are successful, in addition to any potential liability for damages, wecould be required to obtain a license to continue to manufacture or market theaffected product, in which case we may be required to pay substantialroyalties or grant cross-licenses to our patents. However, there can be noassurance that any such license will be available on acceptable terms or atall. To enforce patents issued to us or to determine the scope and validity ofother parties’ proprietary rights, we may also become involved inlitigation or in interference proceedings declared by the United States Patentand Trademark Office, which could result in substantial costs to us, regardlessof the outcome of the litigation, or an adverse decision as to the priority ofour inventions. Ultimately, as a result of patent infringement claims, ourbusiness could be harmed and we could be prevented from commercializing aproduct, or forced to cease some aspect of our business operations.

 

**If we are not able to protect and controlunpatented trade secrets, know-how and other technological innovation, we may suffercompetitive harm.**

 

We also rely on trade secrets to protect our technology, particularlywhen we do not believe that patent protection is appropriate or available.However, trade secrets are difficult to protect. We attempt to protect ourtrade secrets by requiring each of our employees, consultants and advisors toexecute a non-disclosure and assignment of invention agreement before beginninghis or her employment, consulting or advisory relationship with us. We cannotguarantee that these agreements will provide meaningful protection, that theseagreements will not be breached, that we will have an adequate remedy for anysuch breach, or that our trade secrets will not otherwise become known orindependently developed by a third party. Our trade secrets, or those of ourfuture collaborators, may become known or may be independentlydiscovered by others, which could adversely affect the competitive position ofour product candidates.

 

**RisksRelated to the Securities Markets and Ownership of Our Common Stock**

 

***Until our initial public offering in February 2005,there was no public market for our common stock, and the price of our commonstock may be volatile and could decline significantly.**

 

Until our initial public offering, or IPO, in February 2005, therewas no public market for our common stock, and despite our IPO, an activepublic market for these shares may not develop or be sustained. Our stockprice has traded in the range of $7.77 - $3.20 from the commencement of our IPOon February 2, 2005 to August 8, 2006.

 

The stock market in general has been experiencing dramatic fluctuationsthat have often been unrelated to the operating performance of companies. Themarket prices for securities of biotechnology companies in general have beenhighly volatile and may continue to be highly volatile in the future. Ifmarket-based or industry-based volatility continues, the trading price of ourcommon stock could decline significantly, independent of our actual operatingperformance, and you could lose all or part of your investment. The marketprice of our common stock could fluctuate significantly as a result of severalfactors, including:

 

•announcements of technological innovations or new products by us or ourcompetitors;

 

•announcement of FDA approval or non-approval of FavId or any other productcandidates that we may develop, or delays in the FDA review process;

 

• actionstaken by regulatory agencies with respect to FavId and FAV-201, or any otherproduct candidates that we may develop, or our clinical trials,manufacturing process or sales and marketing activities;

 

•regulatory developments in the United States and foreign countries;

 

• successof our research efforts and clinical trials;

 

• anyintellectual property infringement lawsuit in which we may becomeinvolved;

 

• announcementsconcerning our competitors, or the biotechnology or biopharmaceuticalindustries in general;

 

• actual oranticipated fluctuations in our operating results;

 

• changesin financial estimates or recommendations by securities analysts;

 

• sales oflarge blocks of our common stock;

 

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• sales ofour common stock by our executive officers, directors and significantstockholders;

 

• changesin accounting principles; and

 

• loss ofany of our key scientific or management personnel.

 

Specifically, you may not be able to resell your shares at orabove the price you paid for such shares. In addition, class actionlitigation has often been instituted against companies whose securities haveexperienced periods of volatility in market price. Any such litigation broughtagainst us could result in substantial costs and a diversion of management’sattention and resources, which could hurt our business, operating results andfinancial condition.

 

***Concentration of ownership among ourexisting officers, directors and principal stockholders may prevent otherstockholders from influencing significant corporate decisions and depress ourstock price.**

 

As of June 30, 2006, our officers and directors, stockholdersaffiliated with our directors and those stockholders owning at least tenpercent of our outstanding capital stock together beneficially heldapproximately 60.7% of our outstanding common stock on an as-converted basis.If some or all of these officers, directors and principal stockholders acttogether, they will be able to exert a significant degree of influence over ourmanagement and affairs and over matters requiring stockholder approval,including the election of directors, the merger, consolidation or sale of allor substantially all of our assets, and any other significant corporatetransaction. The interests of this concentration of ownership may notalways coincide with our interests or the interests of our other stockholders.For instance, officers, directors and principal stockholders, acting together,could cause us to enter into transactions or agreements that we would nototherwise consider. Similarly, this concentration of ownership may havethe effect of delaying or preventing a change in control of us otherwisefavored by our other stockholders. This concentration of ownership also coulddepress our stock price.

 

**Provisions in our amended and restatedcertificate of incorporation and amended and restated bylaws and applicableDelaware law may prevent or discourage third parties or our stockholdersfrom attempting to replace our management or influencing significant decisions.**

 

Provisions in our amended and restated certificate of incorporation andamended and restated bylaws may have the effect of delaying or preventinga change in control of us or our management, even if doing so would bebeneficial to our stockholders. These provisions include:

 

• dividingour board of directors into three classes serving staggered three-year terms;

 

•authorizing our board of directors to issue preferred stock without stockholderapproval;

 

•prohibiting cumulative voting in the election of directors;

 

•prohibiting stockholder actions by written consent;

 

• limitingthe persons who may call special meetings of stockholders;

 

•prohibiting our stockholders from making certain changes to our certificate ofincorporation or bylaws except with 66.7% stockholder approval; and

 

• requiringadvance notice for raising business matters or nominating directors atstockholders’ meetings.

 

We are also subject to provisions of the Delaware corporation law that,in general, prohibit any business combination with a beneficial owner of 15% ormore of our common stock for five years unless the holder’s acquisition of ourstock was approved in advance by our board of directors. Together, thesecharter and statutory provisions could make the removal of management moredifficult and may discourage transactions that otherwise could involvepayment of a premium over prevailing market prices for our common stock.

 

**Because we do not intend to pay any cashdividends on our shares of common stock, our stockholders will not be able toreceive a return on their shares unless they sell them.**

 

We have never paid or declared any cash dividends on our capital stockand intend to retain any future earnings to finance the development andexpansion of our business. The payment of dividends by us on our common stockis limited by our debt

 

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agreements. We do not anticipate paying any cash dividends on ourcommon stock in the foreseeable future. Unless we pay dividends, ourstockholders will not be able to receive a return on their shares unless theysell them.

 

**We may incur increased costs as a resultof recently enacted and proposed changes in laws and regulations.**

 

Recently enacted and proposed changes in the laws and regulationsaffecting public companies, including the provisions of the Sarbanes-Oxley Actof 2002 and rules related to corporate governance and other matterssubsequently adopted by the SEC and the Nasdaq Stock Market, could result inincreased costs to us. The new rules and any related regulations that may beproposed in the future could make it more difficult or more costly for us toobtain certain types of insurance, including directors’ and officers’ liabilityinsurance, and we may be forced to accept reduced policy limits andcoverage or incur substantially higher costs to obtain the same or similarcoverage. The impact of these events could also make it more difficult for usto attract and retain qualified persons to serve on our board of directors, ourboard committees or as executive officers. We are presently evaluating andmonitoring developments with respect to new and proposed rules and cannotpredict or estimate the amount of the additional costs we may incur or thetiming of such costs.

 

**Item 2.Unregistered Sales of Equity Securities and Use of Proceeds**

 

Ourinitial public offering of our common stock, par value $0.001, was effected througha Registration Statement on Form S-1 (File No. 333-114299) thatwas declared effective by the Securities and Exchange Commission on February 2,2005. Our initial public offering commenced on February 2, 2005. On February 7,2005, 6 million shares of our common stock were sold for an aggregate offeringprice of $42.0 million. On March 7, 2005, 285,000 shares of our commonstock were sold for an aggregate offering price of $2.0 million upon thepartial exercise of the underwriters’ over-allotment option. Our initial publicoffering resulted in aggregate proceeds to us of approximately $39.5 million,net of underwriting discounts and commissions of approximately $3.1 million andoffering expenses of approximately $1.4 million, through a syndicate of underwritersmanaged by Bear, Stearns & Co. Inc., CIBC World Markets Corp., Needham &Company, Inc. and A.G. Edwards & Sons, Inc.

 

Nooffering expenses were paid directly or indirectly to any of our directors orofficers (or their associates) or person owning ten percent or more of any class ofour equity securities or to any other affiliates. All offering expenses werepaid directly to others.

 

Wehad invested $40.9 million in proceeds from the offering, net of underwritingdiscounts and commissions but before expenses, in government agency securities,corporate bonds and notes and money market funds. Through June 30, 2006,we used approximately $31.2 million of the proceeds from our initial publicoffering to develop and prepare for filing a biologic license application,or BLA, for regulatory approval of FavId, for development of our other productcandidates, for marketing, general and administrative expenses, and for workingcapital, including debt repayments.

 

The foregoing payments were direct payments made to third parties whowere not our directors or officers (or their associates), persons owning tenpercent or more of any class of our equity securities or any otheraffiliate, except that the proceeds used for salaries expense included regularcompensation for our officers and directors. The use of proceeds does notrepresent a material change from the use of proceeds described in theprospectus we filed pursuant to Rule 424(b)(4) of the Securities Actof 1933, as amended, with the Securities and Exchange Commission on February 3,2005.

 

**Item 4.****Submission of Mattersto a Vote of Security Holders.**

 

At our 2006 annual meetingof stockholders held on June 14, 2006, the stockholders were asked to voteon three items as follows:

 

1.     The election of two Class I directors to hold office for athree-year term, through the 2009 annual meeting of stockholders. The nomineesfor election were Arda Minocherhomjee, Ph.D. and Ivor Royston, M.D. No othernominations were received in accordance with the Company’s Bylaws.

 

2.     The amendment of the Company’s 2005 Non-Employee Directors’ StockOption Plan to increase the automatic annual grant to each non-employeedirector of options to purchase common stock from 8,000 shares to 12,500shares, and to provide for the additional automatic annual grant of options forthe Chair of the Board and the Chairs of Board Committees.

 

3.     The ratification of the selection of Ernst & Young LLP toserve as the independent registered public accounting firm of the Company forthe fiscal year ending December 31, 2006.

 

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The results of the matterspresented at the annual meeting, based on the presence in person or by proxy ofholders of 18,659,827 shares of the 28,920,426 shares of our common stock ofrecord entitled to vote, were as follows:

 

1. The election of ArdaMinocherhomjee, Ph.D. and Ivor Royston, M.D. as directors of the Company untilthe 2009 annual meeting of stockholders and until their successors are elected wasapproved as follows:

 
| ** **                 | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|----------------------------|------------|------------|------------|--------------|------------|
| Arda Minocherhomjee, Ph.D. |       | 18,603,670 |       | 56,157       |       |
|                       |       |       |       |         |       |
| Ivor Royston, M.D.         |       | 18,019,405 |       | 640,422      |       |

 

The following individualsare continuing directors with terms expiring upon the 2007 annual meeting ofstockholders: Michael L. Eagle, Cam L. Garner and Peter Barton Hutt. Thefollowing individuals are continuing directors with terms expiring upon the 2008annual meeting of stockholders: Antonio J. Grillo-Lopez, M.D., John P.Longenecker, Ph.D., Fred Middleton and Wayne I. Roe.

 

2. The amendment of theCompany’s 2005 Non-Employee Directors’ Stock Option Plan to increase theautomatic annual grant to each non-employee director of options to purchasecommon stock from 8,000 shares to 12,500 shares, and to provide for theadditional automatic annual grant of options for the Chair of the Board andChairs of Board Committees was approved as follows:

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 15,444,229 |       | 647,962     |       | 170,624     |       |

 

3. The ratification of Ernst &Young LLP as the independent registered public accounting firm of the Companyfor its fiscal year ending December 31, 2006 was approved as follows: 

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 18,621,157 |       | 16,518      |       | 22,152      |       |

 

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**Item 6. Exhibits.**

 

Theexhibits listed on the accompanying index to exhibits are filed or incorporatedby reference (as stated therein) as part of this Quarterly Report on Form 10-Q.

 
| **Exhibit  Number** | ** ** | **Description of Document**                                                                                                                                                                                |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                                                 |
| 3.1                 |       | Registrant’s Amended and Restated  Certificate of Incorporation.(1)                                                                                                                                   |
|                |       |                                                                                                                                                                                                       |
| 3.2                 |       | Registrant’s Amended and Restated  Bylaws.(1)                                                                                                                                                         |
|                |       |                                                                                                                                                                                                       |
| 4.1                 |       | Form of Common Stock Certificate of  Registrant.(1)                                                                                                                                                   |
|                |       |                                                                                                                                                                                                       |
| 4.2                 |       | Amended and Restated Investor Rights  Agreement dated March 26, 2004 between the Registrant and certain of its  stockholders.(1)                                                                      |
|                |       |                                                                                                                                                                                                       |
| 4.3                 |       | Amendment No. 1 to Amended and  Restated Investor Rights Agreement dated April 6, 2004 between the  Registrant and certain of its stockholders.(1)                                               |
|                |       |                                                                                                                                                                                                       |
| 4.4                 |       | Securities Purchase Agreement dated March 6,  2006, by and among Favrille and the individuals and entities identified on Exhibit A  thereto (the “Securities Purchase Agreement”). (2) |
|                |       |                                                                                                                                                                                                       |
| 4.5                 |       | Form of Warrant issued pursuant to the  Securities Purchase Agreement. (2)                                                                                                                            |
|                |       |                                                                                                                                                                                                       |
| 31.1                |       | Certification of Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                  |
|                |       |                                                                                                                                                                                                       |
| 31.2                |       | Certification of Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                  |
|                |       |                                                                                                                                                                                                       |
| 32.1                |       | Certification of Chief Executive Officer,  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                 |
|                |       |                                                                                                                                                                                                       |
| 32.2                |       | Certification of Chief Financial Officer,  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                 |

 

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(1)   Previouslyfiled as an Exhibit to Favrille, Inc.’s Registration Statement on Form S-1(File No. 333-114299), as amended, and incorporated by reference herein.

(2)   Previouslyfiled as an exhibit to Favrille’s Current Report on Form 8-K dated March 6,2006 and incorporated herein by reference.

 

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**Favrille, Inc.**

 

**SIGNATURES**

 

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

 
| Dated: August 14, 2006 |                                                                                                    |
|-----------------------------|---------------------------------------------------------------------------------------------------------|
|                        |                                                                                                    |
|                        | Favrille, Inc.                                                                                     |
|                        |                                                                                                    |
|                        |                                                                                                    |
|                        | /s/ Tamara A. Seymour                                                                                   |   |
|                        |                                                                                                    |
|                        | Tamara A. Seymour                                                                                       |
|                        |                                                                                                    |
|                        | Chief Financial Officer                                                                                 |
|                        |                                                                                                    |
|                        | (On behalf of the registrant and as the  registrant’s  Principal Financial and Accounting Officer) |

 

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