**UNITED STATESSECURITIES 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) OFTHE SECURITIES EXCHANGE ACT OF 1934**

**For the quarterly period endedSeptember 30, 2006**

**OR**

**o********TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the transition periodfrom              to              **

**CommissionFile Number 000-51134**

**Favrille, Inc.**

(Exact name of registrant asspecified in its charter)

| **Delaware**                                                    |   | **33-0892797**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **10445  Pacific Center Court, San Diego, CA**                  |   | **92121**                             |
| (Address of  principal executive offices)                       |   | (Zip Code)                            |

 

**(858) 526-8000**

(Registrant’s telephonenumber, including area code)

**N/A**

(Former name, former addressand former fiscal year if changed since last report)

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15 (d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90days.   YES  x    NO o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition ofaccelerated filer and large accelerated filer in Rule 12b-2 of the ExchangeAct (Check one):
| Large Accelerated Filer o | Accelerated Filer o | Non-Accelerated Filer x |
|---------------------------|---------------------|-------------------------|

 

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

Thenumber of shares of the Registrant’s common stock outstanding asof November 10, 2006 was 29,058,006.

 

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**FAVRILLE,INC.**

**QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 2006TABLE OF CONTENTS**
| **PART I.**  | ** ** | **FINANCIAL INFORMATION**                                                                                                                                                                       |
|-------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Item 1.           |       | Financial  Statements                                                                                                                                                                           |
|              |       | Balance Sheets as of  September 30, 2006 (Unaudited) and December 31, 2005                                                                                                                 |
|              |       | Statements of Operations (Unaudited)  for the three and nine months ended September 30, 2006 and 2005 and the  period from January 21, 2000 (inception) to September 30, 2006  (Unaudited) |
|              |       | Statements of Cash Flows (Unaudited) for  the nine months ended September 30, 2006 and 2005 and the period from  January 21, 2000 (inception) to September 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 6.           |       | Exhibits                                                                                                                                                                                        |
|              |       |                                                                                                                                                                                            |
| SIGNATURES        |

 

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**PART I— FINANCIAL INFORMATION**

**Item 1. Financial Statements.**

**FAVRILLE, INC.(a development stage company)BALANCE SHEETS(in thousands, except share and per share data)**
| ** **                                                                                                                                                                                           | ** ** | **September 30,  2006**            | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                           | ** ** | **  (unaudited)  ** | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                           |       |                                    |       |                        |       |
| Current assets:                                                                                                                                                                                      |       |                                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                           |       | $                                       | 19,856     |                        | $          | 12,065 |   |
| Short-term  investments                                                                                                                                                                              |       | 31,542                                  |       | 22,427                      |       |
| Receivables                                                                                                                                                                                          |       | 806                                     |       | 372                         |       |
| Prepaid expenses  and other current assets                                                                                                                                                           |       | 655                                     |       | 563                         |       |
| Total current assets                                                                                                                                                                                 |       | 52,859                                  |       | 35,427                      |       |
| Property and equipment,  net                                                                                                                                                                         |       | 16,329                                  |       | 9,430                       |       |
| Restricted cash                                                                                                                                                                                      |       | 3,451                                   |       | 1,550                       |       |
| Other assets                                                                                                                                                                                         |       | 596                                     |       | 600                         |       |
| Total assets                                                                                                                                                                                         |       | $                                       | 73,235     |                        | $          | 47,007 |   |
| **Liabilities and stockholders’  equity**                                                                                                                                                       |       |                                    |       |                        |       |
| Current liabilities:                                                                                                                                                                                 |       |                                    |       |                        |       |
| Accounts payable  and accrued liabilities                                                                                                                                                            |       | $                                       | 5,804      |                        | $          | 3,888 |   |
| Current portion  of debt                                                                                                                                                                             |       | 4,160                                   |       | 2,553                       |       |
| Total current  liabilities                                                                                                                                                                           |       | 9,964                                   |       | 6,441                       |       |
| Debt, less current  portion                                                                                                                                                                          |       | 4,795                                   |       | 3,532                       |       |
| Deferred rent                                                                                                                                                                                        |       | 4,633                                   |       | 1,320                       |       |
| Commitments and  contingencies                                                                                                                                                                       |       |                                    |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                           |       |                                    |       |                        |       |
| Preferred stock,  $0.001 par value 5,000,000 shares authorized at September 30, 2006 and  December 31, 2005; no shares issued and outstanding at September 30,  2006 and December 31, 2005 |       | —                                  |       | —                      |       |
| Common stock,  $0.001 par value:                                                                                                                                                                     |       |                                    |       |                        |       |
| Authorized  shares, 75,000,000 at September 30, 2006 and December 31, 2005;                                                                                                                     |       |                                    |       |                        |       |
| Issued and  outstanding shares— 29,058,260 and 20,329,046 at September 30, 2006 and  December 31, 2005, respectively                                                                       |       | 29                                      |       | 20                          |       |
| Additional  paid-in capital                                                                                                                                                                          |       | 199,466                                 |       | 156,882                     |       |
| Deferred  stock-based compensation                                                                                                                                                                   |       | —                                  |       | (5,655                      | )          |
| Note receivable  from stockholder                                                                                                                                                                    |       | —                                  |       | (96                         | )          |
| Accumulated  other comprehensive loss                                                                                                                                                                |       | (4                                      | )          | (54                         | )          |
| Deficit  accumulated during the development stage                                                                                                                                                    |       | (145,648                                | )          | (115,383                    | )          |
| Total stockholders’  equity                                                                                                                                                                     |       | 53,843                                  |       | 35,714                      |       |
| Total liabilities and stockholders’ equity                                                                                                                                                      |       | $                                       | 73,235     |                        | $          | 47,007 |   |

 

See accompanying notes.

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

**STATEMENTS OF OPERATIONS(in thousands, except share and per share data)Unaudited**
| ** **                                                                                               | ** ** | **Three Months ended  September 30,** | ** ** | **Nine Months ended  September 30,** | ** ** | **Period from  January 21, 2000  (inception) to  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006**                                                                                  | ** ** | **2005** | ** ** | **2006** | ** ** |
| Operating expenses:                                                                                      |       |                                                 |       |                                                |       |                                                                                      |       |   |   |   |   |
| Research and  development                                                                                |       | $                                                    | 7,487      |                                                | $          | 7,353                                                                                     |       | $ | 23,370 |   | $ | 22,090 |   | $ | 92,226 |   |
| Marketing, general  and administrative                                                                   |       | 2,605                                                |       | 1,534                                               |       | 8,226                                                                                     |       | 4,879 |   | 26,718 |   |
| Total operating  expenses                                                                                |       | 10,092                                               |       | 8,887                                               |       | 31,596                                                                                    |       | 26,969 |   | 118,944 |   |
| Interest income                                                                                          |       | 773                                                  |       | 524                                                 |       | 2,004                                                                                     |       | 1,229 |   | 4,413 |   |
| Interest expense                                                                                         |       | (266                                                 | )          | (166                                                | )          | (644                                                                                      | )          | (555 | ) | (2,652 | ) |
| Other income (expense)                                                                                   |       | —                                               |       | 5                                                   |       | (29                                                                                       | )          | (7 | ) | (305 | ) |
| Total other income, net                                                                                  |       | 507                                                  |       | 363                                                 |       | 1,331                                                                                     |       | 667 |   | 1,456 |   |
| Net loss                                                                                                 |       | (9,585                                               | )          | (8,524                                              | )          | (30,265                                                                                   | )          | (26,302 | ) | (117,488 | ) |
| 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                                                              |       | $                                                    | (9,585     | )                                                   | $          | (8,524                                                                                    | )          | $ | (30,265 | ) | $ | (26,308 | ) | $ | (145,648 | ) |
| Historical net loss per  share:                                                                          |       |                                                 |       |                                                |       |                                                                                      |       |   |   |   |   |
| Basic and diluted                                                                                        |       | $                                                    | (0.33      | )                                                   | $          | (0.43                                                                                     | )          | $ | (1.13 | ) | $ | (1.51 | ) |   |   |
| Weighted-average shares-basic and diluted                                                                |       | 28,805,214                                           |       | 19,913,038                                          |       | 26,679,507                                                                                |       | 17,409,227 |   |   |   |

 

See accompanying notes.

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

**STATEMENTS OF CASH FLOWS(in thousands)Unaudited**
| ** **                                                                              | ** ** | ** **                      | ** ** | ** **              | ** ** | **Period from** | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------|------------|----------------------|------------|
| ** **                                                                              | ** ** | ** **                      | ** ** | ** **              | ** ** | **January 21,** | ** ** |
| ** **                                                                              | ** ** | ** **                      | ** ** | ** **              | ** ** | **2000**             | ** ** |
| ** **                                                                              | ** ** | **Nine Months ended** | ** ** | **(inception) to** | ** ** |
| ** **                                                                              | ** ** | **September 30,**          | ** ** | **September 30,**  | ** ** |
| ** **                                                                              | ** ** | **2006**                        | ** ** | **2005**                | ** ** | **2006**             | ** ** |
| **Operating activities**                                                                |       |                            |       |                    |       |                 |       |
| Net loss                                                                                |       | $                               | (30,265    | )                       | $          | (26,302              | )          | $ | (117,488 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:            |       |                            |       |                    |       |                 |       |
| Depreciation and  amortization                                                          |       | 1,534                           |       | 1,341                   |       | 5,892                |       |
| Stock-based  compensation                                                               |       | 2,898                           |       | 2,159                   |       | 8,348                |       |
| Amortization of  premium/discount on short-term investments                             |       | (428                            | )          | (3                      | )          | (423                 | )          |
| Other                                                                                   |       | 294                             |       | (303                    | )          | 71                   |       |
| Changes in  operating assets and liabilities:                                           |       |                            |       |                    |       |                 |       |
| Receivables                                                                             |       | (547                            | )          | 1                       |       | (605                 | )          |
| Prepaid expenses  and other assets                                                      |       | (88                             | )          | 229                     |       | (953                 | )          |
| Accounts payable  and accrued liabilities                                               |       | 1,915                           |       | 877                     |       | 5,803                |       |
| Deferred rent                                                                           |       | 3,313                           |       | 404                     |       | 4,633                |       |
| Net cash used in  operating activities                                                  |       | (21,374                         | )          | (21,597                 | )          | (94,722              | )          |
| **Investing activities**                                                                |       |                            |       |                    |       |                 |       |
| Purchases of property  and equipment                                                    |       | (8,461                          | )          | (806                    | )          | (22,219              | )          |
| Purchases of short-term  investments                                                    |       | (48,735                         | )          | (23,206                 | )          | (83,223              | )          |
| Maturities of  short-term investments                                                   |       | 40,098                          |       | —                  |       | 52,101               |       |
| Other assets                                                                            |       | —                          |       | —                  |       | (70                  | )          |
| Restricted cash                                                                         |       | (1,901                          | )          | 56                      |       | (3,451               | )          |
| Net cash used in  investing activities                                                  |       | (18,999                         | )          | (23,956                 | )          | (56,862              | )          |
| **Financing activities**                                                                |       |                            |       |                    |       |                 |       |
| Proceeds from debt                                                                      |       | 4,822                           |       | 1,427                   |       | 20,229               |       |
| Payments on debt                                                                        |       | (2,103                          | )          | (1,990                  | )          | (11,186              | )          |
| Issuance of preferred  stock, net                                                       |       | —                          |       | —                  |       | 76,144               |       |
| Proceeds from issuance  of convertible promissory note                                  |       | —                          |       | —                  |       | 650                  |       |
| Issuance of common  stock and warrants                                                  |       | 45,449                          |       | 39,550                  |       | 85,644               |       |
| Repurchase of  restricted common stock                                                  |       | (4                              | )          | (7                      | )          | (41                  | )          |
| Net cash provided by  financing activities                                              |       | 48,164                          |       | 38,980                  |       | 171,440              |       |
| Net (decrease) increase  in cash and cash equivalents                                   |       | 7,791                           |       | (6,573                  | )          | 19,856               |       |
| Cash and cash  equivalents at beginning of period                                       |       | 12,065                          |       | 25,065                  |       | —               |       |
| Cash and cash  equivalents at end of period                                             |       | $                               | 19,856     |                    | $          | 18,492               |       | $ | 19,856 |   |
|                                                                                    |       |                            |       |                    |       |                 |       |
| **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.

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**FAVRILLE,INC.NOTES TO CONDENSEDFINANCIAL STATEMENTSSEPTEMBER 30, 2006UNAUDITED**

**1. Basis of Presentation**

Theaccompanying unaudited interim financial statements have been prepared inaccordance with U.S. generally accepted accounting principles and with therules and regulations of the Securities and Exchange Commission related toa quarterly report on Form 10-Q. Accordingly, they do not include all ofthe information and disclosures required by U.S. generally accepted accountingprinciples for complete financial statements. The balance sheet atDecember 31, 2005 has been derived from the audited financial statementsat that date but does not include all information and footnotes required byU.S. generally accepted accounting principles for complete financialstatements. The interim financial statements reflect all adjustments which, inthe opinion of management, are necessary for a fair presentation of thefinancial condition and results of operations for the periods presented. Exceptas otherwise disclosed, all such adjustments are of a normal recurring nature.

Operatingresults for the three and nine months ended September 30, 2006 are notnecessarily indicative of the results that may be expected for the year endingDecember 31, 2006. These financialstatements should be read in conjunction with the financial statements includedin the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2005 and management’s discussion and analysis of financialcondition and results of operations included elsewhere herein.

Thepreparation of financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities as well as expensesduring the reporting period. Actual results could differ from thoseestimates.  On an ongoing basis, wereview our estimates based on information currently available, and changes infacts and circumstances may cause us to revise these estimates.

Certainreclassifications have been made to prior periods’ financial statements inorder to conform to the current period’s presentation.  The three and nine months ended September 30,2005 Statement of Operations includes stock-based compensation expense in theapplicable research and development and marketing, general and administrativeamounts in a manner consistent with the three and nine months ended September30, 2006 Statement of Operations presentation.

***Stock-Based Compensation***

***Adoption of SFAS 123(R)***

Favrille has its Amended and Restated 2001 EquityIncentive 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 January1, 2006, the Company adopted Statement of Financial Accounting Standards No.123 (revised 2004), “Share-Based Payment,” (SFAS 123(R)).  SFAS 123(R) requires the recognition of thefair value of stock-based compensation in net income.  The Company recognizes the stock-based compensationexpense over the requisite service period of the individual grantees on astraight-line basis over the vesting period, which is generally fouryears.  Prior to January 1, 2006, theCompany recorded compensation expense for stock options 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 the Company’s initial public offering (IPO), the Companyestablished the exercise price based on the fair value of the Company’s stockat the date of grant as determined by the Board of Directors (the Board).Therefore, the options had no intrinsic value upon grant and no expense wasrecorded upon issuance. With respect to certain options granted during 2005 and2004, the Company had recorded deferred compensation of $350,000 and$9.4 million, respectively, for the incremental difference at the grantdate between the fair value per share determined by the Board and the deemedfair value per share determined solely for financial reporting purposes.

TheCompany has elected the modified prospective transition method for adoptingSFAS 123(R).  Under this method, theprovisions of SFAS 123(R) apply to all awards granted or modified after thedate of adoption.  The deferredstock-based compensation balance of $5.7 million as of December 31, 2005, whichwas accounted for under APB 25, was reclassified as a reduction of additionalpaid-in capital upon the adoption of SFAS 123(R).  In addition, the unrecognized expense ofawards not yet vested at the date of adoption will be recognized in net incomeor loss in the periods after the date of adoption using

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thesame Black-Scholes valuation method and assumptions determined under theoriginal provisions of SFAS 123, “Accounting for Stock-Based Compensation,” asdisclosed in our previous quarterly and annual reports.  The cumulative effect of the change in accountingprinciple from APB 25 to SFAS 123(R) was not material, because the amortizationof expense related to options granted prior to the adoption was based on thesingle-option approach.

***Determining Fair Value***

The Company estimates thefair value of each stock-based award on the grant date using the Black-Scholesvaluation model.  To facilitate theadoption of SFAS 123(R), the Company applied provisions of Staff AccountingBulletin (SAB) 107 in developing its methodologies to estimate ourBlack-Scholes valuation model inputs. Option valuation models, including Black-Scholes, require the input ofhighly subjective assumptions, and changes in the assumptions used canmaterially affect the grant date fair value of an award.  Below is a summary of the methodologies theCompany utilized to estimate the assumptions:

*Valuation and Amortization Method –*The Company estimates the fair value of stock options granted using theBlack-Scholes option-pricing formula and a single-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 expected termof the Company’s stock-based awards represents the period that the Company’sstock-based awards are expected to be outstanding and is determined based onthe SAB 107 simplified method, since the Company does not have adequate historyof exercises of its stock-based awards since its IPO in February 2005.

*Expected Volatility-*The Companyestimates its volatility factor by using the historical average volatility,over a period equal to the expected term, of comparable companies since it doesnot have adequate stock price history of its own stock to determine volatility.

*Expected Dividend -*The Black-Scholesvaluation model calls for a single expected dividend yield as an input.  The dividend yield of zero is based on thefact that the Company has never paid cash dividends and has no presentintention to pay cash dividends in the future.

*Risk-Free Interest Rate –*The Company basesthe risk-free interest rate used in the Black-Scholes valuation model on theimplied yield currently available on the U.S. Treasury zero-coupon issues withan equivalent remaining term.  Where theexpected term of the Company’s stock-based awards does not correspond with theterms for which interest rates are quoted, the Company performs a straight-lineinterpolation to determine the rate from the available maturities.

*Estimated Forfeitures –*When estimatingforfeitures, the Company considers voluntary termination behavior as well as ananalysis of actual option forfeitures.  As stock-based compensationexpense recognized in the Statement of Operations for the three and nine monthsended September 30, 2006 is based on awards ultimately expected to vest, itshould be reduced for estimated forfeitures. SFAS 123(R) requires forfeituresto be estimated at the time of grant and revised, if necessary, in subsequentperiods if actual forfeitures differ from those estimates. Pre-vestingforfeitures were estimated based on historical experience. In the Company’s proforma information required under SFAS 123 for the periods prior to January 1,2006, the Company accounted for forfeitures as they occurred.

*Fair Value–*The fair value of the Company’s stock options granted to employees andnon-employee directors for the three and nine months ended September 30, 2006and 2005 and employee stock purchase plan offerings in the three and ninemonths ended September 30, 2006 and 2005 was estimated using the followingassumptions:
| ** **                                | ** ** | **Stock Option Plan**                          | ** ** | **Employee Stock Purchase Plan**          | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                | ** ** | **Three Months ended September 30,** | ** ** | **Three Months ended September 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 |       | 5.02                                                     | %          | 4.06                                                     | %          | 4.99 | % | 3.88 | % |
| Estimated  forfeitures                    |       | 4.0                                                      | %          | —                                                   |       | 4.0 | % | — |   |
| Weighted-average fair  value              |       | $                                                        | 2.82       |                                                     | $          | 2.61 |   | $ | 1.78 |   | $ | 2.09 |   |
|                                           |            |                                                          |            |                                                          |            |  |  |  |  |  |  |  |  |

 

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| ** **                                | ** ** | **Stock Option Plan**                         | ** ** | **Employee Stock Purchase Plan**         | ** ** |
|-------------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **Nine Months ended September 30,** | ** ** | **Nine Months ended September 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 |       | 4.77                                                    | %          | 4.25                                                    | %          | 4.85 | % | 3.45 | % |
| Estimated  forfeitures                    |       | 4.0                                                     | %          | —                                                  |       | 4.0 | % | — |   |
| Weighted-average fair  value              |       | $                                                       | 4.05       |                                                    | $          | 3.20 |   | $ | 2.40 |   | $ | 2.64 |   |
|                                           |            |                                                         |            |                                                         |            |  |  |  |  |  |  |  |  |

 

***Stock-Based Compensation Expense***

Under provisions of SFAS 123(R), the Company recordedapproximately $1.0 million and $2.9 million of stock-based compensation expensein our Statement of Operations for the three and nine months ended September30, 2006, respectively.  The Companyutilized the Black-Scholes valuation model for estimating the fair value of thestock-based compensation granted both before and after the adoption of SFAS123(R).  Prior to the adoption of SFAS123(R), the Company recorded approximately $700,000 and $2.2 million ofstock-based compensation for certain options granted during 2004 and 2005 inour Statement of Operations for the three and nine months ended September 30,2005, respectively, under the provisions of APB 25 based upon their intrinsicvalue.  Total stock-based compensationexpense recognized for the three and nine months ended September 30, 2006 and2005 was as follows (in thousands, except per share data):
| ** **                                              | ** ** | **Three Months  ended  September 30,** | ** ** | **Three Months  ended  September 30,** | ** ** | **Nine Months  ended  September 30,** | ** ** | **Nine Months  ended  September 30,** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                              | ** ** | **2006**                                         | ** ** | **2005**                                         | ** ** | **2006**                                        | ** ** | **2005**                                        | ** ** |
| Research and  development                               |       | $                                                | 458        |                                             | $          | 347                                             |       | $                                               | 1,376      |   | $ | 1,063 |   |
| General and  administrative                             |       | 577                                              |       | 358                                              |       | 1,522                                           |       | 1,096                                           |       |
| Stock-based  compensation expense                       |       | $                                                | 1,035      |                                             | $          | 705                                             |       | $                                               | 2,898      |   | $ | 2,159 |   |
|                                                    |       |                                             |       |                                             |       |                                            |       |                                            |       |
| Net stock-based  compensation expense, per common share |       |                                             |       |                                             |       |                                            |       |                                            |       |
| Basic and  diluted                                      |       | $                                                | 0.04       |                                             | $          | 0.04                                            |       | $                                               | 0.11       |   | $ | 0.12 |   |

 

At September 30,2006, the total compensation cost related to unvested stock-based awardsgranted to employees under the Company’s stock award plans but not yetrecognized was approximately $7.3 million, net of estimated forfeitures ofapproximately $440,000.  This cost willbe amortized on a straight-line basis over a weighted-average period ofapproximately 2.6 years and will be adjusted for subsequent changes inestimated forfeitures.

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***Pro-formaDisclosures***

SFAS123(R) requires the Company to present pro forma information for thecomparative period prior to adoption as if it had accounted for all our stockoptions under the fair value method of the original SFAS 123.  The following table illustrates the effect onnet income and earnings per share if we had applied the fair value recognitionprovisions of SFAS 123 to stock-based employee compensation to the same periodin the prior year (in thousands, except per share data):
|                                                                                                       | ** ** | **Three Months  ended  September 30,** | ** ** | **Nine Months  ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2005**                                         | ** ** | **2005**                                        | ** ** |
| Net loss  applicable to common stockholders as reported                                               |       | $                                                | (8,524     | )                                               | $          | (26,308 | ) |
| Add: Stock-based  employee compensation expense included in net loss                                  |       | 705                                              |       | 2,159                                           |       |
| Deduct: Stock-based  employee compensation expense determined under fair value method for all  awards |       | (816                                             | )          | (2,320                                          | )          |
| Pro forma net  loss applicable to common stockholder                                                  |       | $                                                | (8,635     | )                                               | $          | (26,469 | ) |
| Net loss per  share:                                                                                  |       |                                             |       |                                            |       |
| As reported—Basic and Diluted                                                                    |       | $                                                | (0.43      | )                                               | $          | (1.51 | ) |
| Pro forma—Basic  and Diluted                                                                     |       | $                                                | (0.43      | )                                               | $          | (1.52 | ) |

 

As a result of adopting SFAS 123(R), the Company’snet loss for the three and nine months ended September 30, 2006 isapproximately $360,000 and $830,000 larger, respectively, than if the Companyhad continued to account for stock-based compensation under APB 25.  Basic and diluted net loss per share are$0.01 and $0.03 higher, respectively, than if the Company had continued to account for stock-based compensationunder APB 25.

***Stock Option Activity***

The Company issues new shares of common stock uponexercise of stock options.  The followingis a summary of option activity for the Equity Incentive Plan and the Directors’Plan:

|                                                    | ** ** | **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                                            |       | 896                     |       | $                                                        | 6.50       |                                                 |       |                                |       |   |
| Exercised                                          |       | (88                     | )          | $                                                        | 0.63       |                                                 |       |                                |       |   |
| Forfeited                                          |       | (145                    | )          | $                                                        | 4.55       |                                                 |       |                                |       |   |
| Outstanding at  September 30, 2006                 |       | 2,345                   |       | $                                                        | 3.98       |                                                 | 8.58       |                                | $          | 3,173 |   |
|                                               |       |                    |       |                                                     |       |                                                 |       |                                |       |
| Vested and expected to  vest at September 30, 2006 |       | 2,267                   |       | $                                                        | 3.93       |                                                 | 8.56       |                                | $          | 3127 |   |
|                                               |       |                    |       |                                                     |       |                                                 |       |                                |       |
| Exercisable at September 30, 2006                  |       | 1,052                   |       | $                                                        | 1.74       |                                                 | 8.58       |                                | $          | 2,993 |   |

 

Sharesavailable for future stock option grants under the Equity Incentive Plan andthe Directors’ Plan were 391,584 and 262,500, respectively, at September 30,2006.  Aggregate intrinsic value iscalculated as the difference between the exercise price of the underlying awardsand the quoted price of the Company’s common stock for the 1.1 million optionsthat were in-the-money as of September 30, 2006.

***Stock Purchase Plan Information***

Duringthe three and nine months ended September 30, 2006, 58,232 and 94,302 shareswere issued under the Stock Purchase Plan at a purchase price of $3.66 and$3.93, respectively.  At September 30,2006, approximately 270,000 shares were reserved for future issuance and theaggregate intrinsic value of these reserved shares outstanding under the Company’sStock Purchase Plan was $170,000.

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***Net Loss per Common Share***

Netloss 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 dilutednet loss per share below represent the weighted-average common sharesoutstanding, reduced by the weighted-average unvested common shares subject torepurchase, and include the assumed automatic conversion of all outstandingshares of preferred stock that automatically converted into shares of commonstock upon the closing of our IPO, in February 2005, using the as-ifconverted method as of January 1, 2005 or the date of issuance, if later.
| ** **                                                                                                    | ** ** | **Three Months ended**                                                       | ** ** | **Nine Months ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                    | ** ** | **September 30,**                                                                 | ** ** | **September 30**           | ** ** |
| ** **                                                                                                    | ** ** | **2006**                                                                               | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                                    | ** ** | **(in thousands, except share and per share data)** | ** ** |
| **Historical:**                                                                                               |       |                                                                                   |       |                            |       |   |   |   |   |
| Numerator:                                                                                                    |       |                                                                                   |       |                            |       |   |   |   |   |
| Net loss                                                                                                      |       | $                                                                                      | (9,585     | )                               | $          | (8,524 | ) | $ | (30,265 | ) | $ | (26,302 | ) |
| 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                                                                   |       | $                                                                                      | (9,585     | )                               | $          | (8,524 | ) | $ | (30,265 | ) | $ | (26,308 | ) |
| Denominator:                                                                                                  |       |                                                                                   |       |                            |       |   |   |   |   |
| Weighted-average  common shares                                                                               |       | 28,971,308                                                                             |       | 20,303,297                      |       | 26,890,742 |   | 17,879,917 |   |
| Weighted-average  unvested common shares subject to repurchase                                                |       | (166,094                                                                               | )          | (390,259                        | )          | (211,235 | ) | (470,690 | ) |
| Denominator for  basic and diluted earnings per share                                                         |       | 28,805,214                                                                             |       | 19,913,038                      |       | 26,679,507 |   | 17,409,227 |   |
|                                                                                                          |       |                                                                                   |       |                            |       |   |   |   |   |
| Basic and  diluted net loss per share                                                                         |       | $                                                                                      | (0.33      | )                               | $          | (0.43 | ) | $ | (1.13 | ) | $ | (1.51 | ) |
| **Pro  forma:**                                                                                               |       |                                                                                   |       |                            |       |   |   |   |   |
| Net loss  applicable to common stockholders                                                                   |       | $                                                                                      | (9,585     | )                               | $          | (8,524 | ) | $ | (30,265 | ) | $ | (26,308 | ) |
|                                                                                                          |       |                                                                                   |       |                            |       |   |   |   |   |
| Pro forma basic  and diluted net loss per share                                                               |       | $                                                                                      | (0.33      | )                               | $          | (0.43 | ) | $ | (1.13 | ) | $ | (1.38 | ) |
|                                                                                                          |       |                                                                                   |       |                            |       |   |   |   |   |
| Shares used  above                                                                                            |       | 28,805,214                                                                             |       | 19,913,038                      |       | 26,679,507 |   | 17,409,227 |   |
| Pro forma  adjustments to reflect weighted-average affect of conversion of preferred  stock                   |       | —                                                                                 |       | —                          |       | — |   | 1,650,409 |   |
| Pro forma shares used  to compute basic and diluted net loss per share                                        |       | 28,805,214                                                                             |       | 19,913,038                      |       | 26,679,507 |   | 19,059,636 |   |

 
|                                                                                                              | ** ** | **As of September 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                                                                             |       | 2,345                                  |       | 1,481 |   |
| Common stock  subject to repurchase                                                                          |       | 144                                    |       | 355 |   |
|                                                                                                         |       | 5,611                                  |       | 1,866 |   |

 

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**2.Comprehensive Loss**

Components of comprehensiveloss were as follows (in thousands):
| ** **                                                  | ** ** | **Three Months ended September 30,** | ** ** | **Nine Months ended September 30,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                                 | ** ** | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Net loss                                                    |       | $                                                        | (9,585     | )                                                       | $          | (8,524 | ) | $ | (30,265 | ) | $ | (26,302 | ) |
| Change in  unrealized gain/(loss) on short-term investments |       | 11                                                       |       | (30                                                     | )          | 50 |   | (42 | ) |
| Comprehensive  loss                                         |       | $                                                        | (9,574     | )                                                       | $          | (8,554 | ) | $ | (30,215 | ) | $ | (26,344 | ) |

 

Accumulated other comprehensive loss totaled $4,000and $54,000 at September 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. To date no securities have been issued pursuant to thisregistration statement.

*Private Placement of Common Stock and Warrants*

On March 6, 2006,the Company entered into a securities purchase agreement relating to a privateplacement in which the Company issued and sold to certain investors, for anaggregate purchase price of approximately $45.4 million, 8.6million shares of its common stock and warrants to purchase up to 3 million shares of itscommon stock at an exercise price of $5.26 per share.  At the closing, investorsin the private placement paid $5.26 per share of common stock and an additionalpurchase price equal to $0.125 per warrant.

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

The Company filed aregistration statement with the Securities and Exchange Commission on March 31,2006 covering the resale of the shares of common stock issued in the privateplacement and the shares of common stock issuable upon exercise of the warrantsissued in the private placement.

*Initial Public Offering*

OnFebruary 7, 2005, the Company completed an initial closing of its IPO inwhich it sold 6 million shares of common stock for proceeds of $37.7 million,net of underwriting discounts and commissions and $1.4 million of offeringexpenses. 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.

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**4. Commitments and Contingencies**

*Leases*

As previously disclosed in the footnotes to thefinancial statements in the Company’s Annual Report on Form 10-K for the yearended December 31, 2005, the Company committed to lease a 48,000square-foot facility (New Facility) adjacent to its existing facility (ExistingPremises) to house the Company’s corporate headquarters and warehousing operations.  In September 2006, the Company entered intothe First Amendment to the Amended and Restated Office Lease Agreement(Amendment) pursuant to which the Company agreed to expand the ExistingPremises to include the New Facility. The Amendment is effective December 1, 2006, with an effectivecommencement date of March 1, 2007 (ninety-one days after the effectivedate).  Rental payments related to theNew Facility begin on March 1, 2007, with the base rent for the New Facilityincreasing by 3.5% annually commencing on each March 1st, thereafter.  However, during the first 12 months of thelease related to the New Facility, the Company is obligated to pay only 50% ofthe base rent and operating expenses attributable to the New Facility.  The provisions of the Amended and RestatedOffice Lease Agreement related to the Existing Premises regarding operatingcosts, real estate taxes, insurance, monthly management fees and tenantimprovement fees will also apply to the New Facility.  Unless earlier terminated, the Company’slease of the Existing Premises and the New Facility will expire on June 30,2025, but the Company has the option to extend the term of the lease withrespect to the New Facility for two additional five-year periods.  The Company would have a one-time right toterminate its lease of the New Facility effective as of June 1, 2017, upon sixmonths’ prior notice to the landlord. The landlord will provide the Company with a tenant improvementallowance of $1.2 million for the New Facility.

Future minimum payments as of September 30, 2006 undernon-cancelable operating leases for the Existing Premises and the New Facilityare as follows (in thousands):
|                               | ** ** | **Operating  Leases** | ** ** |
|-------------------------------|------------|-----------------------|------------|
| 2006                          |       | $                     | 556        |   |
| 2007                          |       | 3,689                 |       |
| 2008                          |       | 4,335                 |       |
| 2009                          |       | 4,557                 |       |
| 2010                          |       | 4,717                 |       |
| Thereafter                    |       | 79,667                |       |
| Total minimum lease  payments |       | $                     | 97,521     |   |

 

*Tenant Improvement Allowance*

Aspreviously disclosed in the footnotes to the financial statements in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2005, theCompany entered the Amended and Restated Office Lease Agreement, as amendedpursuant to which the landlord agreed to provide improvement allowances of$10.0 million and $1.2 million, respectively, associated with the expansion ofthe Existing Premises and the build out of the New Facility.  Such costs will be capitalized as leaseholdimprovements and amortized over the shorter of their estimated useful lives orthe remaining lease term, while the tenant improvement allowance will berecorded as deferred rent and recovered ratable over the remaining term of thelease.  The landlord has incurredapproximately $2.2 million in costs through September 30, 2006.

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**Item 2. Management’s Discussion andAnalysis of Financial Condition and Results of Operations.**

**Cautionary Note Regarding Forward-Looking Statements**

*This Form 10-Q contains certain forward-lookingstatements including expectations of market conditions, challenges and plans,within the meaning of Section 21E of the Securities Exchange Act of 1934,as amended, and is subject to the Safe Harbor provisions created by thatstatute. The words “anticipate”, “expect”, “believe”, “plan”, “intend”, andsimilar expressions are intended to identify such statements. Although theforward-looking statements in this Form 10-Q reflect the good faithjudgment of our management, such statements are subject to various risks anduncertainties, including but not limited to those discussed herein and, inparticular, the risks described in Item 1A of Part II  and throughout our Annual Report onForm 10-K for the year ended December 31, 2005. Actual results andthe timing of selected events may differ materially from those anticipated inthese forward-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. We initiated a pivotal Phase 3clinical trial of FavId in patients with follicular B-cell NHL in July 2004and completed patient enrollment in January 2006 with 347 patients randomizedinto the trial.  In addition, FavId hasbeen evaluated in several multi-center, open-label Phase 2 clinical trialsinvolving 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. Moreover, we believe our active immunotherapy expertise and proprietarymanufacturing technology may enable us to develop additional product candidatesfor other oncology indications, such as T-cell lymphoma, and for autoimmunediseases, with an initial focus on multiple sclerosis.  In June 2006, we received an allowance fromthe FDA for an IND for our second product candidate, FAV-201, for the treatmentof cutaneous T-cell lymphoma. We have retained exclusive worldwidecommercialization rights to all of our product candidates.

We wereincorporated in Delaware in January 2000. As of September 30, 2006, we hadnot generated any revenues, and we had financed our operations and internalgrowth through private placements of our common stock and warrants, equipmentand leasehold debt financings and the sale of common stock in our initialpublic offering or IPO in February 2005. We are a development stagecompany and have incurred significant losses since our inception in 2000, as wehave devoted substantially all of our efforts to research and developmentactivities, including clinical trials. As of September 30, 2006, our deficitaccumulated during the development stage was approximately $145.6 million. Weexpect to incur substantial and increasing losses for the next several years aswe:

· continue to develop and prepare for thecommercialization of our lead product candidate, FavId;

· expand our research and development programs;

· expand our current manufacturing capabilities tosupport commercial manufacturing of FavId; and

·  acquire orin-license oncology products that are complementary to our own.

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**FinancialOperations Overview**

***Research and Development Expense. ***Research anddevelopment expense consists primarily of costs associated with clinical trialsof our product 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 clinicaltrials and one additional Phase 3 clinical trial of FavId are ongoing.

From inceptionthrough September 30, 2006, we incurred costs of approximately $92.2 millionassociated with the research and development of FavId, which representssubstantially all of our research and development costs to date. We expect ourresearch and development costs to increase as we advance FavId and new productcandidates into later stages of clinical development. While difficult topredict, we estimate that research and development costs required to completethe development of and file a Biologics Licensing Application, or BLA, forFavId will be an additional $45 million**. **We are unable to estimate with anycertainty the costs we will incur in the continued development of other productcandidates for commercialization. On an ongoing basis, we expect to expand ourresearch and development activities to include clinical development of FAV-201and preclinical research of treatments for autoimmune diseases, primarilymultiple sclerosis.

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 trialcompletion dates and costs vary significantly for each product candidate andare difficult to estimate. The lengthy process of seeking regulatory approvalsand the subsequent compliance with applicable regulations require theexpenditure of substantial resources. Any failure by us to obtain, or any delayin obtaining, regulatory approvals for our product candidates could cause ourresearch and development expenditures to increase and, in turn, have a materialadverse effect on our results of operations. We cannot be certain when, ifever, any cash flows from our current product candidates will commence.

***Marketing, General and 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 product candidates.

***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**

The discussionand analysis of our financial condition and results of operations are based onour financial statements, which have been prepared in accordance with U.S.generally accepted accounting principles. The preparation of financialstatements requires us to make estimates and assumptions that affect thereported 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 our 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 

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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 September 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-Based Compensation.***    Wegrant options to purchase our common stock to our employees and directors underour stock option plans. Eligible employees can also purchase shares of ourcommon stock at 85% of the lower of the fair market value on the first day ofan offering period or the last day of each six-month purchase period during atwenty-four month offering under our employee stock purchase plan.  The benefits provided under these plans arestock-based payments subject to the provisions of SFAS 123(R).  Effective January 1, 2006, we use the fairvalue method to apply the provisions of SFAS 123(R) with a modified prospectivetransition method**,**which provides for certainchanges to the method for valuing stock-based compensation. The valuationprovisions of SFAS 123(R) apply to new awards and to awards that areoutstanding on the effective date and subsequently modified or cancelled. Underthe modified prospective transition method, prior periods are not revised forcomparative purposes.  Prior to the adoptionof SFAS 123(R), we recorded compensation expense for these plans based upontheir intrinsic value on the date of grant pursuant to Accounting PrinciplesBoard Opinion No. 25, *Accounting forStock Issued to Employees (APB 25)*. Prior to our IPO, we established the exercise price based on the fairvalue of the Company’s stock at the date of grant as determined by the Board ofDirectors (the Board). Therefore, the options had no intrinsic value upon grantand no expense was recorded upon issuance. With respect to certain optionsgranted during 2005 and 2004, we had recorded deferred compensation of $350,000and $9.4 million, respectively, for the incremental difference at thegrant date between the fair value per share determined by the Board and thedeemed fair value per share determined solely for financial reportingpurposes.  The deferred stock-basedcompensation balance of $5.7 million as of December 31, 2005, which wasaccounted for under APB 25, was reclassified as a reduction of additionalpaid-in capital upon the adoption of SFAS 123(R) and the unrecognizedexpense of awards not yet vested at the date of adoption will be recognized innet income or loss in the periods after the date of adoption using the sameBlack-Scholes valuation model and assumptions determined under the originalprovisions of SFAS 123, “Accounting for Stock-Based Compensation,” as disclosedin our previous quarterly and annual reports. The cumulative effect of the change in accounting principle from APB 25to SFAS 123(R) was not material, because the amortization of expense related tooptions granted prior to the adoption was based on the single-optionapproach.  Stock-based compensationexpense recognized under SFAS 123(R) for the three and nine months endedSeptember 30, 2006 was approximately $1.0 million and $2.9 million,respectively. At September 30, 2006, total unrecognized estimated compensationexpense related to unvested stock options granted prior to that date was$7.3 million, net of estimated forfeitures of $440,000, which is expectedto be recognized over a weighted-average period of 2.6 years.

Upon adoptionof SFAS 123(R), we estimated the value of stock-based awards on the date ofgrant using a Black-Scholes valuation model. The determination of the fair value of stock-based payment awards on thedate of grant using an option-pricing model is affected by our stock price aswell as assumptions regarding a number of complex and subjective variables.These variables include, but are not limited to, our expected stock pricevolatility over the term of the awards, risk-free interest rate and expecteddividends.

If factors change and we employ different assumptionsin the application of SFAS 123(R) in future periods, the compensation expensethat we record under SFAS 123(R) may differ significantly from what we haverecorded in the current period. Therefore, we believe it is important forinvestors to be aware of the high degree of subjectivity involved when usingoption pricing models to estimate stock-based compensation under SFAS123(R).  Option-pricing models weredeveloped for use in estimating the value of traded options that have novesting or hedging restrictions, are fully transferable and do not causedilution. Because our stock-based payments have characteristics significantlydifferent from those of freely traded options, and because changes in thesubjective input assumptions can materially affect our estimates of fairvalues, in our opinion, existing valuation models, including the Black-Scholesand lattice binomial models, may not provide reliable measures of the fairvalues of our stock-based compensation. Consequently, there is a risk that ourestimates of the fair values of our stock-based compensation awards on thegrant dates may bear little resemblance to the actual values realized upon theexercise, expiration, early termination or forfeiture of those stock-basedpayments in the future. Certain stock-based payments, such as employee stockoptions, may expire worthless or otherwise result in zero intrinsic value ascompared to the fair values originally estimated on the grant date and reportedin our financial statements. Alternatively, value may be realized from theseinstruments that is significantly in excess of the fair values originallyestimated on the grant date and reported in our financial statements. There iscurrently no market-based mechanism or other practical application to verifythe reliability and accuracy of the estimates stemming from these valuationmodels, nor is there a means to compare and adjust the estimates to actualvalues. Although the fair value of stock-based awards is determined inaccordance with SFAS 123(R) and the Securities and Exchange Commission’s StaffAccounting Bulletin No. 107 (SAB 107) using an option-pricing model, thatvalue may not be indicative of the fair value observed in a willingbuyer/willing seller market transaction.

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***Clinical Trial Cost Accrual****.*In the normal course of business, wecontract with numerous third-party clinical trial centers to perform various clinicaltrial activities in the on-going development of FavId. The financial terms ofthese agreements are subject to negotiation and variation from contract tocontract and may result in uneven payment flows. Payment under the contractsdepends on factors such as the completion of individual patients’ treatmentsand the related required documentation. * *We record expenses for contracted clinical trialcosts based upon patient enrollment and the dates that they receive treatment.  Thesecosts are a significant component of research and development expenses.  The objective of our accrual policy isto 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 research anddevelopment expenses in future periods.

***Short- Term Investments.***    Weclassify all of our short-term investments as available-for-sale.  We carry these investments at fair value,based on quoted market prices, and unrealized gains and losses are included inaccumulated other comprehensive income which is reflected as a separatecomponent of stockholders’ equity.  Theamortized cost of securities in this category is adjusted for amortization ofpremiums and accretions of discounts to maturity.  Such amortization is included in interestincome.  Realized gains and losses arerecorded in our statement of operations. If we believe that an other-than-temporary decline exists, it is ourpolicy to record a write-down to reduce the investments to fair value andrecord the related charge as a realized loss.

Management hasdiscussed the development and selection of these critical accounting policieswith the Audit Committee of our Board of Directors and the Audit Committee hasreviewed the disclosures presented above relating to them.

**Results of Operations**

***Comparison of the ThreeMonths Ended September 30, 2006 and 2005***

***Research and Development****.    *Research and development expense increasedfrom approximately $7.4 million for the three months ended September 30, 2005to $7.5 million for the three months ended September 30, 2006. The increase ofapproximately $100,000, or 1%, was due primarily to an increase ofapproximately $430,000 in compensation expenses related to additional personneland the accrual of the 2006 merit bonus program; an increase of approximately$250,000 primarily related to the amortization of deferred rent associated withour facility expansion; an increase of approximately $200,000 in IT, clinicaland regulatory third-party consulting services to prepare forcommercialization of FavId and to support our pivotal Phase 3 clinical trial;an increase of approximately $100,000 in stock-based compensation costs due tothe implementation of SFAS 123(R);offset by a decrease of approximately $500,000 of raw materials andsupplies for the manufacture of FavId dueto the completion of patient enrollment into our pivotal Phase 3 clinical trialin the first quarter of 2006 and a decrease of approximately $400,000 in clinical trial site costsand other third-party vendors supporting the pivotal Phase 3 clinical trial.

***Marketing, General andAdministrative****.   *Marketing, general and administrative expenseincreased from approximately $1.5 million for the three months ended September30, 2005 to $2.6 million for the three months ended September 30, 2006. Theincrease of $1.1 million, or 73%, primarily reflects an increase ofapproximately $400,000 in personnel and outside services related to strategicmarketing programs; an increase of approximately $200,000 associatedwith an increase in general and administrative personnel from 20 employees to 24 employees and the accrualof the 2006 merit bonus program; an increase of approximately $200,000 instock-based compensation costs due to implementation of SFAS 123(R) and anincrease of approximately $100,000 in legal fees and other public companyexpenses.

***Interest Income****.  *Interest income increased from approximately $500,000 for the threemonths ended September 30, 2005 to approximately $800,000 for the three monthsended September 30, 2006. The increase of $300,000, or 60%, was a result ofrising interest rates during the past year and an average balance of approximately$55.0 million for the three months ended September 30, 2006 compared toapproximately $46.0 million over the same period in 2005.

***Comparison of the NineMonths Ended September 30, 2006 and 2005***

***Research and Development****.    *Research and development expense increasedfrom approximately $22.1 million for the nine months ended September 30, 2005to $23.4 million for the nine months ended September 30, 2006. The increase of$1.3 million, or 6%, was due primarily to an increase of approximately $2.0 milliondue to compensation costs of additional personnel and the accrual of the 2006merit bonus program; an increase of approximately $700,000 primarily related tothe amortization of deferred rent associated with our facility expansion; anincrease of approximately $300,000 in stock-based

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compensationcosts due to the implementation of SFAS123(R); offset by a decrease of approximately $2.0 million of raw materials andsupplies for the manufacture of FavId due to the completion of patient enrollment into our pivotal Phase 3clinical trial in the first quarter of 2006 and a decrease ofapproximately $500,000 inclinical trial site costs.

***Marketing, General andAdministrative****.   *Marketing, general and administrativeexpense increased from approximately $4.9 million for the nine months ended September30, 2005 to $8.2 million for the nine months ended September 30, 2006. Theincrease of approximately $3.3 million, or 67%, primarily reflects an increaseof approximately $1.1 million in personnel and outside services related tostrategic marketing programs; an increase of approximately $700,000 incompensation costs associated with an increase in administrativepersonnel from 20 employees to 24employees and the accrual of the 2006 merit bonus program; an increase ofapproximately $425,000 in legal and audit fees and other public companyexpenses; an increase of approximately $425,000 in stock-based compensation dueto the implementation of SFAS 123(R); and an increase of approximately $200,000in facility, maintenance and supply expenses to support the additional generaland administrative personnel.

***Interest Income****.  *Interest income increased from approximately $1.2 million for the ninemonths ended September 30, 2005 to approximately $2.0 million for the ninemonths ended September 30, 2006. The increase of approximately $800,000, or67%, was a result of rising interest rates during the past year and an averagebalance of approximately $54.0 million for the nine months ended September 30,2006 compared to approximately $49.0 million over the same period in 2005.

**Liquidityand Capital Resources**

***Sources of Liquidity***

We havehistorically funded our operations primarily through the sale of our equitysecurities and equipment and leasehold debt financing. As of September 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;proceeds from the sale of common stock in our IPO of approximately $39.5million, net of underwriters’ discounts and commissions of approximately $3.1million and offering expenses of approximately $1.4 million; and proceeds ofapproximately $45.0 million from the sale of common stock and warrants topurchase common stock to certain investors, in a private placement, net ofoffering expenses of approximately $400,000.

As of September30, 2006 we had financed the purchase of equipment and leasehold improvementsthrough debt totaling approximately $17.2 million.  Total debt of $9.0 million was outstanding atthat date.  These obligations are securedby our existing and future assets excluding intellectual property and are duein monthly installments through April 2010. They bear interest at stated ratesranging from approximately 9.34% to 11.54%.** **The debt agreements subject us tocertain financial and non-financial covenants. As of September 30, 2006, wewere in compliance with the terms of the debt agreements.

***Cash Flows***

As of September30, 2006, cash, cash equivalents and short-term investments were approximately$51.4 million as compared to $34.5 million at December 31, 2005, anincrease of approximately $16.9 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 $21.4 million for the ninemonths ended September 30, 2006 compared to $21.6 million for the same period in2005. The decrease of $200,000 is primarily due to an increase in operatingexpenses related to additional personnel and other expenses related to thecontinuing clinical development and preparation for commercialization of FavIdoffset by increases in accounts payables and accrued liabilities and incentiveobligations for our facility expansion project.

Net cash usedin investing activities was approximately $19.0 million for the nine monthsended September 30, 2006 compared to net cash used in investing activities of$24.0 million for the same period in 2005. The decrease of $5.0 million is dueto an increase of $14.6 million in short-term investment maturities net ofshort-term investment purchases, offset by an increase of $7.7 million inproperty and equipment purchases and the increase of $1.9 million in restrictedcash to collateralize the letter of credit which has been increased to $3.5million as required by our facility lease agreement.

Net cashprovided by financing activities for the nine months ended September 30, 2006totaled $48.2 million, reflecting primarily the net proceeds from ourprivate placement of common stock and warrants in March 2006 of approximately$45.0 million.  Net cash provided byfinancing activities for the same period in 2005 totaled $39.0 million,reflecting primarily the net proceeds from our IPO of $39.5 million in February2005.

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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 developmentefforts and other research and development activities;

· rate of progress toward obtaining regulatoryapproval for our product candidates;

· costs of filing, prosecuting, defending andenforcing our patent claims and other intellectual property rights;

· our ability to establish and maintaincollaborative, licensing or other arrangements for the development, sale,marketing or distribution of our product candidates and the terms of thosearrangements;

· effects of competing technological and marketdevelopments;

· the cost of expansion of our current facilityfor commercial production or the construction of a large separatecommercial-scale production facility; and

· the success 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 future cashneeds through the sale of other equity securities, strategic collaborationagreements and debt financing. However, we may not be successful in obtainingcollaboration agreements, or in receiving milestone or royalty payments underthose agreements. In addition, we cannot be sure that our existing cash, cashequivalents and short-term investments will be adequate or that additionalfinancing will be available when needed or that, if available, financing willbe obtained on terms favorable to us or our stockholders. Having insufficientfunds may require us to delay, scale back or eliminate some or all of ourresearch or development programs or to relinquish rights to product candidatesat an earlier stage of development or on less favorable terms than we wouldotherwise choose. Failure to obtain adequate financing may also adverselyaffect our ability to operate as a going concern. If we raise additional fundsby issuing equity securities, substantial dilution to existing stockholderswould likely result. If we raise additional funds by incurring debt financing,the terms of the debt may involve significant cash payment obligations as wellas covenants and specific financial ratios that may restrict our ability tooperate our business.

**Off-BalanceSheet Arrangements**

As ofSeptember 30, 2006, we have not invested in any variable interest entities. Wedo not have any relationships with unconsolidated entities or financial partnerships,such as entities often referred to as structured finance or special purposeentities, which would have been established for the purpose of facilitatingoff-balance sheet arrangements or other contractually narrow or limitedpurposes. In addition, we do not engage in trading activities involvingnon-exchange traded contracts. As such, we are not materially exposed to anyfinancing, liquidity, market or credit risk that could arise if we had engagedin these relationships.

**Item 3.Quantitative and Qualitative Disclosures about Market Risk.**

Theprimary objective of our investment activities is to preserve principal whilemaximizing income without significantly increasing risk. Some of the securitiesin which we invest may be subject to market risk. This means that a change inprevailing interest rates may cause the market value of the investment tofluctuate. To minimize this risk, we may maintain our portfolio of cashequivalents and short-term investments in a variety of securities, including commercialpaper, money market funds and direct or guaranteed obligations of the UnitedStates government. The risk associated with fluctuating interest rates islimited to our investment portfolio and we do not believe that a 1% change ininterest rates would have a significant impact on our interest income. As ofSeptember 30, 2006, all of our short-term investments were government agencysecurities, corporate notes and bonds, and our cash equivalents were held inchecking accounts and money market funds.

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**Item 4. Controls and Procedures.**

As ofthe end of the period covered by this report, we carried out an evaluation,under the supervision and with the participation of our Chief Executive Officerand Chief Financial Officer, of the effectiveness of our disclosure controlsand procedures pursuant to Rule 13a-15 of the Securities Exchange Act of1934, as amended, or Exchange Act. Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that, as of the end ofthe period covered by this report, our disclosure controls and procedures wereeffective to cause material information required to be disclosed by us 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 a control system, no matterhow well designed and operated, is based in part upon certain assumptions aboutthe likelihood of future events, and, therefore, can only provide reasonable,not absolute, assurance that the objectives of the controls system are met, andno evaluation of controls can provide absolute assurance that all controlissues and instances of fraud, if any, within a company will be detected.

Duringthe three months ended September 30, 2006, there were no changes in ourinternal control over financial reporting which materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

**PART II- OTHER INFORMATION.**

**Item1.  Legal Proceedings.**

We are currently not a party to any material legalproceeding. We may be subject to various claims and legal actions arising inthe ordinary course of business from time to time.

**Item1A.  Risk Factors**

*Youshould consider carefully the risk factors described below, together with theother information contained in this report. If any of the following risksactually occur, our business, financial condition, results of operations andfuture growth prospects would likely be materially and adversely affected. Inthese circumstances, the market price of our common stock could decline, andyou may lose all or part of your investment in our common stock.*

*We havemarked with an asterisk those risk factors that reflect substantive changesfrom the risk factors included in our Annual Report on Form 10-K for the yearended December 31, 2005.*

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

***We are dependent on the success ofour lead product candidate, FavId, and we cannot be certain that it will becommercialized.**

We have expendedsignificant time, money and effort in the development of our lead productcandidate, FavId, which is still in clinical development, has not yet receivedregulatory approval and may never be commercialized. In order to commercializeFavId, we will need to demonstrate to the FDA and other regulatory agenciesthat it satisfies rigorous standards of safety and effectiveness. We completedpatient enrollment in a pivotal Phase 3 clinical trial of FavId followingRituxan for the treatment of follicular B-cell NHL in January 2006.

We are also evaluatingFavId for use in other B-cell NHL indications. However, even if we were toreceive regulatory approval of FavId for the treatment of follicular B-cell NHLor the other indications we are exploring, our ability to successfullycommercialize FavId could be jeopardized by the emergence of a competitiveproduct that exhibits greater efficacy, longer duration of response or otherbenefits. In addition, because our initial regulatory and marketing strategycontemplates the administration of FavId to patients following treatment withRituxan, the commercial opportunity for FavId may be limited by the degree towhich oncologists continue to use Rituxan to treat indolent B-cell NHL.Furthermore, to the extent FavId fails to gain market acceptance for itsinitial indication, it may be more difficult for us to generate sufficientcredibility with physicians and patients to commercialize FavId for otherindications.

Other than FavId, we haveonly two other product development programs, which are at significantly earlierstages 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 for the treatment of cutaneous T-cell lymphoma. Wehave ongoing preclinical studies to assess the applicability of our technologyto autoimmune diseases, with an initial focus on multiple sclerosis. We cannotbe certain that we will be able to successfully develop any product candidatefrom these development programs. We cannot be certain that the clinicaldevelopment of FavId or any other product candidate in preclinical testing orclinical trials will be successful, that

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it will receive theregulatory approvals required to commercialize it, or that any of our otherresearch programs will yield a product candidate suitable for entry intoclinical trials. If we are unable to commercialize FavId or our other productcandidates, we may be unable to generate sufficient revenues to attain ormaintain profitability, our ability to raise additional capital will beimpaired and our stock price may be negatively affected.

***Failure to obtain product approvalsby the FDA could harm our business.**

We are subject torigorous and extensive regulation by the FDA. In the United States, ourbiologic product candidates, currently in the preclinical and clinical stagesof development, cannot be marketed until they are approved by the FDA.Obtaining FDA approval involves the submission of the results of preclinicalstudies and clinical trials of the product candidates, among other information.We may not be able to obtain FDA approval, and, even if we are able to do so, theapproval process typically takes many years and requires the commitment ofsubstantial effort and financial resources. The FDA can delay, limit or denyapproval of a biologic product candidate for many reasons, including:

· the FDA may not find that the biologic productcandidate is sufficiently safe or effective;

· FDA officials may interpret data frompreclinical testing and clinical trials differently than we do; and

· the FDA may not find our manufacturing processesor facilities satisfactory.

In addition, the specificactive immunotherapy technology on which FavId is based is a relatively newform of cancer therapy that presents novel issues for the FDA to consider,which may make the regulatory process especially difficult.

We cannot assure you thatany of our product candidates in development will be approved in the UnitedStates in a timely fashion, or at all. Failure to obtain regulatory approval ofour product candidates in a timely fashion, or at all, would prevent or delayus from marketing or selling any products and, therefore, from generatingrevenues from their sale. If this occurs, we may be unable to generatesufficient revenues to attain or maintain profitability, our ability to raiseadditional capital will be impaired and our stock price may be negativelyaffected. In addition, both before and after approval, we are subject tonumerous FDA requirements covering, among other things, testing, manufacturing,quality control, labeling, advertising, promotion and export of biologics.Failure to comply with the law, including statutes and regulations,administered by the FDA, could result in, among others, any of the followingactions:

· warning letters;

· fines and other civil penalties;

· unanticipated expenditures;

· delays in approving or refusal to approve aproduct candidate;

· product recall or seizure;

· interruption of production;

· operating restrictions;

· injunctions; and

· criminal prosecution.

***Before we can seek regulatoryapproval of any of our product candidates, we must successfully completeclinical trials, which are uncertain.**

Conducting clinicaltrials is a lengthy, time-consuming and expensive process, and the results ofthese trials are inherently uncertain. We have completed enrollment of patientsin several Phase 2 clinical trials of FavId involving over 130 indolent B-cellNHL patients and are currently conducting follow-up evaluation of thosepatients. We completed enrollment of patients in a pivotal double-blind,placebo controlled Phase 3 clinical trial of FavId for the treatment offollicular B-cell NHL in January 2006 with 349 randomized patients. During theweek of November 6, 2006, our Data Monitoring Committee completed a plannedinterim analysis of data from the secondary endpoint, overall response improvement,in the first 233 patients enrolled in the trial. The analysis did notdemonstrate a statistically significant difference between treatment andcontrol groups in the secondary endpoint. We anticipate the final analysis ofthe primary endpoint, TTP, during the second half of 2007. Four additionalPhase 2 clinical trials and one additional Phase 3 clinical trial of FavIdare ongoing.  One of these clinicaltrials is being conducted under a

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separatephysician-sponsored IND in the United States. In June 2006, we received an allowance from the FDA for an IND for oursecond product candidate, FAV-201, for the treatment of cutaneous T-celllymphoma.

We have received aSpecial Protocol Assessment, or SPA, from the FDA for our pivotal Phase 3clinical trial of FavId. In the SPA process, the FDA reviewed the design, sizeand planned analysis of our Phase 3 clinical trial and provided comments regardingthe trial’s adequacy to form a basis with respect to effectiveness forapproval of a Biologics Licensing Application, or BLA, if the trial meets itspredetermined objectives. We will not be able to file a BLA for FavId untilafter we receive an analysis of the primary endpoint, TTP, of our ongoingpivotal Phase 3 clinical trial (assuming the TTP data is positive), whichanalysis is anticipated in the second half of 2007, or at all. The FDA’swritten agreement is binding, except in limited circumstances, such as when asubstantial scientific issue essential to determining the safety oreffectiveness of a product candidate is identified after the Phase 3 clinicaltrial is commenced. Despite having received an SPA, we may be required toconduct an additional Phase 3 clinical trial of FavId for the treatment ofindolent B-cell NHL before we can apply for regulatory approval. Although theFDA typically requires successful results in two Phase 3 clinical trials tosupport marketing approval, the FDA has, on several occasions, approvedproducts based on a single Phase 3 clinical trial that demonstrates a highlevel of statistical significance where there is an unmet need for alife-threatening condition. We currently plan to seek FDA approval of FavIdbased on our ongoing pivotal Phase 3 clinical trial alone. In the eventthat the FDA requires the results of a second Phase 3 clinical trial beforeaccepting a BLA or before granting marketing approval of FavId, our launch ofFavId would be delayed, possibly by several years, and we would incursignificant costs in conducting the additional trial.

Completion of necessaryclinical trials may take several years or more. Our commencement and rate ofcompletion of clinical trials may be delayed by many factors, including:

· ineffectiveness ofthe product candidate, or perceptions by physicians that the product candidateis not safe or effective for a particular indication;

· inability to manufacture sufficient quantitiesof the product candidate for use in clinical trials;

· delay or failure in obtaining approval of ourclinical trial protocols from the FDA;

· slower than expected rate of patient recruitmentand enrollment;

· inability to adequately follow and monitorpatients after treatment;

· difficulty in managing multiple clinical sites;

· unforeseen safety issues; and

· government or regulatory delays.

Even if we achievepositive interim results in clinical trials, these results do not necessarilypredict final results, and positive results in early trials may not beindicative of success in later trials. A number of companies in thepharmaceutical industry have suffered significant setbacks in advanced clinicaltrials, even after promising results in earlier trials. Negative or inconclusiveresults or adverse medical events during a clinical trial could cause us torepeat or terminate a clinical trial or require us to conduct additionaltrials. Our clinical trials may be suspended at any time for a variety ofreasons, including if the FDA or we believe the patients participating in ourtrials are exposed to unacceptable health risks or if the FDA findsdeficiencies in the conduct of these trials.

Failures or perceivedfailures in our clinical trials will directly delay our product development andregulatory approval process, damage our business prospects, make it difficultfor us to establish collaboration and partnership relationships, and negativelyaffect our reputation and competitive position in the pharmaceutical community.

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

We may encounter delaysin development and commercialization, or fail to obtain marketing approval, ofFavId or any other product candidate that we may develop if we are unable toenroll enough patients to complete clinical trials. Our ability to enrollsufficient numbers of patients in our clinical trials depends on many factors,including the size of the patient population, the nature of the protocol, theproximity of patients to clinical sites, the eligibility criteria for the trialand competing clinical trials. Although we completed patient enrollment in ourpivotal Phase 3 clinical trial of FavId in January 2006, we have from time totime experienced slower-than-expected patient enrollment in our clinical trialsand may do so in

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the future if additionalclinical trials of FavId are required or if we clinically develop any of ourother product candidates. Delays in planned patient enrollment may result inincreased costs and harm our ability to complete our clinical trials and obtainregulatory approval.

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

Administration of FavIdrequires an adjuvant, which is a substance that is used to enhance the immuneresponse. We use a white blood cell growth factor known as GM-CSF, which iscommercially available solely from Berlex Laboratories, Inc., as anadjuvant for FavId. We currently rely on purchase orders to purchase GM-CSF foruse in our clinical trials and do not have a supply agreement with Berlex. GM-CSFis an FDA-approved and commercially available drug that may be purchased byphysicians. Our current strategy for the initial commercialization of FavIdinvolves the administration of FavId following treatment with Rituxan. Rituxanis a passive immunotherapy for patients with NHL, which is also FDA-approvedand is commercially available solely from Genentech, Inc. and Biogen IdecInc. We currently rely on physicians to order and administer Rituxan topatients prior to the administration of FavId in our registration trial. IfGM-CSF or Rituxan were to become unavailable as a result of regulatory actions,supply constraints or other reasons, our ability to continue the clinicaldevelopment of FavId would be jeopardized.

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

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

We are a developmentstage company with a limited operating history. We have financed our operationsthrough private placements of stock and warrants, an initial public offering ofour common stock and equipment and leasehold debt financing. We have incurredlosses in each year since our inception in 2000. Net losses were $9.6 millionand $30.3 million for the three and nine months ended September 30, 2006,respectively, and $8.5 million and $26.3 million for the three and nine monthsended September 30 2005, respectively. As of September 30, 2006, we had an accumulated deficit of $145.6million.  These losses, among otherthings, have had and will continue to have an adverse effect on ourstockholders’ equity and working capital. We expect to incur substantialoperating losses for at least the next several years. This is due primarily tothe expansion of our clinical trials and research and development programs,preparations to manufacture FavId on a commercial scale, and, selling, generaland administrative expenses. We also have substantial lease and debtobligations related to our new manufacturing and headquarters facilitiesimpacting our operating expenses. We expect that our losses will fluctuate fromquarter to quarter and that these fluctuations may be substantial. We cannotguarantee that we will successfully develop, manufacture, commercialize ormarket any products. As a result, we cannot guarantee that we will ever achieveor sustain product revenues or profitability

**We currently have no source ofrevenue and may never become profitable.**

Our ability to becomeprofitable will depend upon our ability to generate revenue. To date, FavId hasnot generated any revenue, and we do not know when or if FavId will generaterevenue. Our ability to generate revenue depends on a number of factors,including our ability to:

·successfully complete clinical trials for FavId;

·obtain regulatory approval for FavId, including regulatory approval for ourcommercial scale manufacturing facility and process;

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

·successfully market and sell FavId.

We do not anticipate thatwe will generate revenues until 2008, at the earliest. Further, we do notexpect to achieve profitability for at least several years after generatingmaterial revenues. If we are unable to generate revenue, we will not becomeprofitable, and we may be unable to continue our operations.

***We will need substantial additionalfunds to continue operations, which we may not be able to raise on favorableterms, or at all.**

We will need substantialadditional funds for existing and planned preclinical studies and clinicaltrials, to continue research and development activities, for lease and debtobligations related to our manufacturing and headquarter facilities, and toestablish manufacturing and marketing capabilities for any products we maydevelop. In addition, because we do not expect

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to generate revenues fromthe sale of our product candidates for several years, if at all, we will alsoneed to raise additional capital to fund our operations.

We anticipate our cash,cash equivalents and short-term investments to be approximately $40 million atDecember 31, 2006.  We will need to raiseadditional funds in order to commercialize FavId, including the completion ofthe expansion and qualification of our manufacturing facility for commercial-scaleproduction. Our forecast of the period of time through which our financialresources will be adequate to support our operations is a forward-lookingstatement and involves risks and uncertainties, and actual results could varyas a result of a number of factors, including the factors discussed elsewherein this report. We have based this estimate on assumptions that may prove to bewrong, and we could utilize our available capital resources sooner than wecurrently expect.

Our future capitalrequirements or the adequacy of our available funds will depend on manyfactors, including, but not limited to:

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

·rate of progress toward obtaining regulatory approval for our product candidates;

·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 cost of expansion of our current facility for commercial production or theconstruction of a large separate commercial-scale production facility; and

·the success of the commercialization of FavId.

Future capitalrequirements will also depend on the extent to which we acquire or invest inbusinesses, products and technologies, but we currently have no commitments oragreements relating to any of these types of transactions.

To that end, on June 20,2006, we filed a shelf registration statement with the SEC on Form S-3 pursuantto which we may periodically sell up to $60 million in debt securities, commonstock or warrants to purchase debt securities or common stock.  We may seek to access the public or privateequity markets whenever conditions are favorable, even if we do not have animmediate need for additional capital at that time. Additional funding may notbe available to us, and, if available, may not be on acceptable terms. If weraise 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 need toseek 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.

***Future changes in financial accounting standardsor practices or existing taxation rules or practices may cause adverseunexpected revenue or expense fluctuations and affect our reported results ofoperations.**

Achange in accounting standards or practices or a change in existing taxationrules or practices can have a significant effect on our reported results andmay even affect our reporting of transactions completed before the change iseffective. 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 or thequestioning of current practices may adversely affect our reported financialresults or the way we conduct our business. For example, in December 2004, theFASB 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 to adoptthis statement on January 1, 2006. This statement eliminates the abilityto account for stock-based compensation using the intrinsic value methodallowed under APB 25 and requires these transactions to be recognized ascompensation expense in the statement of operations based on the fair values onthe date of grant, with the compensation expense recognized over the period inwhich an employee or director is required to provide service in exchange forthe stock award. This new requirement will result in an increase in ourstock-based compensation expense, which may increase our net losses. Forexample, asa result of adopting SFAS 123(R), the Company’s net loss for the three and ninemonths ended September 30, 2006 is approximately $360,000

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and $830,000 larger,respectively, than if the Company had continued to account for stock-basedcompensation under APB 25.  Basic anddiluted net loss per share for the three and nine months endedSeptember 30, 2006 are $0.01 and $0.03 higher, respectively, than if theCompany had continued toaccount for stock-based compensation under APB 25.

**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 onsingle source suppliers for critical raw materials used in the manufacture ofFavId. In particular, our manufacturing process for FavId requires a foreignprotein derived from shellfish that is known as keyhole limpet hemocyanin, orKLH. We purchase KLH from biosyn Arzneimittel GmbH, or biosyn, which iscurrently the only supplier of KLH that has submitted the required filing,known as a drug master file, to the FDA. In November 2004, we entered intoan eight-year supply and license agreement with biosyn under which biosyn hasagreed to supply us with KLH and we have committed to annual KLH purchaserequirements during the commercialization of FavId.  In October 2006, we made a payment of $50,000to biosyn for the achievement of a milestone. An additional aggregate of up to $250,000 will be due upon theachievement of certain milestones, the timing of which is not known at thistime.  Either party may terminate thesupply 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 ona single source supplier for the cell growth media we use to produce FavId. Wepurchase this material from Expression Systems LLC, which in turn obtainsseveral of the components used in the cell growth media from sole suppliers. Wecurrently rely on purchase orders to obtain this material and do not have asupply agreement with Expression Systems. We intend to qualify a second sourcefor the cell growth media or manufacture the cell growth media in house fromcommercially available raw materials but may not be able to do so.

Establishing additionalor replacement suppliers for these materials may take a substantial amount oftime. In addition, we may have difficulty obtaining similar materials fromother suppliers that are acceptable to the FDA. If we have to switch to areplacement supplier, we may face additional regulatory delays and themanufacture and delivery of FavId, or any other product candidates that we maydevelop, could be interrupted for an extended period of time, which may delaycompletion of our clinical trials or commercialization. If we are unable toobtain adequate amounts of these materials, our clinical trials will bedelayed. In addition, we will be required to obtain regulatory clearance fromthe FDA to use different materials that may not be as safe or as effective. Asa result, regulatory approval of FavId, or any other product candidates that wemay develop, may not be received at all.

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

Our pivotal Phase 3clinical trial of FavId for the treatment of follicular B-cell NHL is beingconducted at 67 centers in the United States and will require long-term followup of the 347 patients randomized into the trial. One clinical trial of FavIdis being conducted under the direction of a physician sponsor, rather thanunder our supervision. We do not have the ability to independently conductclinical trials for FavId, or any other product candidate that we may develop,and we must rely on third parties, such as medical institutions and clinicalinvestigators, including physician sponsors, to conduct our clinical trials. Inparticular, we will rely on these parties to recruit and enroll patients in ourclinical trials. We also rely on third-party couriers to transport patienttissue samples and FavId. If any of the third parties upon whom we rely toconduct our clinical trials or transport patient tissue samples andimmunotherapies do not comply with applicable laws, successfully carry outtheir obligations or meet expected deadlines, and need to be replaced, ourclinical trials may be extended, delayed or terminated.

If the quality oraccuracy of the clinical data obtained by medical institutions and clinical investigators,including physician sponsors and other third-party vendors involved in datamanagement, is compromised due to their failure to adhere to applicable laws orour clinical protocols or for other reasons, we may not be able to obtainregulatory approval for or successfully commercialize FavId, or any otherproduct candidates that we may develop. If any of our relationships with any ofthese organizations or individuals terminates, we believe that we would be ableto enter into arrangements with alternative third parties. However, replacingany of these third parties would delay our clinical trials and could jeopardizeour ability to commercialize FavId and our other product candidates on a timelybasis, or at all.

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**Even ifwe obtain regulatory approval, we will continue to be subject to extensivegovernment regulation that may cause us to delay the introduction of ourproducts or withdraw our products from the market.**

Even if we obtainregulatory approval for FavId or our other product candidates, we will still besubject to extensive regulation. These regulations will impact many aspects ofour operations, including production, record keeping, quality control, adverseevent reporting, storage, labeling, advertising, promotion and personnel. Inaddition, the later discovery of previously unknown problems may result inrestrictions of the product candidates, including their withdrawal from themarket. Furthermore, regulatory approval may subject us to ongoing requirementsfor post-marketing studies. If we or any third party that we involve in ouroperations fail to comply with any continuing regulations, we may be subjectto, among other things, product seizures, recalls, fines or other civilpenalties, injunctions, suspensions or revocations of marketing licenses,operating restrictions and criminal prosecution.

***Before we can obtain marketingapproval for or commercially distribute FavId, we must have a commercial-scalefacility for the manufacture of FavId. In addition, the FDA and the CaliforniaDepartment of Health Services must find our manufacturing facility and processsatisfactory.**

Our manufacturingmethods, equipment and processes must comply with the FDA’s current GoodManufacturing Practices, or cGMP, requirements. We may also need to perform extensiveaudits of vendors, contract laboratories and suppliers. The cGMP requirementsgovern, among other things, record keeping, production processes and controls,personnel and quality control. We have only undertaken initial steps towardsachieving compliance with these regulatory requirements. Additional steps willrequire expenditure of significant time, money and effort. We cannot predictthe likelihood that the FDA will find our facility satisfactory, even if webelieve that we have taken the necessary steps to achieve compliance. If wefail to comply with these requirements or fail to pass a pre-approvalinspection of our manufacturing facility in connection with an application toobtain marketing approval for FavId or another product candidate, we would notreceive regulatory approval, and we would be subject to possible regulatoryaction.

We manufacture FavId forour ongoing pivotal Phase 3 and for the planned and ongoing Phase 1/2/3clinical trials at our facility in San Diego. We currently lease an 80,000square foot facility in San Diego, California under a long-term leaseagreement. Our manufacturing facility consists of approximately 26,000 squarefeet of space in the facility. Our manufacturing facility is subject to thelicensing requirements of the California Department of Health Services. Ourfacility was inspected and licensed by the California Department of HealthServices. Our facility is subject to re-inspection at any time. Failure tomaintain a license from the California Department of Health Services or to meetthe inspection criteria of the California Department of Health Services woulddisrupt our manufacturing processes and prevent us from supplying FavId topatients. If an inspection by the California Department of Health Servicesindicates that there are deficiencies in our manufacturing process, we could berequired to take remedial actions at potentially significant expense, and ourfacility may be temporarily or permanently closed.

We will need to eitherexpand and qualify our current facility or construct and qualify a commercialscale manufacturing facility in order to commercialize FavId or any otherproduct candidates that we may develop. We believe our current facility couldbe used to manufacture FavId for initial commercial launch, and we beganconstruction to expand this facility during the second quarter of 2006. Wecannot assure you that we would be able to meet commercial demand forFavId in this facility. Additionally, we may require a larger productionfacility to meet the demand for FavId if it is approved. We would need to raiseadditional debt or equity capital to finance construction of the largerfacility. Such financing may not be available or, if available, may not beobtained on terms favorable to us or our stockholders.

Preparing a facility forcommercial manufacturing may involve unanticipated delays and the costs ofcomplying with FDA regulations may be significant. In addition, any materialchanges we make to the manufacturing process after approval may requireapproval by the FDA and state regulatory authorities. Obtaining these approvalsis a lengthy, involved process, and we may experience delays that could limitour ability to manufacture commercial quantities, increase our costs andadversely affect our business.

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

Manufacturing FavId is a complex,multi-step process that requires us to expend significant time, money andeffort in production, record keeping and quality systems to assure that FavIdwill meet product specifications and other regulatory requirements. To date, wehave manufactured FavId only for use in Phase 2 and Phase 3 clinical trials andhave no experience in manufacturing FavId for the commercial quantities thatmight be required if we receive regulatory approval. In particular, we cannotbe sure that we will be able to manufacture FavId at a cost that would enablecommercial use. We may experience any of the following problems in our effortsto manufacture our product candidates for our expanding clinical trials or on acommercial scale:

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·failure to 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,transportation restrictions or other reasons;

·failure to ensure adequate quality control and assurance in the manufacturingprocess as we increase the production quantities of FavId;

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

·failure to comply with regulatory requirements, such as FDA regulations andenvironmental laws;

·significant changes in regulatory requirements;

·damage to or destruction of our manufacturing facility or equipment;

·difficulty in qualifying a second-source supplier for certain criticalequipment; and

·shortages of qualified personnel.

In addition, because ourmanufacturing process only begins upon our receipt of a patient’s tumor biopsy,we cannot produce inventory reserves of our product candidate to be stored inanticipation of any of these potential manufacturing problems. The failure toproduce an adequate supply of FavId could delay our clinical trials and, inturn, delay submission of a BLA for FavId and commercial launch. Similarly, anydifficulties we experience in the manufacture and supply of other productcandidates, such as FAV-201, would delay the clinical trials of those productcandidates.

**If our manufacturing facility isdamaged or destroyed, our ability to manufacture products will be significantlyaffected, 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 theavailability and condition of our manufacturing facility in San Diego tomanufacture FavId. We lease the property where this facility is located under alease agreement that expires June 30, 2025, but may be extended at our optionfor two additional five-year periods. After that time, we may not be able tonegotiate a new lease for our facility. If the facility or our equipment in thefacility is damaged or destroyed, we will not be able to quickly orinexpensively replace our manufacturing capacity. This would significantlyaffect our ability to complete clinical trials of, and to manufacture andcommercialize, FavId, or any other product candidates that we may develop.

In addition, ourfacilities have been subject to electrical blackouts as a result of a shortageof available electrical power. Although we have back-up emergency powergenerators to cover energy needs for key support systems, a lengthy outagecould disrupt the operations of our facilities and clinical trials. While wecarry business interruption insurance, this insurance may not be adequate. Anysignificant business interruption could cause delays in our product developmentand harm our business.

***If we do not develop a sufficientsales and marketing force or enter into agreements with third parties to selland market FavId, we may not be able to successfully commercialize ourproducts, which would limit our ability to earn product revenues.**

We plan to retainexclusive worldwide rights to FavId for oncology indications at least until wereceive the results from the pivotal Phase 3 clinical trial. If we aresuccessful in obtaining BLA approval or foreign marketing approval for FavId,we will need to establish sales and marketing capabilities. In the UnitedStates, we plan to do this either by establishing our own sales force or byentering into a co-promotion arrangement with a sales and distribution partner.Outside of the United States, we plan to establish strategic collaborations forthe development and marketing of FavId.

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We do not presentlypossess the resources or experience necessary to market FavId or our otherproduct candidates ourselves, and we currently have no arrangements for thepromotion or distribution of our product candidates. Our future commercialsuccess will depend on our ability to establish our own sales and marketinginfrastructure or to collaborate with third parties that have greater sales andmarketing experience and resources. Developing effective internal sales andmarketing capabilities, which would include the hiring of a sales force, wouldrequire a significant amount of our financial resources and time.

We may be unable toestablish and manage an effective sales force in a timely or cost-effectivemanner, or at all, and any sales force we do establish may not be capable ofgenerating demand for FavId or any other product candidate we may develop. Inaddition, if we cannot enter into co-promotion arrangements in the UnitedStates, or other strategic collaborations for the development and marketing ofFavId in other countries, in a timely manner and on acceptable terms, we maynot be able to successfully commercialize FavId or any other product candidatethat we may develop.

To the extent that weenter into arrangements with third parties to perform sales, marketing anddistribution services, our product revenues are likely to be lower than if wedirectly marketed and sold FavId, or any other product candidates that we maydevelop. If we are unable to establish adequate sales, marketing and distributioncapabilities, independently or with others, we will not be able to generateproduct revenue and will not become profitable.

**If physicians and patients do not useany of our products that may be approved, our ability to generate revenue inthe future will be limited.**

If approved, FavId andother product candidates that we may develop may not gain market acceptanceamong physicians, healthcare payors, patients and the medical community. Demandfor any approved product that we may develop will depend on many factors,including:

·our ability to provide acceptable evidence of safety and efficacy;

·convenience and ease of administration;

·availability of alternative treatments;

·cost effectiveness;

·continuing widespread use of Rituxan to treat our initial target diseasemarket;

·effectiveness of our regulatory and marketing strategies;

·prevalence and severity of adverse side effects;

·publicity concerning our products or competitive products; and

·our ability to obtain third-party coverage or reimbursement.

Furthermore, to theextent FavId fails to gain market acceptance for its initial indication, it maybe more difficult for us to generate sufficient credibility with physicians andpatients to commercialize FavId for other indications.

**If we are unable to obtain acceptableprices or adequate coverage and reimbursement from third-party payors forFavId, or any other product candidates that we may develop, our revenues andprospects for profitability will suffer.**

Our ability tocommercialize FavId, or any other product candidates that we may develop,depends on the extent to which coverage and reimbursement for FavId, or anyother product candidates that we may develop, will be available from:

·governmental payors, such as Medicare and Medicaid;

·private health insurers, including managed care organizations; and

·other third-party payors.

Many patients will not becapable of paying for FavId, or any other product candidates that we maydevelop, themselves and will rely on third-party payors to pay for theirmedical needs. The federal and state governments, insurance companies,

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managed careorganizations and other third-party payors are actively seeking to contain orreduce costs of health care in the United States and exert increasing influenceon decisions regarding the use of, and reimbursement levels for, particulartreatments. Such third-party payors, including Medicare, are scrutinizing newlyapproved medical products and services and may not cover or may limit coverageand reimbursement for our product candidates. In particular, third-party payorsmay limit the indications for which they will reimburse patients who use FavId,or any other 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 lower productrevenues. If the prices for FavId, or any other product candidates that we maydevelop, decrease or if governmental and other third-party payors do notprovide adequate coverage and reimbursement levels for FavId, or any otherproduct candidates that we may develop, our revenue and prospects forprofitability will suffer.

***If we are unable to establish ormanage strategic collaborations in the future, our revenue and productdevelopment may be limited.**

Our strategy may includereliance on strategic collaborations for co-promotion of FavId in the UnitedStates. In addition, we expect to rely on strategic collaborators forcommercialization of FavId outside of the United States and, to an even greaterextent, for worldwide development and commercialization of product candidatesand programs for chronic autoimmune diseases, such as multiple sclerosis. Todate, we have not entered into any agreements with third parties for any ofthese services and do not plan to establish a collaboration for FavId in theUnited States until we have received results of the pivotal Phase 3 clinicaltrial.

Establishing strategiccollaborations is difficult and time-consuming. Our discussions with potentialcollaborators may not lead to the establishment of new collaborations onfavorable terms, or at all. For example, potential partners may rejectcollaborations based upon their assessment of our financial, regulatory or intellectualproperty position. If we successfully establish new collaborations, theserelationships may never result in the successful development orcommercialization of our product candidates or the generation of sales revenue.To the extent that we enter into co-promotion or other collaborativearrangements, our product revenues are likely to be lower than if we directlymarketed and sold any products that we may develop.

Management of anycollaborative relationship we may establish in the 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

·effective allocation of our resources to multiple projects.

If we enter intodevelopment or commercialization collaborations, our success will in partdepend on the performance of our corporate collaborators. We will not directlycontrol the amount or timing of resources devoted by our corporatecollaborators to activities related to our product candidates. Our corporatecollaborators may not commit sufficient resources to our research anddevelopment programs or the commercialization, marketing or distribution of ourproduct candidates. If any corporate collaborator fails to commit sufficientresources, our preclinical or clinical development related to the collaborationcould be delayed or terminated. Also, our collaborators may pursue developmentor commercialization of other products, product candidates or alternative technologiesin preference to our product candidates. Finally, our collaborators mayterminate our relationships, and we may be unable to establish additionalcorporate collaborations 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 focusedon the research, development and commercialization of targeted immunotherapiesfor the treatment of cancer and other diseases of the immune system. Theprocess of successfully developing product candidates is very time-consuming,expensive and unpredictable. We have only recently begun to direct significanteffort toward the development of product candidates in addition to FavId, suchas FAV-201 for T-cell lymphoma and a preclinical product candidate for thetreatment of multiple sclerosis. We do not know whether our planned preclinicalstudies or clinical trials for these other product candidates will begin on timeor be completed on schedule, or at all. In addition, we do not know whetherthese clinical trials will result in marketable products. Typically, there is ahigh rate of attrition for product candidates in preclinical and clinicaltrials. We do not anticipate that any of our product candidates will reach themarket for at least several years.

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We may not identify,develop or commercialize any additional new product candidates from ourproprietary active immunotherapy technology. Our ability to develop successfullyany of these product candidates depends on our ability to demonstrate safetyand efficacy in humans through extensive preclinical testing and clinicaltrials and to obtain regulatory approval from the FDA and other regulatoryauthorities. Development of our product candidates will also dependsubstantially upon the availability of funding for our research and developmentprograms.

***If our competitors develop andmarket products that are more effective than our existing product candidates orothers we may develop, or obtain marketing approval before we do, ourcommercial opportunity may be reduced or eliminated.**

The development andcommercialization of new pharmaceutical products for the treatment of cancerand autoimmune diseases is competitive, and we will face competition fromnumerous sources, including major pharmaceutical companies, specialtypharmaceutical companies and biotechnology companies worldwide. Many of ourcompetitors have substantially greater financial and technical resources anddevelopment, production and marketing capabilities than we do. In addition,many of these companies have more experience than we do in preclinical testing,clinical trials and manufacturing of biologic therapeutics, as well as inobtaining FDA and foreign regulatory approvals. We will also compete withacademic institutions, governmental agencies and private organizations that areconducting research in the fields of cancer and autoimmune disease. Competitionamong these entities to recruit and retain highly qualified scientific,technical and professional personnel and consultants is also intense.

We are aware of a numberof companies that are developing active immunotherapies to treat B-cell NHL.Genitope Corporation is evaluating its idiotype immunotherapy product candidatein a Phase 3 clinical trial in patients with follicular B-cell NHL who are inremission following prior treatment with chemotherapy. Antigenics, Inc.completed a Phase 2 clinical trial evaluating its active immunotherapy candidatein indolent NHL patients. The NCI is also conducting a Phase 3 clinical trialof an active idiotype immunotherapy in collaboration with AccentiaBiopharmaceuticals.

Several companies areengaged in the development and commercialization of passive immunotherapyproducts for the treatment of B-cell NHL that may compete with FavId. Genentechand Biogen Idec are co-marketing Rituxan for the treatment of relapsed orrefractory, indolent B-cell NHL. Biogen Idec is also marketing Zevalin, itspassive radioimmunotherapy product. GlaxoSmithKline plc currently marketsBexxar, a passive radioimmunotherapy product.

The most recent advancesin the treatment of B-cell NHL have involved the combination of existingproducts and changes to approved schedules and doses, particularly for Rituxan.Numerous clinical trials reported in recent years have indicated thatadditional doses of Rituxan and maintenance dosing of Rituxan can improve TTPin patients who respond to therapy. Combination therapies involvingchemotherapeutic or immunostimulatory drugs in combination with Rituxan atvarious doses and schedules may provide patients with an increase in TTP overthat expected with Rituxan alone. Accordingly, we may face competition as aresult of developments in this area.

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

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

·reliably and cost-effectively manufacture sufficient quantities of ourproducts;

·maintain a proprietary position for our manufacturing process and othertechnology;

·price our products competitively;

·obtain appropriate reimbursement approvals for our products;

·establish an adequate sales and marketing force for our products; and

·attract and retain key personnel.

In addition, our abilityto compete effectively will depend on the relative efficacy and safety of otheractive immunotherapy products approved for sale as compared to our ownproducts.

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**We aresubject to new legislation, regulatory proposals and managed care initiativesthat may increase our costs of compliance and adversely affect our ability tomarket our products, obtain collaborators and raise capital.**

There have been a numberof legislative and regulatory proposals aimed at changing the healthcare systemand pharmaceutical industry, including reductions in the cost of prescriptionproducts and changes in the levels at which consumers and healthcare providersare reimbursed for purchases of pharmaceutical products. For example, thePrescription Drug and Medicare Improvement Act of 2003 was recently enacted.This legislation provides a new Medicare prescription drug benefit beginning in2006 and mandates other reforms. Although we cannot predict the full effects onour business of the implementation of this new legislation, it is possible thatthe new benefit, which will be managed by private health insurers, pharmacybenefit managers and other managed care organizations, will result in decreasedreimbursement for prescription drugs, which may further exacerbateindustry-wide pressure to reduce the prices charged for prescription drugs.This could harm our ability to market our products and generate revenues.

**We depend on attracting and retainingkey scientific and management personnel to advance our technology, and the lossof these personnel could impair the development of our products.**

Our success depends onour continued ability to attract, retain and motivate highly qualifiedmanagement, clinical and scientific personnel and on our ability to develop andmaintain important relationships with leading academic institutions, cliniciansand scientists. We are highly dependent upon our senior management andscientific staff, particularly John P. Longenecker, Ph.D., our President andChief Executive Officer, and Daniel P. Gold, Ph.D., one of our co-founders andour Chief Scientific Officer. The loss of services of Dr. Longenecker orDr. Gold, or one or more of our other members of senior management, coulddelay or prevent the successful completion of our pivotal Phase 3 clinicaltrial or the commercialization of FavId. Although we have employment agreementswith each of our executives, their employment with us is “at will,” and eachexecutive can terminate his or her agreement with us at any time. We do notcarry “key person” insurance covering members of senior management, other thanDrs. Longenecker and Gold. This insurance may not continue to be availableon commercially reasonable terms and may prove inadequate to compensate us forthe loss of their services.

The competition forqualified personnel in the biotechnology field is intense. In particular, ourmanufacturing process depends on our ability to attract and retain qualifiedmanufacturing and quality control personnel. We will need to hire additionalpersonnel as we continue to expand our manufacturing, research and developmentactivities. We may not be able to attract and retain quality personnel onacceptable terms given the competition for such personnel among biotechnology,pharmaceutical and other companies. We are not aware of any key personnelplanning to retire or terminate their employment in the near future.

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

As of September 30, 2006,we had 150 employees. Of these, 121 employees were in research and developmentcomprised of 86 in manufacturing, quality control and quality assurance, 32 inresearch and process development, and three members of senior management. Of the remaining employees, three were members of senior management and 26 werein marketing, general and administration. We will need to expand our financial,managerial, operational and other resources in order to continue our clinicaltrials and commercialize FavId, FAV-201, or any other product candidates thatwe may develop. Future growth would impose significant added responsibilitieson our management team, including the need to identify, recruit, maintain andintegrate additional employees. Our ability to commercialize FavId, FAV-201, orany other product candidates that we may develop, and our future financialperformance in general, will depend in part on our ability to manage any futuregrowth effectively. In order to meet these challenges, we would need to:

·manage our clinical trials effectively;

·manage our research and development efforts effectively;

·develop our administrative, accounting and management information systems andcontrols; and

·hire, train and integrate additional management, administrative, manufacturingand sales and marketing personnel.

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

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**If weuse biological and hazardous materials in a manner that causes injury orviolates laws, we may be liable for damages.**

Our research anddevelopment and manufacturing activities involve the use of biological andhazardous materials that could be dangerous to human health, safety or theenvironment. Although we believe our safety procedures for handling anddisposing of these materials comply with federal, state and local laws andregulations, we cannot entirely eliminate the risk of accidental injury orcontamination from the use, storage, handling or disposal of these materials.In the event of contamination or injury, we could be held liable for anyresulting damages, and any liability could exceed our resources. We currentlymaintain property and casualty insurance coverage which covers liability forhazardous and controlled materials. However, this insurance coverage may not besufficient to cover our liability and we may not be able to obtain sufficientcoverage in the future at a reasonable cost. In addition, we may incursignificant costs complying with both existing and future environmental lawsand regulations. In particular, we are subject to regulation by theOccupational Safety and Health Administration, or OSHA, and the EnvironmentalProtection Agency, or EPA, and to regulation under the Toxic Substances ControlAct and the Resource Conservation and Recovery Act. OSHA, the EPA or otheragencies may adopt regulations that adversely affect our research anddevelopment programs.

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

Our business exposes usto potential liability risks that may arise from the clinical testing of ourproduct candidates and the manufacture and sale of any approved products. Theserisks will exist even with respect to those product candidates that areapproved for commercial sale by the FDA and manufactured in facilitiesregulated by the FDA. Any product liability claim or series of claims broughtagainst us could significantly harm our business by, among other things,reducing demand for our products, injuring our reputation and creatingsignificant adverse media attention and costly litigation. Plaintiffs havereceived substantial damage awards in some jurisdictions against pharmaceuticalcompanies based upon claims for injuries allegedly caused by the use of theirproducts. Any judgment against us that is in excess of our insurance policylimits would have to be paid from our cash reserves, which would reduce ourcapital resources. We currently maintain clinical trial insurance. Although webelieve our current insurance coverage is adequate, we cannot be certain thatit will be sufficient. Furthermore, we cannot be certain that our currentinsurance coverage will continue to be available, or that increased coverage,which will be necessary if we are able to commercialize our products, will beavailable in the future on reasonable terms, or at all. Further, we may nothave sufficient capital resources to pay a judgment, in which case ourcreditors could levy claims against our assets, including our intellectualproperty.

**We could be negatively impacted byfuture interpretation or implementation of federal and state fraud and abuselaws, including anti-kickback laws and other federal and state anti-referrallaws.**

If we are able tocommercialize FavId or any other product candidates that we may develop, wewill be subject to various federal and state laws pertaining to healthcarefraud and abuse, including anti-kickback laws and physician self-referral laws.Violations of these laws are punishable by criminal and civil sanctions,including, in some instances, imprisonment and exclusion from participation infederal and state healthcare programs, including Medicare, Medicaid andVeterans Administration health programs. Because of the far-reaching nature ofthese laws, we may be required to alter one or more of our practices to be incompliance with these laws. Healthcare fraud and abuse regulations are complex,and even minor, inadvertent irregularities can potentially give rise to claimsthat a statute or prohibition has been violated. Any violations of these laws,or any action against us for violation of these laws, even if we successfullydefend against it, could result in a material adverse effect on our business,financial condition and results of operations. If there is a change in law,regulation or administrative or judicial interpretations, we may have to changeour business practices or our existing business practices could be challengedas unlawful, which could have a material adverse effect on our business,financial condition and results of operations. In addition, some allegationsunder these laws have been claimed to violate the False Claims Act, discussedin more detail below.

In addition, if we areable to commercialize FavId or any other product candidates that we maydevelop, we could become subject to false claims litigation under federalstatutes, which can lead to civil money penalties, criminal fines andimprisonment, and exclusion from participation in Medicare, Medicaid and otherfederal and state healthcare programs. These false claims statutes include theFalse Claims Act, which allows any person to bring suit on behalf of thefederal government alleging the submission of false or fraudulent claims, orcausing to present such false or fraudulent claims, under federal programs orcontracts claims or other violations of the statute and to share in any amountspaid by the entity to the government in fines or settlement. These suitsagainst biotechnology companies have increased significantly in recent yearsand have increased the risk that a healthcare company will have to defend afalse 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 againstsuch actions, that such actions will not have a material adverse effect on ourbusiness, financial condition and results

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of operations. Inaddition, we cannot assure you that the costs of defending claims orallegations under the False Claims Act will not have a material adverse effecton our business, financial condition and results of operations.

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

***If we are unable to obtain andmaintain protection for our intellectual property, the value of our technologyand products may be adversely affected.**

Our business andcompetitive positions are dependent upon our ability to protect our proprietarytechnology. Our success will depend in large part on our ability to obtain andmaintain patent protection for our product and technologies, preserve tradesecrets and operate without infringing the intellectual property right ofothers. Because of the substantial length of time and expense associated withdevelopment of new products, we, along with the rest of the biopharmaceuticalindustry, place considerable importance on obtaining and maintaining patentprotection for new technologies, products and processes. The patent positionsof pharmaceutical, biopharmaceutical and biotechnology companies, including us,are generally uncertain and involve complex legal and factual questions. Ourpatent applications may not protect our technologies and products because,among other things:

·there is no guarantee that any of our pending patent applications will resultin issued patents;

·we may develop additional proprietary technologies that are not patentable;

·there is no guarantee that any patents issued to us, our collaborators or ourlicensors will provide a basis for a commercially viable product;

·there is no guarantee that any patents issued to us or our collaborators or ourlicensors will provide us with any competitive advantage;

·there is no guarantee that any patents issued to us or our collaborators or ourlicensors will not be challenged, circumvented or invalidated by third parties;and

·there is no guarantee that any patents previously issued to others or issued inthe future will not have an adverse effect on our ability to do business.

We attempt to protect ourintellectual property position by filing United States patent applicationsrelated to our proprietary technology, inventions and improvements that areimportant to the development of our business. Currently we own U.S. Patent No.6,911,204 concerning the treatment of NHL with our technology together withfour pending United States patent applications covering methods of treatingimmune system diseases, including B-cell and T-cell lymphomas, using ourproprietary immunotherapy production methods, as well as methods for combiningthe idiotype immunotherapies with other therapies that are used to treat diseasesof the immune system.

Outside of the UnitedStates, we have six issued patents and twenty-four pending patentapplications.  Limitations on patentprotection in some countries outside the United States, and the differences inwhat constitutes patentable subject matter in these countries, may limit theprotection we have under patents issued to us outside of the United States. Inaddition, laws of foreign countries may not protect our intellectual propertyto the same extent as would laws of the United States. In determining whetheror not to seek a patent or to license any patent in a particular foreigncountry, we weigh the relevant costs and benefits, and consider, among otherthings, the market potential of our product candidates in the jurisdiction, andthe scope and enforceability of patent protection afforded by the law of thejurisdiction. Failure to obtain adequate patent protection for our proprietaryproduct candidates and technology would impair our ability to be commerciallycompetitive in these markets.

Although we believe ourissued patents, as well as our patent applications if they issue as patents,will provide a competitive advantage, we may not be able to develop additionalpatentable products or processes.  Further, we may not be able to obtainpatents from any of the pending applications. Even if patent claims areallowed, the claims may not issue, or in the event of issuance, may not besufficient to protect our technology. In addition, any patents or patent rightswe obtain may be circumvented, challenged or invalidated by our competitors.

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**We arenot able to prevent others, including potential competitors, from using certaintypes of patient-specific idiotype protein-KLH conjugates, like those we use inour lead product candidate, FavId, for the treatment of indolent B-cell NHL.**

Certain types ofpatient-specific idiotype-KLH conjugates, comprising single idiotype proteins,and their use for the treatment of indolent B-cell NHL are in the public domainand therefore cannot be patented. Consequently, we may only be able to seekpatent protection for methods of treating immune system diseases, includingB-cell and T-cell lymphomas, using our proprietary immunotherapy productionmethods for making idiotype protein conjugates and compositions comprising suchconjugates, as well as methods for combining the idiotype or T-cellreceptor-based immunotherapies with other therapies that are used to treatdiseases of the immune system. As a result, we may not be able to prevent othercompanies using different manufacturing processes from developing activeimmunotherapies 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, resultsof operations, financial condition and cash flow.**

The pharmaceutical fieldis characterized by a large number of patent filings involving complex legaland factual questions, and, therefore, we cannot predict with certainty whetherour patents will be enforceable. Competitors may have filed applications for orhave been issued patents and may obtain additional patents and proprietaryrights related to products or processes that compete with or are similar toours. We may not be aware of all of the patents potentially adverse to ourinterests that may have been issued to others. Litigation may be necessary toprotect our patent position, and we cannot be certain that we will have therequired resources to pursue litigation or otherwise to protect our patentrights. In addition, our efforts to protect our patents may not be successful.

**Our ability to market our productsmay be impaired by the intellectual property rights of third parties.**

Our commercial successwill depend in part on not infringing the patents or proprietary rights ofthird parties. We are aware of competing intellectual property relating toactive idiotype immunotherapies for cancer. Competitors or third parties may beissued, or may currently hold, patents that may cover subject matter that weuse in developing the technology required to bring our product candidates tomarket, that we use in producing our product candidates, or that we use intreating patients with our product candidates. In addition, from time to timewe receive correspondence inviting us to license patents from third parties.While we currently believe we have freedom to operate in our area, others maychallenge our position in the future. There has been, and we believe that therewill continue to be, significant litigation in the pharmaceutical industryregarding patent and other intellectual property rights.

While we believe that ourpre-commercialization activities fall within the scope of an availableexemption against patent infringement provided by 35 U.S.C. §271(e), andthat our subsequent manufacture of our commercial products will also notrequire the license of any patents, claims may be brought against us in thefuture based on these or other patents held by others. As our product candidatesprogress toward commercialization, competitors or other parties may assert thatwe infringe on their patents or proprietary rights.

In particular, we areaware 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 listedabove was issued to Genentech in 2001. We do not believe that this patentcovers our technology, and we note that in May 2005, a third party filed arequest for reexamination of this patent with the U.S. Patent and TrademarkOffice, requesting that the claims of this patent be reexamined as to theirpatentability; the reexamination is currently pending.  If this patent reissues and we decide toattempt to obtain a license for this patent, we cannot guarantee that we wouldbe able to obtain such a license on commercially reasonable terms, or at all.

Additionally, becausepatent prosecution can proceed in secret prior to issuance of a patent, thirdparties may obtain other patents with claims of unknown scope relating to ourproduct candidates, which they could attempt to assert against us. Further, aswe develop our products, we may infringe the current patents of third partiesor patents that may issue in the future.  Third parties could bring legalactions against us claiming damages and seeking to enjoin clinical testing,

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manufacturing andmarketing of the affected product or products. If we become involved in anylitigation, it could consume a substantial portion of our resources, regardlessof the outcome of the litigation. If any of these actions are successful, inaddition to any potential liability for damages, we could be required to obtaina license to continue to manufacture or market the affected product, in whichcase we may be required to pay substantial royalties or grant cross-licenses toour patents. However, there can be no assurance that any such license will beavailable on acceptable terms or at all. To enforce patents issued to us or todetermine the scope and validity of other parties’ proprietary rights, we mayalso become involved in litigation or in interference proceedings declared bythe United States Patent and Trademark Office, which could result in substantialcosts to us, regardless of the outcome of the litigation, or an adversedecision as to the priority of our inventions. Ultimately, as a result ofpatent infringement claims, our business could be harmed and we could beprevented from commercializing a product, or forced to cease some aspect of ourbusiness operations.

**If we are not able to protect andcontrol unpatented trade secrets, know-how and other technological innovation,we may suffer competitive harm.**

We also rely on tradesecrets to protect our technology, particularly when we do not believe thatpatent protection is appropriate or available. However, trade secrets aredifficult to protect. We attempt to protect our trade secrets by requiring eachof our employees, consultants and advisors to execute a non-disclosure andassignment of invention agreement before beginning his or her employment,consulting or advisory relationship with us. We cannot guarantee that theseagreements will provide meaningful protection, that these agreements will not bebreached, that we will have an adequate remedy for any such breach, or that ourtrade secrets will not otherwise become known or independently developed by athird party. Our trade secrets, or those of our future collaborators, maybecome known or may be independently discovered by others, which couldadversely affect the competitive position of our product candidates.

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

***Until our initial public offering inFebruary 2005, there was no public market for our common stock, and the priceof our common stock may be volatile and could decline significantly.**

Until our initial publicoffering, or IPO, in February 2005, there was no public market for ourcommon stock, and despite our IPO, an active public market for these shares maynot develop or be sustained. Our stock price has traded in the range of $7.77 -$3.20 from the commencement of our IPO on February 2, 2005 to November 10,2006.

The stock market ingeneral has been experiencing dramatic fluctuations that have often beenunrelated to the operating performance of companies. The market prices forsecurities of biotechnology companies in general have been highly volatile andmay continue to be highly volatile in the future. If market-based orindustry-based volatility continues, the trading price of our common stockcould decline significantly, independent of our actual operating performance,and you could lose all or part of your investment. The market price of ourcommon stock could fluctuate significantly as a result of several factors,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;

·actions taken by regulatory agencies with respect to FavId and FAV-201, or anyother product 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;

·success of our research efforts and clinical trials;

·any intellectual property infringement lawsuit in which we may become involved;

·announcements concerning our competitors, or the biotechnology orbiopharmaceutical industries in general;

·actual or anticipated fluctuations in our operating results;

·changes in financial estimates or recommendations by securities analysts;

·sales of large blocks of our common stock;

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

·changes in accounting principles; and

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

Specifically, you may notbe able to resell your shares at or above the price you paid for such shares.In addition, class action litigation has often been instituted againstcompanies whose securities have experienced periods of volatility in marketprice. Any such litigation brought against us could result in substantial costsand a diversion of management’s attention and resources, which could hurt ourbusiness, operating results and financial 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 September 30, 2006,our officers and directors, stockholders affiliated with our directors andthose stockholders owning at least ten percent of our outstanding capital stocktogether beneficially held approximately 60.6% of our outstanding common stockon an as-converted basis. If some or all of these officers, directors andprincipal stockholders act together, they will be able to exert a significantdegree of influence over our management and affairs and over matters requiringstockholder approval, including the election of directors, the merger,consolidation or sale of all or substantially all of our assets, and any othersignificant corporate transaction. The interests of this concentration ofownership may not always coincide with our interests or the interests of ourother stockholders. For instance, officers, directors and principalstockholders, acting together, could cause us to enter into transactions oragreements that we would not otherwise consider. Similarly, this concentrationof ownership may have the effect of delaying or preventing a change in controlof us otherwise favored by our other stockholders. This concentration ofownership also could depress our stock price.

**Provisions in our amended andrestated certificate of incorporation and amended and restated bylaws andapplicable Delaware law may prevent or discourage third parties or ourstockholders from attempting to replace our management or influencing significantdecisions.**

Provisions in our amendedand restated certificate of incorporation and amended and restated bylaws mayhave the effect of delaying or preventing a change in control of us or ourmanagement, even if doing so would be beneficial to our stockholders. Theseprovisions include:

·dividing our board of directors into three classes serving staggered three-yearterms;

·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;

·limiting the 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

·requiring advance notice for raising business matters or nominating directorsat stockholders’ meetings.

We are also subject toprovisions of the Delaware corporation law that, in general, prohibit anybusiness combination with a beneficial owner of 15% or more of our common stockfor five years unless the holder’s acquisition of our stock was approved inadvance by our board of directors. Together, these charter and statutoryprovisions could make the removal of management more difficult and maydiscourage transactions that otherwise could involve payment of a premium overprevailing market prices for our common stock.

**Because we do not intend to pay anycash dividends on our shares of common stock, our stockholders will not be ableto receive a return on their shares unless they sell them.**

We have never paid ordeclared any cash dividends on our capital stock and intend to retain anyfuture earnings to finance the development and expansion of our business. The paymentof dividends by us on our common stock is limited by our debt

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agreements. We do notanticipate paying any cash dividends on our common stock in the foreseeablefuture. Unless we pay dividends, our stockholders will not be able to receive areturn on their shares unless they sell them.

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

Recently enacted andproposed changes in the laws and regulations affecting public companies,including the provisions of the Sarbanes-Oxley Act of 2002 andrules related to corporate governance and other matters subsequentlyadopted by the SEC and the Nasdaq Stock Market, could result in increased coststo us. The new rules and any related regulations that may be proposed inthe future could make it more difficult or more costly for us to obtain certaintypes of insurance, including directors’ and officers’ liability insurance, andwe may be forced to accept reduced policy limits and coverage or incursubstantially higher costs to obtain the same or similar coverage. The impactof these events could also make it more difficult for us to attract and retainqualified persons to serve on our board of directors, our board committees oras executive officers. We are presently evaluating and monitoring developmentswith respect to new and proposed rules and cannot predict or estimate theamount of the additional costs we may incur or the timing of such costs.

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

Our initial public offering of our common stock, par value $0.001, waseffected through a Registration Statement on Form S-1 (FileNo. 333-114299) that was declared effective by the Securities andExchange Commission on February 2, 2005. On February 7, 2005, 6 million shares of our common stock were soldfor an aggregate offering price of $42.0 million.  On March 7, 2005,285,000 shares of our common stock were sold for an aggregate offering price of$2.0 million upon the partial exercise of the underwriters’ over-allotmentoption.  Our initial public offering resulted in aggregateproceeds to us of approximately $39.5 million, net of underwritingdiscounts and commissions of approximately $3.1 million and offering expensesof approximately $1.4 million, through a syndicate of underwriters managed byBear, Stearns & Co. Inc., CIBC World Markets Corp., Needham &Company, Inc. and A.G. Edwards & Sons, Inc.

No offering expenses were paid directly or indirectly to any of ourdirectors or officers (or their associates) or person owning ten percent ormore of any class of our equity securities or to any other affiliates. All offering expenses were paid directly to others.

We had invested $40.9 million in proceeds from the offering, net ofunderwriting discounts and commissions but before expenses, in governmentagency securities, corporate bonds and notes and money market funds. Through September 30, 2006, we used approximately $40.7 million of the proceedsfrom our initial public offering to develop and prepare for filing abiologic license application, or BLA, for regulatory approval of FavId, fordevelopment of our other product candidates, for marketing, general andadministrative expenses, and for working capital, including debt repayments.

The foregoing paymentswere direct payments made to third parties who were not our directors orofficers (or their associates), persons owning ten percent or more of any classof our equity securities or any other affiliate, except that the proceeds usedfor operating expense included regular compensation for our officers anddirectors.  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 Act of 1933,as amended, with the Securities and Exchange Commission on February 3, 2005.

In the three months endedSeptember 30, 2006, there were no unregistered sales of equity.

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**Item 6.  Exhibits.**

The exhibits listed on the accompanying index toexhibits are filed or incorporated by reference (as stated therein) as part ofthis 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)                                                                                                                       |
|            |       |                                                                                                                                                                                            |
| 10.1            |       | First Amendment to Amended and Restated Office Lease  dated September 22, 2006 between the Registrant and Kilroy, L.P.                                                                          |
|            |       |                                                                                                                                                                                            |
| 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 onForm S-1 (File No. 333-114299), as amended, and incorporated byreference herein.

(2)   Previously filed as an exhibit to Favrille’sCurrent Report on Form 8-K dated March 6, 2006 and incorporated herein byreference.

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**Favrille, Inc.**

**SIGNATURES**

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