Anadys Pharmaceuticals 10Q 2006 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(MARK ONE)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO .

COMMISSION FILE NUMBER: 0-31161

ANADYS PHARMACEUTICALS, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


Delaware		22-3193172
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)		(I.R.S. EMPLOYER IDENTIFICATION NO.)

3115 Merryfield Row
San Diego, California		92121
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)		(ZIP CODE)

Company’s telephone number, including area code: 858-530-3600

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yesþ Noo

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

Large accelerated filero Accelerated filerþ Non-accelerated filero

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yeso Noþ

The number of shares of common stock outstanding as of the close of business on November 1, 2006:


Class		Number of Shares Outstanding
Common Stock, $0.001 par value		28,561,989

ANADYS PHARMACEUTICALS, INC.

Table of Contents


	Page
	Number
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements		3
Condensed Consolidated Balance Sheets — As of September 30, 2006 and December 31, 2005		3
Condensed Consolidated Statements of Operations — Three and nine months ended September 30, 2006 and 2005		4
Condensed Consolidated Cash Flow Statements — Nine months ended September 30, 2006 and 2005		5
Notes to Condensed Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
Item 3. Quantitative and Qualitative Disclosures About Market Risk		19
Item 4. Controls and Procedures		19

PART II. OTHER INFORMATION
Item 1A. Risk Factors		20
Item 6. Exhibits		40
SIGNATURES		41
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ANADYS PHARMACEUTICALS, INC.

Condensed Consolidated Balance Sheets
(In thousands, except share and per share amounts)


	September 30,			December 31,
	2006			2005
	(Unaudited)			(Note)
Assets
Current assets:

Cash and cash equivalents	$	68,329		$	93,659
Securities available-for-sale		20,444			11,192
Accounts receivable		1,503			6,025
Prepaid expenses and other current assets		944			651

Total current assets		91,220			111,527

Property and equipment, net		4,007			3,809
Other assets, net		1,445			1,640


Total assets	$	96,672		$	116,976


Liabilities and Stockholders’ Equity
Current liabilities:

Accounts payable and accrued expenses	$	4,850		$	4,879
Current portion of long-term debt		—			854
Current portion of deferred rent		437			433
Deferred revenue		4,458			6,679

Total current liabilities		9,745			12,845

Long-term debt, net of current portion		—			682
Long-term portion of deferred rent		1,046			1,370
Long-term portion of deferred revenue		20,237			23,143

Commitments and contingencies

Stockholders’ equity:

Preferred stock, $0.001 par value; 10,000,000 shares authorized at September 30, 2006 and December 31, 2005, respectively; no shares issued and outstanding at September 30, 2006 and December 31, 2005.		—			—
Common stock, $0.001 par value; 90,000,000 shares authorized at September 30, 2006 and December 31, 2005; 28,561,989 and 28,374,136 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively		29			28
Additional paid-in capital		272,468			267,499
Deferred compensation		—			(839	)
Accumulated other comprehensive gain (loss)		9			(32	)
Accumulated deficit		(206,862	)		(187,720	)

Total stockholders’ equity		65,644			78,936


Total liabilities and stockholders’ equity	$	96,672		$	116,976

See accompanying notes to unaudited condensed consolidated financial statements.

Note: The balance sheet at December 31, 2005, has been derived from audited financial statements at that date but does not include all of the disclosures required by U.S. generally accepted accounting principles for complete financial statements.

ANADYS PHARMACEUTICALS, INC.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)


	Three months ended September 30,						Nine months ended September 30,
	2006			2005			2006			2005
Revenues:

Collaborative agreements	$	1,139		$	1,564		$	4,228		$	2,489
Grants		6			173			41			391


Total revenues		1,145			1,737			4,269			2,880

Operating Expenses:

Research and development		5,496			3,671			18,978			16,675
General and administrative		3,097			2,052			7,835			5,886


Total operating expenses		8,593			5,723			26,813			22,561

Interest income and other, net		1,189			635			3,471			1,092
Interest expense		—			(63	)		(69	)		(267	)


Net interest income and other		1,189			572			3,402			825


Net loss		(6,259	)		(3,414	)		(19,142	)		(18,856	)


Net loss per share, basic and diluted	$	(0.22	)	$	(0.13	)	$	(0.67	)	$	(0.80	)


Shares used in calculating net loss per share, basic and diluted		28,562			25,819			28,489			23,544

See accompanying notes to unaudited condensed consolidated financial statements.

ANADYS PHARMACEUTICALS, INC.

Condensed Consolidated Cash Flow Statements
(In thousands)
(Unaudited)


	Nine months ended September 30,
	2006			2005
Operating Activities:
Net loss	$	(19,142	)	$	(18,856	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		1,163			1,107
Share-based compensation expense		4,951			1,653
Rent expense related to warrants issued in connection with lease		38			39
Interest expense related to warrants issued in connection with debt		23			37
Loss on disposal of property and equipment		61			2
Changes in operating assets and liabilities:
Accounts receivable		4,522			(3,881	)
Prepaid expenses and other current assets		(293	)		360
Other assets, net		195			206
Accounts payable and accrued expenses		(29	)		1,427
Deferred revenue		(5,127	)		30,571
Deferred rent		(320	)		69


Net cash (used in) provided by operating activities		(13,958	)		12,734

Investing Activities:
Purchases of securities available-for-sale		(11,961	)		(8,294	)
Proceeds from sale and maturity of securities available-for-sale		2,750			25,109
Purchases of property and equipment		(1,422	)		(652	)


Net cash (used in) provided by investing activities		(10,633	)		16,163
Financing Activities:
Proceeds from sale of common stock, net of issuance costs		—			66,435
Proceeds from exercise of stock options and employee stock purchase plan		820			817
Proceeds from the issuance of long-term debt		—			393
Principal payments on long-term debt		(1,559	)		(1,088	)


Net cash (used in) provided by financing activities		(739	)		66,557

Net (decrease) increase in cash and cash equivalents		(25,330	)		95,454
Cash and cash equivalents at beginning of period		93,659			5,988


Cash and cash equivalents at end of period	$	68,329		$	101,442


Supplemental Disclosure of Non-Cash Investing and Financing Activities:

Unrealized gain on securities available-for-sale	$	41		$	24

See accompanying notes to unaudited condensed consolidated financial statements.

ANADYS PHARMACEUTICALS, INC.

Notes To Condensed Consolidated Financial Statements

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Anadys Pharmaceuticals, Inc. (together with its wholly owned subsidiaries, Anadys Pharmaceuticals Europe GmbH and Anadys Development Limited, the Company) should be read in conjunction with the audited financial statements and notes as of and for the year ended December 31, 2005 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on March 15, 2006. The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information, in accordance with the instructions to Form 10-Q and the guidance in Article 10 of Regulation S-X. Accordingly, since they are interim financial statements, the accompanying financial statements do not include all of the information and disclosures required by U.S. GAAP for complete financial statements. The accompanying financial statements reflect all adjustments, consisting of normal recurring adjustments, that are, in the opinion of management, necessary for a fair statement of the results of operations for the interim periods presented. Interim results are not necessarily indicative of results for a full year.

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements and notes thereto. A discussion of the Company’s critical accounting policies and management estimates is described in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this quarterly report on Form 10-Q.

2. Revenue Recognition

The Company may receive payments from collaborators for compound licenses, technology access fees, option fees, research services, milestones and royalty obligations. These payments are recognized as revenue or reported as deferred revenue until they meet the criteria for revenue recognition as outlined in Staff Accounting Bulletin (SAB) No. 104,Revenue Recognition,which provides guidance on revenue recognition in financial statements, and is based on the interpretations and practices developed by the SEC and Emerging Issues Task Force (EITF) Issue 00-21,Revenue Arrangements with Multiple Deliverables.The Company recognizes revenue when (1) persuasive evidence of the arrangement exists; (2) delivery has occurred or services were rendered; (3) the price is fixed or determinable and (4) the collectibility is reasonably assured. In addition, the Company has followed the following principles in recognizing revenue:

	•		Revenue from milestones is recognized when earned, as evidenced by written acknowledgment from the collaborator or other persuasive evidence that the milestone has been achieved, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement, (ii) the Company’s performance obligations after the milestone achievement will continue to be funded by the collaborator at the comparable level and (iii) the milestone is not refundable or creditable. If all of these criteria are not met, the milestone payment is recognized over the remaining minimum period of the Company’s performance obligations under the agreement. Upfront fees under collaborations, such as technology access fees, are recognized over the period the related services are provided. Non-refundable upfront fees not associated with the Company’s future performance are recognized when received.

	•		Fees the Company receives for research services are generally recognized as the services are provided, as long as the amounts received are not refundable regardless of the results of the research project. Research services may include agreements through which the Company will deploy its internal capabilities to assist a collaborator to advance their target, such as the Company’s medicinal chemistry and screening capabilities.

3. Net Loss Per Share

The Company calculates basic and diluted net loss per share for all periods presented in accordance with the Statement of Financial Accounting Standards (SFAS) No. 128,Earnings Per Share. Basic net loss per share was calculated by dividing the net loss for the period by the weighted-average number of common shares outstanding during the period, without consideration for common stock equivalents. Diluted net loss per share was calculated by dividing the net loss for the period by the weighted-average number of common stock equivalents outstanding during the period determined using the treasury-stock method. For purposes of this calculation, options and warrants are considered to be common stock equivalents and are only included in the calculation of diluted earnings per share when their effect is dilutive. The Company has excluded all outstanding options and warrants from the calculation of diluted net loss per common share because all such securities are anti-dilutive for all periods presented.


	For the nine months ended September 30,
	2006		2005
	(In thousands)
Historical outstanding anti-dilutive securities not included in diluted net loss per share calculation
Options to purchase common stock		3,684		2,293
Warrants		279		376

		3,963		2,669

4. Comprehensive Loss

Comprehensive loss is comprised of net loss adjusted for changes in market values in securities available-for-sale. Below is a reconciliation of net loss to comprehensive loss for the periods presented.


	Three months ended September 30,						Nine months ended September 30,
	2006			2005			2006			2005
	(in thousands)						(in thousands)
Net loss	$	(6,259	)	$	(3,414	)	$	(19,142	)	$	(18,856	)
Unrealized gain on securities available-for-sale		116			13			41			24

Comprehensive loss	$	(6,143	)	$	(3,401	)	$	(19,101	)	$	(18,832	)

5. Share-Based Payment

Background

In 2002, the Company adopted the 2002 Equity Incentive Plan (2002 Plan). In connection with the adoption of the 2002 Plan, the Company’s 1994 Stock Option Plan and 1998 Equity Incentive Plan (collectively, Prior Plans) were amended and restated into the 2002 Plan. All options that were previously granted under the Prior Plans became governed by the 2002 Plan and the Prior Plans no longer existed as individual plans. The 2002 Plan provided for the issuance of incentive stock options (ISO) to officers and other employees of the Company and non-qualified stock options (NQSO), awards of stock and direct stock purchase opportunities to directors, officers, employees and consultants of the Company.

Upon the effectiveness of the Company’s initial public offering (IPO), the 2004 Equity Incentive Plan (2004 Plan) was adopted. The initial share reserve under the 2004 Plan was equal to the number of shares of common stock reserved under the 2002 Plan that remained available for future stock awards upon the effectiveness of the IPO. Options granted under the 2002 Plan continue to be governed by the provisions of the 2002 Plan.

On September 5, 2006, the Company registered an additional 999,669 shares for issuance under the 2004 Plan in accordance with the provisions of the 2004 Plan. The total number of shares which remain available for grant under the 2004 Plan is 1,049,391 at September 30, 2006. The options are exercisable at various dates and will expire no more than ten years from their date of grant. The exercise price of each option is equal to the fair market value of the Company’s stock on the date of the option grant.

Upon the effectiveness of the Company’s IPO, the 2004 Non-Employee Directors’ Stock Option Plan (NEDSOP Plan) was adopted. On September 5, 2006, the Company registered an additional 50,000 shares for issuance under the NEDSOP Plan in accordance with the provisions of the NEDSOP Plan. The total number of shares which remain available for grant under the NEDSOP Plan is 221,333 at September 30, 2006. The options are exercisable at various dates and will expire no more than ten years from their date of grant. The exercise price of each option is equal to the fair market value of the Company’s stock on the date of the option grant.

In connection with the hiring of both James L. Freddo, M.D., the Company’s Chief Medical Officer, and James T. Glover, the Company’s Senior Vice President of Operations and Chief Financial Officer, the Compensation Committee of the Company’s Board of Directors approved inducement grants of a non-qualified stock option to purchase a total of 200,000 and 175,000 shares of Anadys’ Common Stock, respectively. These option awards were granted without stockholder approval pursuant to NASDAQ Marketplace Rule 4350(i)(1)(A)(iv). Although these options were granted outside the 2004 Plan, they are subject to substantially identical terms and conditions as those contained in the 2004 Plan.

A summary of the Company’s stock option activity and related information during the nine months ended September 30, 2006 is as follows:


						Weighted-
				Weighted		Average
				Average		Remaining		Aggregate
	Options			Exercise		Contractual		Intrinsic Value
	Outstanding			Price		Term		(in thousands)
Balance at January 1, 2006		3,089,271		$	6.06
Granted		809,250			6.78
Exercised		(134,987	)		4.05
Cancelled		(79,813	)		8.14

Balance at September 30, 2006		3,683,721		$	6.25		8.19	$	7

Exercisable at September 30, 2006		1,324,453		$	4.54		6.91	$	—

The total intrinsic value of options exercised during the nine months ended September 30, 2006 was $971,000, determined as of the date of exercise.

Adoption of SFAS No. 123R, Share Based Payment

In December 2004, the Financial Accounting Standards Board issued Statement No. 123 (revised 2004),Share-Based Payment(SFAS No. 123R), which is a revision of SFAS No. 123,Accounting for Stock-Based Compensation(SFAS No. 123).This statement supersedes Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees,(APB No. 25), and amends SFAS No. 95,Statement of Cash Flows. Generally, the approach in SFAS No. 123R is similar to the approach described in SFAS No. 123; however, SFAS No. 123R requires all share-based payments to employees and non-employee directors, including grants of employee stock options, to be recognized in the statement of operations based on their fair values.

The Company adopted SFAS No. 123R using the modified prospective method on January 1, 2006. Under the modified prospective method, compensation cost is recognized in the financial statements beginning with the effective date of SFAS No. 123R, based on the requirements of SFAS No. 123R for all share-based payments granted after that date, and based on the requirements for SFAS No. 123 for all unvested awards granted prior to the effective date of SFAS No. 123R. In addition, the unrecognized compensation cost of awards not yet vested at the date of adoption, determined under the original provisions of SFAS No. 123, shall be recognized in expense over the vesting periods after adoption. The fair value of stock options is determined using the Black-Scholes valuation model, which is consistent with valuation techniques previously utilized for options in footnote disclosures required under SFAS No. 123, as amended by SFAS No. 148,Accounting for Stock-Based Compensation – Transition and Disclosure. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method under SFAS No. 123.

The Company continues to account for compensation expense for options granted to non-employees other than directors in accordance with SFAS No. 123 and EITF Issue No. 96-18,Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods or Services. Such expense is based on the fair value of the options issued using the Black-Scholes method and is periodically remeasured as the underlying options vest in accordance with EITF Issue No. 96-18.

SAB No. 107,Share-Based Payments,requires that stock-based compensation expense be reported on the same line on the Statement of Operations as the related cash wages. Historically, the Company has reported stock-based compensation expense as a separate line in the operating expenses section of the Statement of Operations. Under SFAS No. 123R, the Company has reported the following amounts of stock-based compensation expense in the Statements of Operations for the three and nine months ended September 30, 2006 (in thousands, except per share data):


	Three months ended		Nine months ended
	September 30, 2006		September 30, 2006
Research and development expense	$	644	$	2,249
General and administrative expense		1,366		2,702

Total share-based compensation expense	$	2,010	$	4,951


Net share-based compensation expense, per common share
basic and diluted	$	0.07	$	0.17

On June 12, 2006, Dr. Xanthopoulos provided notice of his resignation as President and Chief Executive Officer of the Company effective December 31, 2006 or such earlier time as a successor has been identified and appointed. The Company has agreed to accelerate in full all of Dr. Xanthopoulos’ unvested stock options upon completion of the transition and his resignation as President and Chief Executive Officer. The Company calculated the additional share-based expense associated with the modification and acceleration of his unvested stock options upon his termination with the Company in accordance with SFAS 123R. For the three and nine months ended September 30, 2006, the Company included $1.1 million and $1.8 million, respectively, of share-based expense as a component of general and administrative expense related to stock options granted to Dr. Xanthopoulos. As of September 30, 2006, there was approximately $1.2 million of total unrecognized compensation cost related to Dr. Xanthopoulos’ stock options which will be recognized into general and administrative expense through December 31, 2006 or such earlier time as a successor has been identified and appointed. The incremental cost associated with the modification and acceleration of Dr. Xanthopoulos’ unvested stock options was not material.

As of September 30, 2006, there was an additional $7.0 million of total unrecognized compensation cost related to unvested share-based awards granted under the Company’s stock option plans, excluding stock options granted to Dr. Xanthopoulos. This unrecognized compensation cost is expected to be recognized over a weighted-average period of 3.03 years.

The following assumptions were used to estimate the fair value of options granted for the three and nine months ended September 30, 2006 and 2005 and a discussion of our methodology for developing each of the assumptions used in the valuation model follows:


	Three months ended September 30,						Nine months ended September 30,
	2006			2005			2006			2005
Stock Options:
Dividend yield		0.0	%		0.0	%		0.0	%		0.0	%
Expected volatility		65.0	%		70.0	%		65	%		70.0	%
Risk-free interest rate		4.87	%		4.04	%		4.86	%		3.99	%
Expected life of the option term (in years)		6.04			5.00			6.11			5.00

Dividend Yield—The Company has never declared or paid dividends on common stock and has no plans to do so in the foreseeable future.

Expected Volatility—Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated or is expected to fluctuate during a period. The Company considered the historical volatility from its IPO through the dates of grants, in combination with the historical volatility of similar companies and business and economic considerations in order to estimate the expected volatility, due to the Company’s short history as a public company.

Risk-Free Interest Rate—This is the U.S. Treasury rate for the week of each option grant during the quarter having a term that most closely resembles the expected life of the option.

Expected Life of the Option Term—This is the period of time that the options granted are expected to remain unexercised. Options granted during the quarter have a maximum term of ten years. The Company estimates the expected life of the option term based on actual past behavior for similar options with further consideration given to the class of employees to whom the options were granted.

Employee Stock Purchase Plan

Under the Company’s 2004 Employee Stock Purchase Plan (Purchase Plan), employees may purchase common stock every six months (up to but not exceeding 12% of each employee’s earnings) over the offering period at 85% of the fair market value of the common stock at certain specified dates. The offering period may not exceed 24 months. The purchase discount is significant enough to be considered compensatory under SFAS No. 123R. As a result, the Company recorded $68,000 and $228,000, in stock-based compensation for the three and nine months ended September 30, 2006, respectively, related to the Purchase Plan.

The following assumptions were used to estimate the fair value of shares to be issued under the Purchase Plan for the three and nine months ended September 30, 2006 and 2005:


	Three months ended September 30,						Nine months ended September 30,
	2006			2005			2006			2005
Employee Stock Purchase Plan:
Dividend yield		0.0	%		0.0	%		0.0	%		0.0	%
Expected volatility		68.0	%		70.0	%		69.0	%		70.0	%
Risk-free interest rate		4.07	%		3.55	%		3.95	%		3.45	%
Expected life of the option term (in years)		1.58			1.27			1.43			1.16

Pro Forma Information under SFAS No. 123 for Periods Prior to January 1, 2006

As permitted by SFAS No. 123, the Company had elected to follow APB No. 25, and related interpretations in accounting for its employee stock options. Under APB No. 25, when the exercise price of the Company’s employee and non-employee director stock options equals or exceeds the fair value of the underlying stock on the date of issuance or grant, no compensation expense was recognized. In conjunction with the Company’s IPO, the Company reviewed its historical exercise prices through March 25, 2004 and, as a result, revised the estimate of fair value for all stock options granted on or after July 1, 2002. With respect to these options granted, the Company had recorded deferred stock compensation for the difference between the original exercise price per share determined by the Board of Directors and the revised estimate of fair value per share at the respective grant dates. Deferred stock compensation related to employee stock options issued between July 1, 2002 and March 25, 2004 was recognized and amortized on an accelerated basis in accordance with Financial Accounting Standards Board Interpretation No. 28,Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, over the vesting period of the related options, generally four years. Upon the adoption of and in accordance with SFAS No. 123R, on January 1, 2006, we reclassed our remaining unamortized deferred compensation balance calculated in accordance with APB No. 25 into additional paid-in capital.

The following pro forma information regarding net loss and net loss per share has been determined as if the Company had accounted for its employee and director stock options under the fair value method prescribed by SFAS No. 123 for the three and nine months ended September 30, 2005 (in thousands, except per share data):



	Three months ended			Nine months ended
	September 30, 2005			September 30, 2005
Net loss applicable to common stockholders	$	(3,414	)	$	(18,856	)
Add: Stock-based employee compensation included in reported net loss		358			1,418
Deduct: Total stock-based employee compensation determined under fair value based method for all awards		(1,053	)		(3,031	)

Pro forma net loss	$	(4,109	)	$	(20,469	)

Net loss per share:
Basic and diluted — as reported	$	(0.13	)	$	(0.80	)

Basic and diluted — pro forma	$	(0.16	)	$	(0.87	)

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

This discussion and analysis should be read in conjunction with our unaudited financial statements and notes included in this Quarterly Report on Form 10-Q (this Quarterly Report) and the audited financial statements and notes as of and for the year ended December 31, 2005 included with the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the SEC) on March 15, 2006. Operating results are not necessarily indicative of results that may occur in future periods.

This Quarterly Report contains forward-looking statements. These forward-looking statements involve a number of risks and uncertainties. Such forward-looking statements include statements about our strategies, objectives, discoveries, collaborations, clinical trials, internal programs, and other statements that are not historical facts, including statements which may be preceded by the words “intend,” “will,” “plan,” “expect,” “anticipate,” “estimate,” “aim,” “seek,” “believe,” “hope” or similar words. For such statements, we claim the protection of the Private Securities Litigation Reform Act of 1995. Readers of this Quarterly Report are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. We undertake no obligation to update publicly or revise any forward-looking statements. Actual events or results may differ materially from our expectations. Important factors that could cause actual results to differ materially from those stated or implied by our forward-looking statements include, but are not limited to, the risk factors identified in our SEC reports, including this Quarterly Report.

Overview

We are a biopharmaceutical company committed to the discovery, development and commercialization of small-molecule medicines for the treatment of viral infections and cancer. Our current clinical development programs include: ANA380 for the treatment of hepatitis B virus (HBV) infection, which we are co-developing with LG Life Sciences (LGLS) and ANA975, an oral prodrug of isatoribine for the treatment of hepatitis C virus (HCV) infection and HBV, which we are co-developing with Novartis International Pharmaceutical Ltd., a Novartis AG company (Novartis). The Investigational New Drug Application (IND) for ANA975 is currently on full clinical hold. We are also pursuing additional pre-clinical anti-viral programs for the treatment of hepatitis virus and human immunodeficiency virus (HIV) infection. In December 2005, we selected ANA773, a novel Toll-Like Receptor-7 (TLR-7) oral prodrug, for our next Toll-Like Receptor (TLR) development program. We have completed pre-IND studies with ANA773 and are evaluating optimal therapeutic indications in oncology. Our therapeutic focus in viral infections and cancer leverages our core capabilities in structure-based drug design and TLR-based small molecules, and is aimed to advance a balanced and strong pipeline of drug candidates into the clinic. We have incurred significant operating losses since our inception and, as of September 30, 2006, our accumulated deficit was $206.9 million. We expect to incur substantial and increasing losses for at least the next several years as we:

	•		fund our portion of the global development costs of ANA380 for the treatment of HBV;

	•		fund our portion of the global development of ANA975 for the treatment of HCV and HBV;

	•		continue the development of our other product candidates;

	•		advance our preclinical candidates into clinical development;

	•		develop and scale-up product candidates for clinical trials and potential commercialization;

	•		further our research and development programs;

	•		establish a commercial infrastructure;

	•		commercialize any product candidates that receive regulatory approval; and

	•		potentially in-license technology and acquire or invest in businesses, products or technologies that are synergistic with our own.

On June 12, 2006, Kleanthis G. Xanthopoulos Ph.D. provided notice of his resignation as our President and Chief Executive Officer effective December 31, 2006 or such earlier time as a successor has been identified and appointed. Dr. Xanthopoulos will continue to serve as a member of our Board of Directors following his resignation. We have agreed to accelerate in full all of Dr. Xanthopoulos’ unvested stock options upon completion of the transition and his resignation as President and Chief Executive Officer. We calculated the additional share-based expense associated with the modification and acceleration of his unvested stock options upon his termination in accordance with SFAS 123R.

On June 26, 2006, we announced that we had suspended dosing HCV patients in our then ongoing Phase 1b clinical trial with ANA975 pending additional analysis of then newly obtained information from pre-clinical 13-week toxicology studies in animals.

Preliminary analysis of this information revealed various new observations which appear consistent with intense immune stimulation in animals. Subsequent to our decision to suspend dosing, we received notification from the Food and Drug Administration (FDA) that our IND for ANA975 is on full clinical hold. Together with Novartis we are currently preparing to initiate a new 13-week pre-clinical toxicology study with a newly developed crystalline form of ANA975 to assess safety and tolerability in animals. We believe this study should provide information necessary to further our objective to resume dosing of ANA 975 in patients with HCV.

Share-Based Payment

In December 2004, the Financial Accounting Standards Board issued Statement No. 123 (revised 2004),Share-Based Payment(SFAS No. 123R), which is a revision of SFAS No. 123,Accounting for Stock-Based Compensation.This statement supersedes Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees,(APB No. 25), and amends SFAS No. 95,Statement of Cash Flows. Generally, the approach in SFAS No. 123R is similar to the approach described in SFAS No. 123; however, SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values.

We adopted SFAS No. 123R using the modified prospective method on January 1, 2006. Under the modified prospective method, compensation cost is recognized in the financial statements beginning with the effective date of SFAS No. 123R, based on the requirements of SFAS No. 123R for all share-based payments granted after that date, and based on the requirements for SFAS No. 123 for all unvested awards granted prior to the effective date of SFAS No. 123R.

Prior to adopting the provisions of SFAS No. 123R, we recorded estimated compensation expense for employee stock options based upon their intrinsic value on the date of grant pursuant to APB No. 25.In conjunction with our initial public offering (IPO), we reviewed our historical exercise prices through March 25, 2004 and, as a result, revised our estimate for financial reporting purposes of fair value for stock options granted on or after July 1, 2002 through the date of our IPO. With respect to these options, we recorded deferred stock-based compensation for the difference between the original exercise price per share determined by the Board of Directors and our revised estimate of fair value per share at the respective grant dates. We recorded these amounts as a component of stockholders’ equity and were amortizing these amounts, on an accelerated basis, as a non-cash charge to operations over the vesting period of the options. Upon the adoption of and in accordance with SFAS No. 123R, on January 1, 2006, we reclassed our remaining unamortized deferred compensation balance calculated in accordance with APB No. 25 into additional paid-in capital.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses and related disclosure of contingent assets and liabilities. We review our estimates on an on-going basis and make adjustments to the financial statements as considered necessary. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.

Revenue Recognition.We may receive payments from collaborators for compound licenses, technology access fees, option fees, research services, milestones and royalty obligations. These payments are recognized as revenue or reported as deferred revenue until they meet the criteria for revenue recognition as outlined in Staff Accounting Bulletin, No. 104,Revenue Recognition,which provides guidance on revenue recognition in financial statements, and is based on the interpretations and practices developed by the SEC, and Emerging Issues Task Force (EITF) Issue 00-21,Revenue Arrangements with Multiple Deliverables.We recognize revenue when (1) persuasive evidence of the arrangement exists; (2) delivery has occurred or services were rendered; (3) the price is fixed or determinable and (4) the collectibility is reasonably assured. Specifically, we have applied the following policies in recognizing revenue:

	•		Revenue from milestones is recognized when earned, as evidenced by written acknowledgment from the collaborator or other persuasive evidence that the milestone has been achieved, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement, (ii) our performance obligations after the milestone achievement will continue to be funded by the collaborator at the comparable level and (iii) the milestone is not refundable or creditable. If all of these criteria are not met, the milestone payment is recognized over the remaining minimum period of our performance obligations under the agreement. Upfront fees under our collaborations, such as technology access fees, are recognized over the period the related services are provided. Non-refundable upfront fees not associated with our future performance are recognized when received.

	•		Fees that we receive for research services are generally recognized as the services are provided, as long as the amounts received are not refundable regardless of the results of the research project. Research services may include agreements through which we will deploy our internal capabilities to assist a collaborator to advance their target, such as our medicinal chemistry and screening capabilities.

Drug Development Costs.We review and accrue drug development costs based on work performed, which relies on estimates of total costs incurred based on subject enrollment, estimated timeline for completion of studies and other events. These costs and estimates vary based on the type of clinical trial, the site of the clinical trial and the length of dose period for each subject as well as other factors. Drug development costs are subject to revisions as trials and studies progress to completion. Expense is adjusted for revisions in the period in which the facts that give rise to the revision become known.

Share-based Compensation.We account for share-based compensation in accordance with SFAS No. 123R. Under the provisions of SFAS No. 123R, share-based compensation cost is estimated at the grant date based on the award’s fair-value as calculated by a Black-Scholes option-pricing model and is recognized as expense evenly over the requisite service period. The Black-Scholes model requires various highly judgmental assumptions including volatility, forfeiture rates, and expected option life. If any of the assumptions used in the model change significantly, share-based compensation expense may differ materially in the future from that recorded in the current period.

Results of Operations

Three Months Ended September 30, 2006 and 2005

Revenue.We recorded revenue of $1.1 million for the three months ended September 30, 2006 compared to $1.7 million for the three months ended September 30, 2005. Revenue for the three months ended September 30, 2006 was primarily attributable to revenue derived from our collaboration with Novartis. During the quarters ended September 30, 2006 and 2005, we recorded revenue of $1.0 million and $1.1 million, respectively, associated with the amortization of our $20.0 million up-front payment and $10.0 million IND milestone payment from Novartis. The up-front payment and the IND milestone payment are both being amortized over the estimated development period for ANA975. The expected duration of this estimated development period is reviewed on a periodic basis. We recorded revenue of $0.3 million during the three months ended September 30, 2005 related to our collaboration with Roche. During January 2006, we completed our portion of our collaboration with Roche and as such we recorded no revenue related to this collaboration during the three months ended September 30, 2006. During the quarters ended September 30, 2006 and 2005, we recorded revenue of $0.01 million and $0.2 million, respectively, associated with our Phase II SBIR grant from the National Institutes of Health. During the three months ended September 30, 2006, we substantially completed our performance under our Phase II SBIR grant from the National Institutes of Health. Fluctuations in our collaboration-related revenue from period to period are expected, as amounts recognized are dependent upon a number of factors including but not limited to, the timing of agreements, the timing of the workflow under the agreements, our collaborators’ abilities to provide us with the materials and information necessary for us to conduct our portion of the collaboration effort and the occurrence of events that may trigger milestone payments to us. We expect our revenue to continue to fluctuate in future periods as we continue to enter into new agreements and perform activities under existing agreements.

Research and Development Expenses.Research and development expenses were $5.5 million for the three months ended September 30, 2006 compared to $3.7 million for the three months ended September 30, 2005. Excluding our estimate of Novartis’ net share of ANA975 expenses, research and development expenses were $7.4 million for the three months ended September 30, 2006 compared to $7.3 million for the three months ended September 30, 2005. The $0.1 million increase in research and development expenses was primarily related to an increase in our share-based compensation as a result of our adoption of SFAS No. 123R effective January 1, 2006 and an increase in personnel related expenses, partially offset by a decrease in our external development expenses. We included as a component of research and development expense $0.6 million of employee share-based compensation expense in accordance with SFAS No. 123R during the three months ended September 30, 2006. During the three months ended September 30, 2005, we included $0.2 million as a component of research and development expense with respect to deferred compensation on employee stock options in accordance with APB No. 25. Personnel related expenses increased $0.8 million from the three months ended September 30, 2005 to the three months ended September 30, 2006. This expense was driven by an overall increase in personnel, recruiting costs, lab supplies and travel from the three months ended September 30, 2005 to the three months ended September 30, 2006. External development expenses decreased by $1.4 million from the three months ended September 30, 2005 to the three months ended September 30, 2006. This decrease was primarily driven by development costs associated with ANA975 which decreased by $2.0 million which was partially offset by an increase in external development costs associated with ANA773 which increased by $0.6 million over the same period. The decrease in ANA975 external development expenses was primarily driven by our suspension of dosing of HCV patients in our Phase 1b clinical trial with ANA975 during June 2006. In addition, the Company incurred expenses of approximately $1.7 million associated with our Phase I ANA975-502 clinical trial during the three months ended September 30, 2005.

Our research and development expenses noted above were offset by the recording of $1.9 million as an offset to research and development expense in the three months ended September 30, 2006, which represents an estimate of Novartis’ net share (80.5%) of ANA975 expenses incurred from July 1, 2006 through September 30, 2006 as well as a one-time contractual obligation for costs previously incurred which became reimbursable during the three months ended September 30, 2006. During the three months ended September 30, 2005, we recorded a $3.6 million offset to research and development expense which represented an estimate of Novartis’ net share of ANA975 expenses incurred from June 1, 2005 through September 30, 2005.

During the first quarter of 2006, we implemented a new project costing methodology which enables us to allocate internal direct costs such as personnel costs and supplies and materials directly to projects for periods after January 1, 2006. Facility costs, depreciation and amortization, research and development support personnel and other indirect personnel related costs are included as a component of infrastructure and support personnel.

The following summarizes our research and development expenses based on the project costing methodology described above for the three months ended September 30, 2006 (in thousands):


ANA975	$	1,394
ANA773		936
ANA380		227
Discovery stage programs		2,212
Infrastructure and support personnel		1,980
Non-cash employee and non-employee share-based compensation		644
Reimbursement of ANA975 costs by Novartis		(1,897	)

Total research and development expense	$	5,496

Prior to January 1, 2006, we allocated only direct external costs such as fees paid to consultants, joint development collaboration costs and related contract research to projects. Other costs such as internal direct and indirect costs which included compensation and other expenses for research and development personnel, supplies and materials, facility costs and depreciation were not allocated directly to projects. During the three months ended September 30, 2005, we reported direct external expenses of $3.1 million associated with the development of ANA975 and $3.0 million associated with our unallocated indirect internal costs and overhead.

General and Administrative Expenses.General and administrative expenses were $3.1 million for the three months ended September 30, 2006 compared to $2.1 million for the three months ended September 30, 2005. The increase in general and administrative expenses was primarily related to an increase in our share-based compensation as a result of our adoption of SFAS No. 123R effective January 1, 2006. We included, as a component of general and administrative expense during the three months ended September 30, 2006, $1.4 million of share-based compensation expense in accordance with SFAS No. 123R. Included as a component of share-based compensation expense for the three months ended September was $1.1 million of share-based expense related to options granted to Dr. Xanthopoulos. As of September 30, 2006, there was approximately $1.2 million of total unrecognized compensation cost related to Dr. Xanthopoulos’ stock options which will be recognized into general and administrative expense through December 31, 2006 or such earlier time as a successor has been identified and appointed. During the three months ended September 30, 2005, we included $0.3 million as a component of general and administrative expense with respect to deferred compensation on employee stock options in accordance with APB No. 25.

Interest Income and Other, net.Interest income was $1.2 million for the three months ended September 30, 2006 compared to $0.6 million for the three months ended September 30, 2005. The $0.6 million increase in our interest income from the three months ended September 30, 2006 to the three months ended September 30, 2005 was the result of the receipt of the following amounts which were invested into interest bearing securities during 2005: an up-front license payment of $20.0 million from Novartis in July 2005, $66.4 million, net of underwriting discounts and commissions and offering costs, from our follow-on public offering of common stock in August 2005 and a $10.0 million milestone payment from Novartis received in September 2005 triggered by the acceptance of our IND application by the FDA.

Nine Months Ended September 30, 2006 and 2005

Revenue.We recorded revenue of $4.3 million for the nine months ended September 30, 2006 compared to $2.9 million for the nine months ended September 30, 2005. Revenue for the nine months ended September 30, 2006 was attributable to revenue derived from our collaboration with Novartis and, to a lesser extent, our collaboration with Roche and our Phase II SBIR grant from the National Institutes of Health. During the nine months ended September 30, 2006 and 2005, we recorded revenues of $3.5 million and $1.1 million, respectively, associated with the amortization of our $20.0 million up-front payment and $10 million IND milestone payment from Novartis. The up-front payment and the IND milestone payment are both being amortized over the estimated development period for ANA975. The expected duration of this estimated development period is reviewed on a periodic basis. We recorded revenue of $0.1 million and $1.2 million during the nine months ended September 30, 2006 and 2005, respectively, related to our collaboration with Roche. In January 2006, we completed our portion of our collaboration with Roche. Fluctuations in our

collaboration-related revenue from period to period are expected, as amounts recognized are dependent upon a number of factors including but not limited to, the timing of agreements, the timing of the workflow under the agreements, our collaborators’ abilities to provide us with the materials and information necessary for us to conduct our portion of the collaboration effort and the occurrence of events that may trigger milestone payments to us. We expect our revenue to continue to fluctuate in future periods as we continue to enter into new agreements and perform activities under existing agreements.

Research and Development Expenses.Research and development expenses were $19.0 million for the nine months ended September 30, 2006 compared to $16.7 million for the nine months ended September 30, 2005. The $2.3 million increase in research and development expenses was primarily related to an increase in our share-based compensation as a result of our adoption of SFAS No. 123R effective January 1, 2006 and to a lesser extent an increase in personnel related expenses, partially offset by a decrease of external development expenses. We included as a component of research and development expense $2.3 million of employee share-based compensation expense in accordance with SFAS No. 123R during the nine months ended September 30, 2006. During the nine months ended September 30, 2005, we included $0.8 million as a component of research and development expense with respect to deferred compensation on employee stock options in accordance with APB No. 25. Personnel related expenses increased $2.3 million from the nine months ended September 30, 2005 to the nine months ended September 30, 2006. This expense was driven by an overall increase in research and development personnel and recruiting costs from the nine months ended September 30, 2005 to the nine months ended September 30, 2006. External development expenses decreased by $2.5 million from the nine months ended September 30, 2005 to the nine months ended September 30, 2006. This decrease was primarily driven by development costs associated with ANA975 which decreased by $4.4 million and was partially offset by an increase in external development costs associated with ANA773 which increased $2.1 million over the same period. The decrease in ANA975 external development expenses was primarily driven by our suspension of dosing of HCV patients in our Phase 1b clinical trial with ANA975 during June 2006. In addition, the Company incurred expenses of approximately $1.8 million associated with our Phase I ANA975-502 clinical trial during the nine months ended September 30, 2005.

In the first quarter of 2006, we implemented a new project costing methodology which enables us to allocate internal direct costs such as personnel costs and supplies and materials directly to projects for periods after January 1, 2006. Facility costs, depreciation and amortization, research and development support personnel and other indirect personnel related costs are included as a component of infrastructure and support personnel.

The following summarizes our research and development expenses based on the project costing methodology described above for the nine months ended September 30, 2006 (in thousands):


ANA975	$	4,027
ANA773		3,450
ANA380		440
Discovery stage programs		6,670
Infrastructure and support personnel		5,565
Non-cash employee and non-employee share-based compensation		2,249
Reimbursement of ANA975 costs by Novartis		(3,423	)

Total research and development expense	$	18,978

Prior to January 1, 2006, we allocated only direct external costs such as fees paid to consultants, joint development collaboration costs and related contract research to projects. Other costs such as internal direct and indirect costs which included compensation and other expenses for research and development personnel, supplies and materials, facility costs and depreciation were not allocated directly to projects. During the nine months ended September 30, 2005, we reported direct external expenses of $7.3 million associated with the development of ANA975 and $9.1 million associated with our unallocated indirect internal costs and overhead.

General and Administrative Expenses.General and administrative expenses were $7.8 million for the nine months ended September 30, 2006 compared to $5.9 million for the nine months ended September 30, 2005. The increase in general and administrative expenses was primarily related to an increase in our share-based compensation as a result of our adoption of SFAS No. 123R effective January 1, 2006. We included, as a component of general and administrative expense during the nine months ended September 30, 2006, $2.7 million of employee share-based compensation expense in accordance with SFAS No. 123R. Included as a component of share-based compensation expense for the nine months ended September 30, 2006 was $1.8 million of share-based expense related to options granted to Dr. Xanthopoulos. As of September 30, 2006, there was approximately $1.2 million of total unrecognized compensation cost related to Dr. Xanthopoulos’ stock options which will be recognized into general and administrative expense through December 31, 2006 or such earlier time as a successor has been identified and appointed. During the nine months ended September 30, 2005, we included $0.9 million as a component of general and administrative expense with respect to employee stock options in accordance with APB No. 25.

Interest Income and Other, net.Interest income was $3.5 million for the nine months ended September 30, 2006 compared to $1.1 million for the nine months ended September 30, 2005. The $2.4 million increase in our interest income from the nine months ended September 30, 2006 to the nine months ended September 30, 2005 was the result of the receipt of the following amounts which were invested into interest bearing securities during 2005: an up-front license payment of $20.0 million from Novartis in July 2005, $66.4 million, net of underwriting discounts and commissions and offering costs, from our follow-on public offering of common stock in August 2005 and a $10.0 million milestone payment from Novartis received in September 2005 triggered by the acceptance of our IND application by the FDA.

Interest Expense.Interest expense was $0.07 million for the nine months ended September 30, 2006 compared to $0.3 million for the nine months ended September 30, 2005. The decrease in our interest expense is a result of our payment in full of our outstanding principal balance of $1.6 million on our equipment financing line of credit in February 2006.

Liquidity and Capital Resources

As of September 30, 2006, we had cash, cash equivalents, and securities available-for-sale of $88.8 million. To date, we have funded our operations primarily through the sale of equity securities and payments received pursuant to our License and Co-Development Agreement with Novartis. Through September 30, 2006, we had received approximately $237.8 million from the sale of equity securities.

Cash Flows from Operating Activities and Investing Activities:

Our condensed consolidated statements of cash flows are summarized as follows:


	For the nine months ended September 30,
	2006			2005
	(In thousands)
Net cash (used in) provided by operating activities	$	(13,958	)	$	12,734


Investing Activities:

Purchases of securities available-for-sale	$	(11,961	)	$	(8,294	)
Proceeds from sale and maturity of securities available-for-sale		2,750			25,109
Purchases of property and equipment		(1,422	)		(652	)


Net cash (used in) provided by investing activities	$	(10,633	)	$	16,163

Cash flows used in operating activities decreased by $26.7 million from the nine months ended September 30, 2005 to the nine months ended September 30, 2006. The decrease was primarily a result of an increase in deferred revenue during the nine months ended September 30, 2005 attributable to the receipt of an up-front license payment of $20.0 million from Novartis in July 2005 and the receipt of a $10.0 million milestone payment from Novartis triggered by the acceptance of our IND application by the FDA in September 2005.

Cash flows used in investing activities decreased by $26.8 million from the nine months ended September 30, 2005 to the nine months ended September 30, 2006. The decrease was primarily the result of the sale and maturity of available-for-sale securities during the nine months ended September 30, 2005 to fund our operations. During the nine months ended September 30, 2006, we primarily utilized cash and cash equivalents to fund our operations.

Cash Flows from Financing Activities:

Our condensed consolidated statements of cash flows are summarized as follows:


	For the nine months ended September						30,
	2006			2005
	(In thousands)
Financing Activities:
Proceeds from sale of common stock, net of issuance costs	$	—		$	66,435
Proceeds from exercise of stock options and employee stock purchase plan		820			817
Proceeds from the issuance of long-term debt		—			393
Principal payments on long-term debt		(1,559	)		(1,088	)


Net cash (used in) provided by financing activities	$	(739	)	$	66,557

Cash flows used in financing activities decreased by $67.3 million from the nine months ended September 30, 2005 to the nine months ended September 30, 2006. The decrease was primarily a result of the receipt of $66.4 million, net of underwriting discounts and commissions and offering costs, from our follow-on public offering of common stock completed during August 2005.

Aggregate Contractual Obligations

The following summarizes our long-term contractual obligations as of September 30, 2006 (In thousands):


			Less than		2007 to		2009 to
Contractual Obligations	Total		1 year		2008		2010		Thereafter
Operating leases	$	6,041	$	1,877	$	4,164	$	—	$	—
Minimum royalty commitment		975		75		200		200		500


	$	7,016	$	1,952	$	4,364	$	200	$	500

We also enter into agreements with clinical sites and contract research organizations that conduct our clinical trials. We generally make payments to these entities based upon the number of subjects enrolled and the length of their participation in the trials. To date, the majority of our clinical costs have been to clinical sites and contact research organizations for subjects who have participated in our clinical trials as well as the manufacturing of compounds used in our clinical trials. Costs associated with clinical trials will continue to vary as the trials go through their natural phases of enrollment and follow-up. Our portion of the costs will also be influenced by the pace and timing of the development activities conducted under our joint development agreements with our collaborators, including Novartis and LGLS. At this time, because of the risks inherent in the clinical trial process and given the early stage of development of our product development programs, we are unable to estimate with any certainty the total costs we will incur in the continued development of our clinical candidates for potential commercialization. Because of these same factors, we are unable to determine the completion dates for our current product development programs. Clinical development timelines, probability of success and development costs vary widely. As we continue our discovery, pre-clinical and clinical programs, we anticipate that we will make determinations as to which programs to pursue and how much funding to direct to each program on an ongoing basis in response to the scientific and clinical success of each product candidate, as well as an ongoing assessment of the product candidate’s commercial potential. In addition, we cannot forecast with any degree of certainty which currently un-partnered product candidates will be subject to future partnering, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements. As a result of the above factors, we cannot be certain when and to what extent we will receive cash inflows from the commercialization of our drug candidates.

We expect our development expenses to be substantial and to increase as we continue the advancement of our development programs. The lengthy process of completing clinical trials and seeking regulatory approval for our product candidates requires the expenditure of substantial resources. Any failure by us or delay in completing clinical trials, or in obtaining regulatory approvals, could cause our research and development expenses to increase and, in turn, have a material adverse effect on our results of operations.

Overview of Financial Position and Future Cash Requirements

Our condensed consolidated balance sheet as of September 30, 2006, compared to our condensed consolidated balance sheet as of December 31, 2005, was primarily impacted by the decrease in cash, cash equivalents and securities available-for-sale of $16.1 million which represents the use of our cash, cash equivalents and securities available-for-sale to fund our operations during the nine months ended September 30, 2006 and the payment in full of our outstanding principal balance of $1.6 million on our equipment financing line of credit. This decrease in cash, cash equivalents and securities available-for-sale includes the receipt of $5.9 million from Novartis which represented Novartis’ share of ANA975 development costs incurred from June 1, 2005 to December 31, 2005, which was included as a component of accounts receivable at December 31, 2005.

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

	•		the progress of our clinical trials;

	•		the progress of our preclinical development activities;

	•		the progress of our research activities;

	•		the number and scope of our research programs;

	•		our ability to establish and maintain strategic collaborations;

	•		the costs involved in enforcing or defending patent claims and other intellectual property rights;

	•		the pace and timing of development activities conducted under joint development agreements with our collaborators;

	•		the costs and timing of regulatory approvals;

	•		the costs of establishing or expanding manufacturing, sales and distribution capabilities;

	•		the costs related to development and manufacture of pre-clinical, clinical and validation lots for regulatory and commercialization drug supply;

	•		the success of the commercialization of ANA380, ANA975, ANA773 or any other product candidates we may develop; and

	•		the extent to which we acquire or invest in other products, technologies and businesses.

In connection with our collaboration with LGLS for the development of ANA380, we may be required to make milestone payments totaling up to $25.5 million, subject to the attainment of product development and commercialization objectives. We will pay royalties on any product sales in our sales territory to LGLS and will receive royalties on any product sales in China from LGLS.

In connection with our License and Co-Development Agreement with Novartis for the development of ANA975 and potentially additional TLR-7 oral prodrugs for chronic HCV and HBV infections, as well as other potential infectious disease indications, we may receive up to $540.0 million in additional payments for the achievement of specified development, regulatory and sales milestones. In addition, Novartis will fund 80.5% of the global development costs of the lead product candidate, and we will fund 19.5% of such development costs, subject to certain limitations. As we progress through the development plan for ANA975, more operational responsibility for the clinical trials will transition from us to Novartis with reimbursement for research and development expenditures then flowing from us to Novartis.

We believe that our existing cash, cash equivalents, and securities available-for-sale and revenues we may generate from our current collaborations will be sufficient to meet our projected operating requirements for at least the next fiscal year. We expect to incur substantial expenses for at least the next several years as we continue our research and development activities, including manufacturing and development expenses for compounds in preclinical and clinical studies. We continue to review our programs and resource requirements. Changes to our current operating plan may require us to consume available capital resources significantly sooner than we expect.

Until we can generate significant cash from our operations, we expect to continue to fund our operations with existing cash resources that were primarily generated from the proceeds of offerings of our equity securities and cash receipts from collaboration agreements. In addition, we may finance future cash needs through the sale of other equity securities, strategic collaboration agreements and debt financing. However, we may not be successful in obtaining collaboration agreements, or in receiving milestone or royalty payments under those agreements. In addition, we cannot be sure that our existing cash and securities available-for-sale resources will be adequate or that additional financing will be available when needed or that, if available, financing will be obtained on terms favorable to us or our stockholders. Having insufficient funds may require us to delay, reduce the scope of or eliminate some or all of our research or development programs or to relinquish greater or all rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose. Failure to obtain adequate financing also may adversely affect our ability to operate as a going concern. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders would likely result. If we raise additional funds by incurring debt financing, the terms of the debt may involve significant cash payment obligations as well as covenants and specific financial ratios that may restrict our ability to operate our business.

As of September 30, 2006 and 2005, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term marketable securities. Due to the nature of our short-term investments, we believe that we are not subject to any material market risk exposure. We do not have any foreign currency or other derivative financial instruments.

Item 4.Controls and Procedures

Our President and Chief Executive Officer, Senior Vice President, Operations and Chief Financial Officer (who joined us on September 25, 2006) and Vice President, Finance performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-l5(e) and l5d-15(e) of the Securities Exchange Act of 1934 (the Exchange Act)) as of the end of the period covered by this Quarterly Report. Based on that evaluation, our President and Chief Executive Officer, Senior Vice President, Operations and Chief Financial Officer and Vice President, Finance concluded that as of the date of such evaluation, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in our periodic reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our President and Chief Executive Officer, Senior Vice President, Operations and Chief Financial Officer and Vice President, Finance, as appropriate, to allow timely decisions regarding required disclosure. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and can therefore only provide reasonable, not absolute, assurance that the design will succeed in achieving its stated goals.

An evaluation was also performed under the supervision and with the participation of our management, including our Chief Executive Officer, Senior Vice President, Operations and Chief Financial Officer and Vice President, Finance, of any change in our internal control over financial reporting that occurred during our last fiscal quarter and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. That evaluation has included certain internal control areas in which we have made and are continuing to make changes to improve and enhance controls. During the third quarter of 2006, we implemented a new General Ledger Accounting system which is expected to maintain our internal controls over financial reporting. This implementation has made some changes to how transactions are being processed but has not changed the structure and operation of our internal controls over financial reporting. The implementation has proceeded to date without any material adverse effect on our internal control over financial reporting.

Except as noted above there were no other changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1A. Risk Factors

Risk Factors

You should consider carefully the following information about the risks described below, together with the other information contained in this Quarterly Report and in our other public filings before making any investment decisions regarding our stock. If any of the following risks actually occurs, our business, financial condition, results of operations and future growth prospects would likely be materially and adversely affected. In these circumstances, the market price of our common stock would likely decline, and you may lose all or part of the money you paid to buy our common stock.

The risk factors set forth below with an asterisk (*) next to the title are new risk factors or risk factors containing changes, including any material changes, from the risk factors previously disclosed in our annual report onForm 10-K for the year ended December 31, 2005, as filed with the Securities and Exchange Commission.

Risks Related to Our Business

*We have recently suspended our 28-day clinical trial of ANA975 in HCV infected patients, and we do not currently know when or if we will be able to resume dosing. If dosing is substantially delayed or if clinical development of ANA975 is terminated, our stock price could decline significantly.

In June 2006, we suspended dosing in our 28-day clinical trial of ANA975 in HCV infected patients due to then newly obtained information from pre-clinical 13-week animal toxicology studies. Subsequently, the FDA put our ANA975 IND on full clinical hold. We are currently analyzing the information from the toxicology studies, along with viral load data from the patients who received ANA975 prior to the suspension of dosing and are working with our collaborator Novartis to determine the next steps for the development program. Although we have plans to initiate a new 13 week pre-clinical toxicology study in animals, we cannot currently predict when or if we will be able to resume dosing ANA975 in humans. There is no guarantee that ANA975 clinical trials will be resumed at all. Based on existing and future toxicology data, we may not be able to identify a dose that we expect to provide therapeutic benefit without causing unacceptable adverse events, in which case we would likely terminate the ANA975 development program. A delay in resuming dosing or the termination of the clinical development of ANA975 could cause our stock price to decline significantly.

*We are currently evaluating the animal toxicology observations that led to the suspension of dosing in our ANA975 HCV clinical trial. If we are unable to identify levels of immune stimulation that provide sufficient therapeutic benefit with an acceptable safety profile, our ANA773 program for cancer and our other earlier stage TLR7 programs could be negatively impacted, causing our stock price to decline.

ANA975 is an oral prodrug of isatoribine, a TLR-7 agonist. We are currently evaluating the toxicology observations from the 13-week animal studies that led to the suspension of dosing in our ANA975 HCV clinical trial to determine their potential impact, if any, on our other TLR7 programs, including ANA773, ANA975 for HBV and our earlier stage TLR-7 programs. We will need to determine whether the level of immune stimulation induced by TLR-7 agonists can be modulated to achieve a potential therapeutic benefit with an acceptable safety profile. If we are unable to modulate the immunomodulatory effect with a dose that provides therapeutic benefit without causing unacceptable adverse events, then the future development of our other TLR-7 programs may be terminated, which would materially and adversely affect our business and cause our stock price to decline significantly.

We are at an early stage of development, and we may never attain product sales.

Our existing organizational structure was formed in May 2000. Since then, most of our resources have been dedicated to the development of our proprietary drug discovery technologies, research and development and preclinical and early stage clinical testing of compounds. Any compounds discovered or in-licensed by us will require extensive and costly development, preclinical testing and clinical trials prior to seeking regulatory approval for commercial sales. Our most advanced product candidates, ANA380 and ANA975 and any other compounds we discover or in-license, may never be approved for commercial sales. The time required to attain product sales and profitability is lengthy and highly uncertain, and we cannot assure you that we will be able to achieve or maintain product sales.

*We expect our net operating losses to continue for at least several years, and we are unable to predict the extent of future losses and when we will become profitable, if ever.

We have incurred net operating losses since our incorporation in 1992, and through September 30, 2006 we have an accumulated deficit of $206.9 million. Our operating losses are attributable in large part to the significant research and development costs required to identify and validate potential product candidates and conduct preclinical studies and clinical trials of isatoribine, ANA975 and ANA380. To date, we have generated limited revenues, consisting of one-time or limited payments associated with our collaborations or grants, and we do not anticipate generating product revenues for at least several years, if ever. We expect to increase our operating expenses over at least the next several years as we plan to fund our share of the development costs of ANA975 and ANA380, further our research and development activities and potentially acquire or license new technologies and product candidates. As a result, we expect to continue to incur significant and increasing operating losses for the foreseeable future. Because of the numerous risks and uncertainties associated with our research and product development efforts, we are unable to predict the extent of any future losses or when we will become profitable, if ever. Even if we do achieve profitability, we may not be able to sustain or increase profitability on an ongoing basis.

*The technologies on which we rely are unproven and may not result in the discovery or development of commercially viable products.

Our proprietary technologies and methods of identifying, prioritizing and screening molecular targets represent unproven approaches to the identification of drug leads that may possess therapeutic potential. Much of our research focuses on the biology of a specific receptor, or protein, named Toll-Like Receptor-7, or TLR-7, and on structure-based drug design. However, structure-based drug design is difficult, time-consuming and expensive. Additionally, the interaction between isatoribine and TLR-7 represents a new mechanism of action for the treatment of HCV and HBV, and there is no guarantee that an acceptable balance between therapeutic benefit and risk will be achieved with ANA975 in HCV- or HBV-infected patients. For example, we have suspended dosing in our ANA975 clinical trials due to new information from 13 week toxicology studies in animals while we conduct additional pre-clinical studies and evaluate whether there is an acceptable balance between therapeutic benefit and risk. Likewise, the use of a TLR-7 agonist represents a new mechanism of action for the treatment of cancer, and there is no guarantee that an acceptable balance between therapeutic benefit and risk will be achieved with ANA773 in cancer patients. Furthermore, there is no guarantee that TLR biology will result in an acceptable balance between therapeutic benefit and risk in any other therapeutic area, such as asthma, allergies or vaccine adjuvants. There are no drugs on the market that have been discovered or developed using our proprietary technologies. The process of successfully discovering product candidates is expensive, time-consuming and unpredictable, and the historical rate of failure for drug candidates is extremely high. Research programs to identify product candidates require a substantial amount of our technical, financial and human resources even if no product candidates are identified. If we are unable to identify new product candidates using our proprietary drug discovery technologies or capabilities, we may not be able to establish or maintain a clinical development pipeline or generate product revenue.

*We currently depend on one collaboration partner, Novartis, for substantially all our revenues and for commercialization of one of our lead product candidates, and we may depend on Novartis for commercialization of other product candidates. If our development, license and commercialization agreement with Novartis terminates, our business and, in particular, our drug development programs, will be seriously harmed.

We have licensed our product candidate ANA975 under a development, license and commercialization agreement with Novartis, dated June 1, 2005, which we refer to as the collaboration agreement. We may derive substantially all of our near-term revenues from Novartis. Novartis may terminate the collaboration agreement in any country or with respect to any product or product candidate licensed under the collaboration agreement for any reason. If the collaboration agreement is terminated in whole or in part and we are unable to enter similar arrangements with other collaborators, our business would be materially and adversely affected.

*The success of ANA975 depends heavily on our collaboration with Novartis, which was established only recently. If Novartis is unwilling to further develop or commercialize ANA975, or experiences significant delays in doing so, our business may be materially harmed.

As a result of the joint development aspect of our collaboration agreement with Novartis, the future success of our HCV and HBV programs and the continued funding from Novartis will depend in large part on our ability to maintain our relationship with Novartis with respect to ANA975 or any other product candidate licensed under the collaboration agreement. We do not have a significant history of working together with Novartis and cannot predict the success of the collaboration. We cannot guarantee that Novartis will not reduce or curtail its efforts to develop ANA975 with us because of changes in its research and development budget, its internal development priorities, its perceptions of the viability of the ANA975 program, the success or failure of its other product candidates or other factors affecting its business or operations. For example, Novartis recently in-licensed rights to Albuferon from Human Genome Sciences and there is no guarantee that Novartis will not re-prioritize its HCV development efforts in favor of Albuferon at the expense of ANA975. Furthermore, prior to resuming clinical trials with ANA975, we will need to gain agreement with Novartis on the impact that the recent 13 week toxicological observations will have on the future development of ANA975 and will need to agree to any necessary modifications to the pre-clinical and clinical development plan for ANA975. Although we have plans with Novartis to initiate a new 13-week pre-clinical toxicology study in ANA975 to assess safety and tolerability in animals, there is no

guarantee that we will reach agreement with Novartis on the future development of ANA975. If we are not able to maintain a positive relationship with Novartis with respect to ANA975, we may not be able to effectively develop or commercialize products based on ANA975, in which case our HCV development and commercialization efforts could be significantly impaired. If we materially breach this collaboration agreement and are unable within an agreed time period to cure such breach, the collaboration agreement may be terminated by Novartis and we may be required to grant Novartis an exclusive license to develop, manufacture and/or sell such products. Any loss of Novartis as a collaborator in the development or commercialization of ANA975, dispute over terms of, or decisions regarding the collaboration or other adverse developments in our relationship with Novartis would materially harm our business and might accelerate our need for additional capital.

Novartis has the right under certain circumstances to market and sell products that compete with the product candidates and products that we license to it, and any competition by Novartis could have a material adverse effect on our business.

Novartis may under certain circumstances market, sell, promote or license, competitive products. Novartis has significantly greater financial, technical and human resources than we have and is better equipped to discover, develop, manufacture and commercialize products. In addition, Novartis has more extensive experience in preclinical studies and clinical trials, obtaining regulatory approvals and manufacturing and marketing pharmaceutical products. Moreover, any direct or indirect competition with Novartis with respect to products that we have licensed to it could result in confusion in the market. In the event that Novartis competes with us, our business could be materially and adversely affected.

*We are dependent on the commercial success of ANA975 or another oral prodrug of isatoribine or other TLR-7 agonists and we cannot be certain that ANA975 or any other oral prodrug of isatoribine or other TLR-7 agonists will be commercialized.

Most of our work to date with ANA975 has been limited to pre-clinical studies and early stage clinical trials in a small number of healthy volunteers. We have only recently begun clinical trials of ANA975 in HCV-infected patients and this trial is currently suspended and on clinical hold pending evaluation of toxicological findings and further discussion with Novartis and regulatory authorities. We will have to spend considerable additional time, money and effort before seeking regulatory approval to market any product candidates, including ANA975, another oral prodrug of isatoribine or another TLR-7 agonist. Our business prospects depend primarily on our ability to successfully complete clinical trials, obtain required regulatory approvals and successfully commercialize ANA975, another oral prodrug of isatoribine or another TLR-7 agonist. If we fail to commercialize ANA975, another oral prodrug of isatoribine or another TLR-7 agonist, we may be unable to generate sufficient revenues to attain profitability, and our reputation in the industry and in the investment community would likely be significantly damaged, each of which would cause our stock price to decrease.

*Because the results of preclinical studies and initial clinical trials of isatoribine, ANA975 and ANA380 are not necessarily predictive of future results, we can provide no assurances that ANA975 or ANA380 will have favorable results in later clinical trials, or receive regulatory approval.

Positive results from preclinical studies or early clinical trials should not be relied upon as evidence that later or larger-scale clinical trials will succeed. Initial clinical trials of isatoribine, ANA975 and ANA380 have been conducted only in small numbers of patients that may not fully represent the diversity present in larger populations infected with HCV or HBV. The limited results we have obtained may not predict results from studies in larger numbers of patients drawn from more diverse populations and also may not predict the ability of isatoribine to achieve a sustained virologic response or the ability of ANA380 to provide a long-term therapeutic benefit. These initial trials have not been designed to assess the long-term therapeutic utility of isatoribine, ANA975 or ANA380. We will be required to demonstrate through larger-scale clinical trials that ANA975 and ANA380 are safe and effective for use in a diverse population before we can seek regulatory approvals for their commercial sale. There is typically an extremely high rate of attrition from the failure of drug candidates proceeding through clinical trials. Furthermore, if concurrent toxicology studies have unexpected results, the clinical development of the compound at issue could be suspended, delayed and/or terminated. If ANA975, ANA380, or any other product candidate, fails to demonstrate sufficient safety and efficacy in any clinical trial or shows unexpected findings in concurrent toxicology studies, we would experience potentially significant delays in, or be required to abandon, development of that product candidate. If we delay or abandon our development efforts related to ANA975 or ANA380, we may not be able to generate sufficient revenues to become profitable, and our reputation in the industry and in the investment community would likely be significantly damaged, each of which would cause our stock price to decrease significantly.

*The IND covering the ANA975 development plan in the U.S. is currently on full clinical hold and we will need to obtain agreement with the FDA and regulatory authorities in Europe prior to resuming clinical trials.

In June 2006, we voluntarily suspended dosing in our 28-day Phase 1b clinical trial of ANA975 in HCV-infected patients and the FDA subsequently notified us that it was placing the IND covering ANA975 on full clinical hold. We will need to gain agreement with the FDA on the significance of the toxicological findings and the future clinical trial design prior to resuming clinical trials with ANA975. If we are unable to show a data package that the FDA finds acceptable to support future clinical trials, the FDA may decline

to lift the clinical hold, in which case we will not be permitted to conduct clinical trials of ANA975 in the U.S. or ultimately seek or obtain U.S. regulatory approval for commercialization for ANA975. Similarly, we will need to gain agreement from the applicable regulatory authorities in Europe prior to resuming dosing of ANA975 in Europe.

*We will need to file an additional IND application to conduct trials of ANA975 for HBV in the U.S. and will need to continue our dialogue with the FDA as we and/or Novartis conduct additional trials of ANA975 in the U.S. for either HCV or HBV.

Even if the FDA allows us to resume dosing with ANA975 in HCV infected patients, we will still need to file an additional IND application before commencing clinical trials for the HBV indication in the U.S. If we are unable to obtain FDA acceptance of an IND application for ANA975 for HBV, we will not be permitted to conduct clinical trials of ANA975 for HBV in the U.S. or ultimately seek or obtain U.S. regulatory approval for commercialization for this indication. In addition, if we and/or Novartis conduct further trials of ANA975 for HCV, we and/or Novartis will need to continue the dialogue with the FDA to ensure that the FDA concurs with our proposed trial design. Conducting any such dialogue could potentially result in delays in the commencement of future clinical trials. As a result, any delay in either an IND becoming effective for the study of ANA975 as an HBV therapy or the commencement of further clinical trials of ANA975 could delay the further development of our lead product candidate and potential commercialization, adversely affect our collaborative relationship with Novartis and delay our ability to generate product sales.

*We may not realize the anticipated benefits of the development and potential commercialization of ANA380 for HBV.

In April 2004, we entered into an agreement with LGLS for the joint development and potential commercialization of ANA380. Under the terms of the agreement, we and LGLS are jointly conducting and equally funding the global clinical development of ANA380 for HBV and LGLS has granted to us an exclusive license to commercialize ANA380 as a therapy for chronic HBV in North America, Europe, Japan and all other countries in the world other than China, Korea, India and countries in Southeast Asia. As a result of the joint development aspect of our agreement with LGLS, the future success of our HBV programs will depend in part on our ability to maintain our relationship with LGLS with respect to ANA380. We cannot guarantee that LGLS will not reduce or curtail its efforts to develop ANA380 with us because of changes in its research and development budget, its development priorities or other factors affecting its business or operations. Additionally, if we are not able to maintain a positive relationship with LGLS with respect to ANA380, we may not be able to effectively develop or commercialize products based on ANA380, in which case our HBV development and potential commercialization efforts could be significantly impaired and our ability to generate anticipated product revenues may suffer. Furthermore, given the increased number of currently available treatments for HBV as well as those in development, we and LGLS are continuing to evaluate the market opportunity for ANA380. As part of this evaluation, we are assessing the overall projected costs of our ANA380 program and the potential market opportunity for ANA380 if it is ultimately commercialized as a treatment for HBV. At this time, we are preparing to initiate a Phase 2b clinical trial with ANA380 in 2007. However, there is no guarantee that we will be able to realize the anticipated benefits of the development and potential commercialization of ANA380. If we are unable to do so, then our business could be materially and adversely affected and our stock price could decline significantly.

*Delays in the commencement of clinical testing of our current and potential product candidates could result in increased costs to us and delay our ability to generate revenues.

Our potential drug products and our collaborators’ potential drug products will require preclinical testing and extensive clinical trials prior to submission of any regulatory application for commercial sales. We commenced clinical trials of isatoribine in late 2002, and in February 2004 we commenced clinical trials of ANA971 and our joint development program with LGLS for ANA380. We commenced clinical trials of ANA975 in early 2005. As a result, we have very limited experience conducting clinical trials. In part because of this limited experience, we cannot be certain that planned clinical trials will begin or be completed on time, if at all. Delays in the commencement of clinical testing could significantly increase our product development costs and delay product commercialization. In addition, many of the factors that may cause, or lead to, a delay in the commencement of clinical trials may also ultimately lead to denial of regulatory approval of a product candidate.

The commencement of clinical trials can be delayed for a variety of reasons, including delays in:

	•		Demonstrating sufficient safety and efficacy to obtain regulatory approval to commence a clinical trial;

	•		Reaching an agreement on acceptable terms with our collaborators on all aspects of the clinical trial, including the contract research organizations and the trial sites;

	•		reaching agreement on acceptable terms with prospective contract research organizations and trial sites;

	•		Manufacturing sufficient quantities or producing drug meeting our quality standards of a product candidate;

	•		obtaining approval of an IND application or proposed trial design from the FDA; and

	•		obtaining institutional review board approval to conduct a clinical trial at a prospective site.

In addition, the commencement of clinical trials may be delayed due to insufficient patient enrollment, which is a function of many factors, including the size and nature of the patient population, the nature of the protocol, the proximity of patients to clinical sites, the availability of effective treatments for the relevant disease, and the eligibility criteria for the clinical trial. Furthermore, due to the June 2006 suspension of our Phase Ib ANA975 clinical trial and subsequent IND clinical hold, we may experience difficulty recruiting and enrolling patients in future clinical trials of ANA975.

*Delays in the completion of, or the termination of, clinical testing of our current and potential product candidates could result in increased costs to us and delay or prevent us from generating revenues.

Once a clinical trial has begun, it may be delayed, suspended or terminated by us, our collaborators, the FDA, or other regulatory authorities due to a number of factors, including:

	•		ongoing discussions with the FDA or other regulatory authorities regarding the scope or design of our clinical trials;

	•		failure to conduct clinical trials in accordance with regulatory requirements;

	•		lower than anticipated enrollment or retention rate of patients in clinical trials;

	•		inspection of the clinical trial operations or trial sites by the FDA or other regulatory authorities resulting in the imposition of a clinical hold;

	•		lack of adequate funding to continue clinical trials;

	•		negative results of clinical trials;

	•		negative or potentially problematic results of ongoing and concurrent pre-clinical toxicology studies;

	•		requests by the FDA for supplemental information on, or clarification of, the results of clinical trials conducted in other countries;

	•		insufficient supply or deficient quality of drug candidates or other materials necessary for the conduct of our clinical trials; or

	•		serious adverse events or other undesirable drug-related side effects experienced by participants.

Many of the factors that may lead to a delay, suspension or termination of clinical testing of a current or potential product candidate may also ultimately lead to denial of regulatory approval of a current or potential product candidate. If we experience delays in the completion of, or termination of, clinical testing, our financial results and the commercial prospects for our product candidates may be harmed, and our ability to generate product revenues will be delayed.

*The success of the clinical development program of ANA380 will depend, at least in part, on our or our collaborators’ ability to maintain a positive working relationship with the FDA and other regulatory authorities, and the failure to do so may harm or delay our ability to commercialize ANA380 in the U.S. or other countries.

Although a U.S. IND covering ANA380 has been filed with the FDA, to date no clinical trials of ANA380 have been conducted in the U.S. As a result, if we or our collaborators proceed with the development of ANA380 in the U.S., the FDA may subject the clinical trial design for ANA380 to additional scrutiny and we may incur additional costs and delays responding to potential future FDA requests for supplemental information or clarification. Any delay imposed by the FDA regarding conducting clinical trials of ANA380 in the U.S. could delay the further development of ANA380 and its potential commercialization and delay our ability to generate product sales. In addition, due to the structure of our joint development program with LGLS for the clinical development of ANA380, we do not have complete control over the design of the clinical trials of ANA380 and will be affected, at least in part, by decisions previously made by LGLS with respect to clinical trial structure and communications with regulatory authorities. If we pursue the development of ANA380 in the U.S., we will need to maintain open communication channels with regulatory authorities, including the FDA. Furthermore, if the FDA does not agree with our proposed clinical development plan, our clinical development plan in the U.S. and other countries may be delayed. A delay in the clinical development of ANA380 may harm the value of the program, decrease our ability to enter into a licensing arrangement with a collaborator around ANA380, and adversely affect our ability to generate revenues.

If our efforts to obtain rights to new products or product candidates from third parties do not yield product candidates for clinical development or are not otherwise successful, we may not generate product revenues or achieve profitability.

Our long-term ability to earn product revenue depends on our ability to identify, through internal research programs, potential product candidates that may be developed into new pharmaceutical products and/or obtain new products or product candidates through licenses from third parties. If our internal research programs to discover and develop small-molecule therapeutics for the treatment of infectious diseases and for other disease areas do not generate sufficient product candidates, we will need to obtain rights to new products or product candidates from third parties. We may be unable to obtain suitable product candidates or products from third parties for a number of reasons, including:

	•		we may be unable to purchase or license products or product candidates on terms that would allow us to make an appropriate return from resulting products;

	•		competitors may be unwilling to assign or license product or product candidate rights to us; or

	•		we may be unable to identify suitable products or product candidates within, or complementary to, our areas of interest relating to small-molecule anti-infective medicines and the treatment of HCV, HBV, other serious infections and cancer.

If we are unable to obtain rights to new products or product candidates from third parties, our ability to generate product revenues and achieve profitability may suffer.

As we evolve from a company primarily involved in discovery and development to one also involved in commercialization, we may encounter difficulties in managing our growth and expanding our operations successfully.

We have experienced a period of rapid and substantial growth that has placed a strain on our administrative and operational infrastructure, and we anticipate that our continued growth will have a similar impact. As we advance our product candidates through clinical trials and regulatory approval processes, we will need to expand our development, regulatory, manufacturing, marketing and sales capabilities or contract with third parties to provide these capabilities for us. As our operations expand, we expect that we will need to manage additional relationships with various collaborative partners, suppliers and other third parties. Our ability to manage our operations and growth requires us to continue to improve our operational, financial and management controls, reporting systems and procedures.

Because we acquired isatoribine from Valeant Pharmaceuticals International (formerly known as ICN Pharmaceuticals, Inc.) any dispute with Valeant Pharmaceuticals International may adversely affect our ability to commercialize isatoribine or prodrugs of isatoribine.

In March 2000, we acquired the exclusive worldwide rights to isatoribine and five other compounds from Valeant Pharmaceuticals International (formerly known as ICN Pharmaceuticals, Inc.), or Valeant, as part of an agreement with Valeant and Devron R. Averett, Ph.D. If there is any dispute between Valeant and us regarding our rights under the agreement, our ability to develop and market isatoribine or any other compound licensed from Valeant may be adversely affected. In the past we have been involved in disputes with Valeant regarding patent prosecution matters related to the licensed compounds and entered into a new agreement with Valeant in December 2002 that superseded the original license agreement and resolved these disputes. Valeant may develop technologies and products similar to the drugs we may derive from these compounds, which do not infringe the patents acquired by us. If we are not able to resolve any future license disputes that may arise or obtain adequate patent protection, our ability to develop isatoribine or the other relevant compounds may be compromised, and we may not be able to prevent competitors, including Valeant, from making, using and selling competing products, which could have a material adverse effect on our financial condition and results of operation.

Even if we successfully complete clinical trials of ANA975, ANA380 or any future product candidate, there are no assurances that we will be able to submit, or obtain FDA approval of, a new drug application.

There can be no assurance that if our clinical trials of ANA975, ANA380 or any other potential product candidate are successfully completed, we will be able to submit a new drug application, or NDA, to the FDA or that any NDA we submit will be approved by the FDA in a timely manner, if at all. If we are unable to submit a NDA with respect to ANA975, ANA380 or any future product candidate, or if any NDA we submit is not approved by the FDA, we will be unable to commercialize that product in the U.S. The FDA can and does reject NDAs and may require additional clinical trials, even when drug candidates performed well or achieved favorable results in large-scale Phase III clinical trials. If we fail to commercialize ANA975, ANA380 or any future product candidate in clinical trials, we may be unable to generate sufficient revenues to attain profitability, and our reputation in the industry and in the investment community would likely be damaged, each of which would cause our stock price to decrease.

If we successfully develop products but those products do not achieve and maintain market acceptance, our business will not be profitable.

Even if ANA975, ANA380 or any future product candidates are approved for commercial sale by the FDA or other regulatory authorities, the degree of market acceptance of any approved product candidate by physicians, healthcare professionals and third-party payors and our profitability and growth will depend on a number of factors, including:

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

	•		relative convenience and ease of administration;

	•		the prevalence and severity of any adverse side effects;

	•		availability of alternative treatments;

	•		pricing and cost effectiveness;

	•		effectiveness of our or our collaborators’ sales and marketing strategy; and

	•		our ability to obtain sufficient third-party insurance coverage or reimbursement.

The current standard of care for the treatment of chronic HCV is the combination of pegylated interferon-alpha and ribavirin. If ANA975 or any future product candidate that we discover and develop for the treatment of HCV does not provide a treatment regimen that is more beneficial than the current standard of care or otherwise provides patient benefit, that product likely will not be accepted favorably by the market. Similarly, if ANA380 does not provide a treatment regime that is more beneficial than any current or proposed therapy for the treatment of HBV, that product will likewise not be accepted favorably by the market. If any products we or our collaborations may develop do not achieve market acceptance, then we will not generate sufficient revenue to achieve or maintain profitability.

In addition, even if our products achieve market acceptance, we may not be able to maintain that market acceptance over time if:

	•		new products or technologies are introduced that are more favorably received than our products, are more cost effective or render our products obsolete; or

	•		complications, such as antibiotic or viral resistance, arise with respect to use of our products.

If we were to decide to pursue the commercialization of isatoribine and were unable to obtain statutory marketing exclusivity after our patents covering isatoribine expire, we would face increased competition, which could result in reduced potential revenues.

The primary composition of matter patents covering isatoribine will expire in 2007 and 2008. We have filed for patent protection on ANA975 and other prodrugs of isatoribine and plan to pursue commercialization of one or more prodrugs of isatoribine rather than isatoribine itself, although there can be no assurance that we will be able to secure adequate patent protection. After the patent expirations of isatoribine itself, we will have no direct means to prevent third parties from making, selling, using or importing isatoribine in the U.S., Europe or Japan. Instead, if we were to decide to pursue commercialization of isatoribine, we would expect to rely upon the U.S. Drug Price Competition and Patent Term Restoration Act of 1984, commonly known as the Hatch-Waxman Act, and applicable foreign legislation, to achieve market exclusivity for isatoribine. For NDAs for new chemical entities not previously approved, the Hatch-Waxman Act provides for marketing exclusivity to the first applicant to gain approval for a particular drug by prohibiting acceptance or approval of an abbreviated new drug application, or ANDA, from a generic competitor for up to five years after approval of the original NDA. This exclusivity only applies to submissions of an ANDA and would not prevent a third party from conducting pivotal clinical trials and thereafter filing a complete NDA regulatory submission for isatoribine after the patent expirations. Our competitors will be free during any period of statutory exclusivity to develop the data necessary either to file an ANDA at the end of the exclusivity period or to conduct studies in support of a complete NDA filing during the period of market exclusivity. Japanese law may provide us with marketing exclusivity in Japan for a period up to six years following Japanese marketing approval. Although statutory market exclusivity in Europe, the U.S. and Japan may apply even when the composition of matter patent has already expired, it is possible that isatoribine will not qualify for such exclusivity, or alternatively, the terms of the Hatch-Waxman Act, or similar foreign statutes, could be amended or interpreted to our disadvantage. If we were to decide to pursue commercialization of isatoribine and we did not qualify for marketing exclusivity for isatoribine, the competition we face would increase, reducing our potential revenues and adversely affecting our ability to attain or maintain profitability.

We will need additional funding and may be unable to raise capital when needed, which would force us to delay, reduce or eliminate our research and development programs or commercialization efforts.

We will need to raise additional capital at least within the next several years to, among other things:

	•		fund our research and development programs;

	•		fund our share of the further clinical development and regulatory review and approval of ANA975 and ANA380;

	•		establish and maintain manufacturing, sales and marketing operations;

	•		commercialize our product candidates, if any, that receive regulatory approval; and

	•		acquire rights to products or product candidates, technologies or businesses.

Our future funding requirements will depend on, and could increase significantly as a result of many factors, including:

	•		the progress of our clinical trials;

	•		the progress of our research activities;

	•		the number and scope of our research programs;

	•		the progress of our preclinical development activities;

	•		our ability to establish and maintain strategic collaborations;

	•		the costs involved in enforcing or defending patent claims and other intellectual property rights;

	•		the pace and timing of development activities conducted under joint development arrangements with our collaborators;

	•		the cost and timing of regulatory approvals;

	•		the costs of establishing or expanding manufacturing, sales and distribution capabilities;

	•		the costs related to development and manufacture of pre-clinical, clinical and validation lots for regulatory and commercialization of drug supply;

	•		the success of the commercialization of ANA380 and ANA975; and

	•		the extent to which we acquire or invest in other products technologies and businesses.

We do not anticipate that we will generate significant continuing revenues for at least several years, if ever. Until we can generate significant continuing revenues, we expect to satisfy our future cash needs through public or private equity offerings, debt financings, corporate collaboration and licensing arrangements and grant funding, as well as through interest income earned on cash balances. We cannot be certain that additional funding will be available to us on acceptable terms, or at all. If funds are not available, we may be required to delay, reduce the scope of or eliminate one or more of our research or development programs or our commercialization efforts.

Raising additional funds by issuing securities or through collaboration and licensing arrangements may cause dilution to existing stockholders, restrict our operations or require us to relinquish proprietary rights.

We may raise additional funds through public or private equity offerings, debt financings or corporate collaborations and licensing arrangements. We cannot be certain that additional funding will be available on acceptable terms, or at all. To the extent that we raise additional capital by issuing equity securities, our stockholders’ ownership will be diluted. Any debt financing we enter into may involve covenants that restrict our operations. These restrictive covenants may include limitations on borrowing, specific

restrictions on the use of our assets as well as prohibitions on our ability to create liens, pay dividends, redeem capital stocks or make investments. In addition, if we raise additional funds through collaboration and licensing arrangements, it may be necessary to relinquish potentially valuable rights to our potential products or proprietary technologies, or grant licenses on terms that are not favorable to us. For example, we might be forced to relinquish all or a portion of our sales and marketing rights with respect to potential products or license intellectual property that enables licensees to develop competing products.

If we fail to establish new collaborations, we may not generate sufficient revenue to attain profitability.

Our near and long-term viability will depend in part on our ability to successfully establish new strategic collaborations with pharmaceutical and biotechnology companies. Since we do not currently possess the resources necessary to independently fully develop and commercialize other potential products that may be based upon our technologies, we will either need to develop or acquire these resources on our own, which will require substantial funding, time and effort, or will need to enter into additional collaborative agreements to assist in the development and commercialization of some of these potential products. Establishing strategic collaborations is difficult and time-consuming. Potential collaborators may reject collaborations based upon their assessment of our financial, regulatory or intellectual property position or based on existing collaborations. If we fail to establish a sufficient number of additional collaborations on acceptable terms, we may not generate sufficient revenue. Even if we successfully establish new collaborations, these relationships may never result in the successful development or commercialization of any product candidates or the generation of sales or royalty revenue.

*If we fail to maintain our existing and future collaborations, we may not generate sufficient revenue to attain profitability.

Our future success will also depend in part on our ability to maintain our existing collaborations and any future collaborations we may establish. Our existing collaborators and future collaborators may decide to reduce or curtail their collaborations with us because of changes in their research and development budgets or other factors affecting their business or operations. Our present collaborative arrangements and any future collaboration opportunities could be harmed if:

	•		we or our collaborators do not achieve our respective objectives under our collaboration agreements;

	•		we or our collaborators encounter development hurdles that prevent or delay further development of our product candidates;

	•		we are unable to obtain patent protection for the product candidates or proprietary technologies we discover in our collaborations;

	•		we are unable to properly manage multiple simultaneous product discovery and development collaborations;

	•		our present or potential collaborators are less willing to expend their resources on our programs due to their focus on other programs or as a result of general market conditions;

	•		our collaborators become competitors of ours or enter into agreements with our competitors;

	•		we or our collaborators encounter regulatory hurdles that prevent commercialization of our product candidates;

	•		we develop products and processes or enter into additional collaborations that conflict with the business objectives of our other collaborators;

	•		consolidation in our target markets or the pharmaceutical or biotechnology industry limits the number of potential collaborators;

	•		the rights granted under our collaboration agreements prove insufficient to adequately develop and commercialize our products and product candidates;

	•		a collaborator breaches, terminates or fails to renew a collaboration with us; or

	•		we are unable to negotiate additional collaboration agreements on terms satisfactory to us.

If any of these events occur, we may not be able to develop or commercialize products or generate sufficient revenue to support our operations and attain and maintain profitability. To the extent that we enter into co-promotion or other collaborative arrangements, our product revenues are likely to be lower than if we directly marketed and sold any products that we may develop.

*We are dependent on collaborators allocating adequate resources to our collaborations, and actions taken by collaborators could prevent us from commercializing products and earning milestone and other contingent payments, royalties or other revenue.

Much of the potential revenue from our existing and future collaborations will consist of contingent payments, such as payments for achieving development milestones and royalties payable on sales of drugs developed using our technologies or capabilities. The milestone and royalty revenues that we may receive under these collaborations will depend upon our collaborator’s ability to successfully develop, introduce, market and sell new products. In addition, our existing collaborators may decide to enter into arrangements with third parties to commercialize products developed under our existing or future collaborations using our technologies or capabilities, which could reduce the milestone and royalty revenue that we may receive, if any. In many cases we will not be involved in these processes and accordingly will depend entirely on our collaborators. Our collaboration partners may fail to develop or effectively commercialize products using our products or technologies because they:

	•		decide not to devote the necessary resources due to challenges or delays in pre-clinical or clinical development;

	•		decide not to devote the necessary resources due to internal constraints, such as limited personnel with the requisite scientific expertise, limited cash resources or specialized equipment limitations, or other drug development priorities that our collaboration partners believe may have a higher likelihood of obtaining regulatory approval or may potentially generate a greater return on investment;

	•		do not have sufficient resources necessary to carry the product candidate through clinical development, regulatory approval and commercialization;

	•		are unable to allocate sufficient resources due to factors affecting their businesses or operations or as a result of general market conditions;

	•		decide to pursue a competitive potential product developed outside of the collaboration;

	•		cannot obtain the necessary regulatory approvals; or

	•		are otherwise subject to adverse events affecting their business.

If our collaboration partners fail to develop or effectively commercialize product candidates or products for any of these reasons or for any other reason, we may not be able to replace the collaboration partner with another partner to develop and commercialize a product candidate or product under the terms of the collaboration or because we are unable to obtain a license from such collaboration partner on terms acceptable to us.

A number of our collaboration agreements have been directed toward the discovery and development of drug candidates. Under these collaboration agreements, we generally would not earn significant milestone payments unless and until our collaborators have advanced product candidates into clinical testing, which may not occur for many years, if ever. In addition, a collaborator may disagree as to whether a particular milestone has been achieved. Consequently, we cannot guarantee that milestone payments will be received or that commercialized drugs will be developed on which royalties will be payable to us. If we are unable to generate significant milestone and royalty revenues from our collaborations, we may never attain profitability.

If any conflicts arise between us and any of our collaborators, our reputation, revenues and cash position could be significantly harmed.

Conflicts may arise between our collaborators and us, such as conflicts concerning the conduct of research, the achievement of milestones or the ownership or protection of intellectual property developed during the collaboration. In addition, in the past we have been involved in disputes with Valeant Pharmaceuticals International (formerly ICN Pharmaceuticals, Inc.) regarding the license of certain compounds, which resulted in us entering into a new agreement with Valeant in December 2002 that superseded the original March 2000 license agreement between us and Valeant and resolved the disputes. Any such disagreement between us and a collaborator could result in one or more of the following, each of which could harm our reputation, result in a loss of revenues and a reduction in our cash position, and cause a decline in our stock price:

	•		unwillingness on the part of a collaborator to pay us research funding, milestone payments or royalties we believe are due to us under our collaboration agreement;

	•		uncertainty regarding ownership of intellectual property rights arising from our collaborative activities, which could result in litigation and prevent us from entering into additional collaborations;

	•		unwillingness on the part of a collaborator to keep us informed regarding the progress of its development and commercialization activities, or to permit public disclosure of the results of those activities;

	•		slowing or cessation of a collaborator’s development or commercialization efforts with respect to our products; or

	•		termination or non-renewal of the collaboration.

In addition, certain of our current or future collaborators may have the right to terminate the collaboration agreement on short notice. Accordingly, in the event of any conflict between the parties, our collaborators may elect to terminate the collaboration prior to completion of its original term. If a collaboration is terminated prematurely, we would not realize the anticipated benefits of the collaboration, our reputation in the industry and in the investment community may be harmed and our stock price may decline.

In addition, in each of our collaborations, we generally have agreed not to conduct independently, or with any third party, activities directly competitive with the subject matter of our collaborations. Our collaborations may have the effect of limiting the areas of research, development and/or commercialization that we may pursue, either alone or with others. Under certain circumstances, however, our collaborators, may research, develop, and/or commercialize, either alone or with others, products in related fields that are competitive with the products or potential products that are the subject of these collaborations.

We depend on outside parties to conduct our clinical trials, which may result in costs and delays that prevent us from obtaining regulatory approval or successfully commercializing product candidates.

Although we have designed and managed our preclinical studies and clinical trials relating to isatoribine, ANA971 and ANA975 to date, we engaged clinical investigators and medical institutions to enroll patients in these clinical trials and contract research organizations to perform data collection and analysis and other aspects of our preclinical studies and clinical trials. As a result, we depend on these clinical investigators, medical institutions and contract research organizations to properly perform the studies and trials. If these parties do not successfully carry out their contractual duties or obligations or meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to the failure to adhere to our clinical protocols or for other reasons, our clinical trials may be extended, delayed or terminated. We may not be able to enter into replacement arrangements without undue delays or excessive expenditures. If there are delays in testing or regulatory approvals as a result of the failure to perform by third-parties, our drug discovery and development costs will increase and we may not be able to obtain regulatory approval for or successfully commercialize our product candidates. In addition, we may not be able to maintain any of these existing relationships, or establish new ones on acceptable terms, if at all.

We do not have internal manufacturing capabilities, and if we fail to develop and maintain supply relationships with collaborators or other outside manufacturers, we may be unable to develop or commercialize any of our non-partnered products.

Our ability to develop and commercialize future products we may develop will depend in part on our ability to manufacture, or arrange for collaborators or other parties to manufacture, our products at a competitive cost, in accordance with regulatory requirements and in sufficient quantities for clinical testing and eventual commercialization. We currently do not have any significant manufacturing arrangements or agreements, as our current product candidates will not require commercial-scale manufacturing for at least several years, if ever. Our inability to enter into or maintain manufacturing agreements with collaborators or capable contract manufacturers on acceptable terms could delay or prevent the development and commercialization of our products, which would adversely affect our ability to generate revenues and would increase our expenses.

If we are unable to establish sales and marketing capabilities or enter into agreements with third parties to sell and market any products we may develop, we may not be able to generate product revenue.

We do not currently have the capabilities for the sales, marketing and distribution of pharmaceutical products. In order to commercialize any products, we must build our sales, marketing, distribution, managerial and other non-technical capabilities or make arrangements with third parties to perform these services. Although we currently expect to commercialize in the U.S. our HCV product candidate and other potential product candidates that are of strategic interest to us, because the most advanced of these product candidates are in early stage clinical development, we have not definitively determined whether we will attempt to establish internal sales and marketing capabilities or enter into agreements with third parties to sell and market any products we may develop. The establishment and development of our own sales force to market any products we may develop in the U.S. will be expensive and time-consuming and could delay any product launch, and we cannot be certain that we would be able to successfully develop this capacity. If we are unable to establish our sales and marketing capability or any other non-technical capabilities necessary to commercialize any product we may develop, we will need to contract with third parties to market and sell any products we may develop in the U.S. We will also need to develop a plan to market and sell any products we may develop outside the U.S. If we are unable to establish adequate sales, marketing and distribution capabilities, whether independently or with third parties, we may not be able to generate product revenue and may not become profitable.

We will need to increase the size of our organization, and we may encounter difficulties managing our growth, which could adversely affect our results of operations.

We will need to expand and effectively develop our managerial, operational, financial and other resources in order to successfully pursue our research, development and commercialization efforts and secure collaborations to market and distribute our products. If we continue to grow, it is possible that our management, accounting and scientific personnel, systems and facilities currently in place may not be adequate to support this future growth. To manage any growth, we will be required to continue to improve our operational, financial and management controls, reporting systems and procedures and to attract and retain sufficient numbers of talented employees. We may be unable to successfully manage the expansion of our operations or operate on a larger scale and, accordingly, may not achieve our research, development and commercialization goals.

*If we are unable to attract and retain key management and scientific staff, we may be unable to successfully develop or commercialize our product candidates.

We are a small company, with under 100 employees, and our success depends on our continued ability to attract, retain and motivate highly qualified management and scientific personnel. In particular, our research and drug discovery programs depend on our ability to attract and retain highly skilled chemists, biologists, and preclinical and clinical personnel, especially in the fields of HCV, HBV and structure-based drug design. We may not be able to attract or retain qualified management and scientific personnel in the future due to the intense competition for qualified personnel among biotechnology and pharmaceutical businesses, particularly in the San Diego, California area. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will impede significantly the achievement of our research and development objectives and our ability to meet the demands of our collaborators in a timely fashion. In addition, all of our employees are “at will” employees, which means that any employee may quit at any time and we may terminate any employee at any time. Currently we do not have employment agreements with any employees or members of senior management that provide any guarantee of continued employment by us. We do not carry “key person” insurance covering members of senior management other than Kleanthis G. Xanthopoulos, Ph.D., our President and Chief Executive Officer. The insurance covering Dr. Xanthopoulos is in the amount of $1 million. In particular, if we are unable to identify a suitable replacement for Dr. Xanthopoulos, who has announced his resignation to be effective at the end of 2006 or such earlier time as a replacement is identified and appointed, our business may be harmed. In addition, if we lose the services of Stephen T. Worland, Ph.D., our President, Pharmaceuticals, James T. Glover, our Senior Vice President, Operations and Chief Financial Officer, or other members of our senior management team, we may not be able to find suitable replacements, and our business may be harmed as a result.

Our quarterly results and stock price may fluctuate significantly.

We expect our results of operations to be subject to quarterly fluctuations. The level of our revenues, if any, and results of operations at any given time, will be based primarily on the following factors:

	•		the status of development of ANA380, ANA975 and our other product candidates, including results of preclinical studies and clinical trials and changes in regulatory status;

	•		our recommendation of additional compounds for preclinical development;

	•		our execution of collaborative, licensing or other arrangements, and the timing and accounting treatment of payments we make or receive under these arrangements;

	•		whether or not we achieve specified research or commercialization milestones under any agreement that we enter into or have entered into with collaborators and the timely payment by commercial collaborators of any amounts payable to us;

	•		our collaborators’ termination of any of our collaborative, licensing or other arrangements, or any disputes regarding such arrangements;

	•		our addition or termination of research programs or funding support;

	•		variations in the level of expenses related to our product candidates or potential product candidates during any given period; and

	•		the effect of competing technological and market developments.

These factors, some of which are not within our control, may cause the price of our stock to fluctuate substantially. In particular, if our quarterly operating results fail to meet or exceed the expectations of securities analysts or investors, our stock price could drop suddenly and significantly. In addition, fluctuations in the stock prices of other companies in the biotechnology and pharmaceuticals industries and in the financial markets generally may affect our stock price. We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.

If we engage in any acquisition, we will incur a variety of costs, and we may never realize the anticipated benefits of the acquisition.

We may attempt to acquire businesses, technologies, services or products or in-license technologies that we believe are a strategic fit with our business, at the appropriate time and as resources permit. We believe that strategic acquisitions of complementary businesses, technologies, services or products are a material component of our business strategy to provide us with access to new compounds that are potentially synergistic with our existing product candidate portfolio. If we undertake any acquisition in addition to our in-license of ANA380 from LGLS, the process of integrating the acquired business, technology, service or product may result in unforeseen operating difficulties and expenditures and may divert significant management attention from our ongoing business operations. These operational and financial risks include:

	•		exposure to unknown liabilities;

	•		disruption of our business and diversion of our management’s time and attention to acquiring and developing acquired products or technologies;

	•		incurrence of substantial debt or dilutive issuances of securities to pay for acquisitions;

	•		higher than expected acquisition and integration costs;

	•		increased amortization expenses;

	•		negative effect on our earnings (or loss) per share;

	•		difficulty and cost in combining and integrating the operations and personnel of any acquired businesses with our operations and personnel;

	•		impairment of relationships with key suppliers, contractors or customers of any acquired businesses due to changes in management and ownership; and

	•		inability to retain key employees of any acquired businesses.

Although we acquired the exclusive worldwide rights to isatoribine as part of a licensing agreement with Valeant Pharmaceuticals International (formerly known as ICN Pharmaceuticals, Inc.) and have obtained from LGLS development and commercialization rights to ANA380 in certain territories, we have limited experience in identifying acquisition targets, successfully completing potential acquisition targets and integrating any acquired businesses, technologies, services or products into our current infrastructure. Moreover, we may fail to realize the anticipated benefits of any acquisition or devote resources to potential acquisitions that are never completed. If we fail to successfully identify strategic opportunities, complete strategic transactions or integrate acquired businesses, technologies, services or products, we may not be able to successfully expand our product candidate portfolio to provide adequate revenue to attain and maintain profitability.

Earthquake damage to our facilities could delay our research and development efforts and adversely affect our business.

Our headquarters and research and development facilities in San Diego, California, are located in a seismic zone, and there is the possibility of an earthquake, which could be disruptive to our operations and result in delays in our research and development efforts. In the event of an earthquake, if our facilities or the equipment in our facilities are significantly damaged or destroyed for any reason, we may not be able to rebuild or relocate our facility or replace any damaged equipment in a timely manner and our business, financial condition and results of operations could be materially and adversely affected.

Risks Related to Our Industry

Because our product candidates and development and collaboration efforts depend on our intellectual property rights, adverse events affecting our intellectual property rights will harm our ability to commercialize products.

Our commercial success depends on obtaining and maintaining patent protection and trade secret protection of our product candidates, proprietary technologies and their uses, as well as successfully defending these patents against third-party challenges. We will only be able to protect our product candidates, proprietary technologies and their uses from unauthorized use by third parties to the extent that valid and enforceable patents or effectively-protected trade secrets cover them.

Due to evolving legal standards relating to the patentability, validity and enforceability of patents covering pharmaceutical inventions and the scope of claims made under these patents, our ability to obtain and enforce patents is uncertain and involves complex legal and factual questions. Accordingly, rights under any issued patents may not provide us with sufficient protection for isatoribine, ANA975, ANA380, other oral prodrugs of isatoribine, other TLR-7 oral prodrugs or our other drug candidates or provide sufficient protection to afford us a commercial advantage against competitive products or processes. In addition, we cannot guarantee that any patents will issue from any pending or future patent applications owned by or licensed to us. Even with respect to patents that have issued or will issue, we cannot guarantee that the claims of these patents are, or will be valid, enforceable or will provide us with any significant protection against competitive products or otherwise be commercially valuable to us. For example:

	•		we might not have been the first to make, conceive, or reduce to practice the inventions covered by all or any of our pending patent applications and issued patents;

	•		we might not have been the first to file patent applications for these inventions;

	•		others may independently develop similar or alternative technologies or duplicate any of our technologies;

	•		it is possible that none of our pending patent applications will result in issued patents;

	•		our issued or acquired patents may not provide a basis for commercially viable products, may not provide us with any competitive advantages, or may be challenged by third parties;

	•		our issued patents may not be valid or enforceable;

	•		we may not develop additional proprietary technologies that are patentable; or

	•		the patents of others may have an adverse effect on our business.

Patent applications in the U.S. are maintained in confidence for up to 18 months after their filing. Consequently, we cannot be certain that we or our collaborators were the first to invent, or the first to file patent applications on our product candidates. In the event that a third party has also filed a U.S. patent application relating to our product candidates or a similar invention, we may have to participate in interference proceedings declared by the U.S. Patent Office to determine priority of invention in the U.S. The costs of these proceedings could be substantial and it is possible that our efforts would be unsuccessful, resulting in a material adverse effect on our U.S. patent position. Furthermore, we may not have identified all U.S. and foreign patents or published applications that affect our business either by blocking our ability to commercialize our drugs or by covering similar technologies that affect our drug market.

In addition, some countries, including many in Europe, do not grant patent claims directed to methods of treating humans, and in these countries patent protection may not be available at all to protect our drug candidates. Even if patents issue, we cannot guarantee that the claims of those patents will be valid and enforceable or provide us with any significant protection against competitive products, or otherwise be commercially valuable to us. We may be particularly affected by this because we expect that ANA975 and ANA380, if approved, will be marketed in foreign countries with high incidences of HCV and HBV infection.

Other companies may obtain patents and/or regulatory approvals to use the same drugs to treat diseases other than HCV or HBV. As a result, we may not be able to enforce our patents effectively because we may not be able to prevent healthcare providers from prescribing, administering or using another company’s product that contains the same active substance as our products when treating patients infected with HCV or HBV.

If we fail to obtain and maintain patent protection and trade secret protection of ANA380, ANA975, other oral prodrugs of isatoribine or other TLR-7 oral prodrugs or our other product candidates, proprietary technologies and their uses, the competition we face would increase, reducing our potential revenues and adversely affecting our ability to attain or maintain profitability.

If we are sued for infringing intellectual property rights of others, it will be costly and time- consuming, and an unfavorable outcome in that litigation would have a material adverse effect on our business.

Our commercial success also depends upon our ability to develop, manufacture, market and sell our product candidates and use our proprietary technologies without infringing the proprietary rights of third parties. We may be exposed to future litigation by third

parties based on claims that our product candidates, technologies or activities infringe the intellectual property rights of others. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in HCV, HBV and the other fields in which we are developing products. These could materially affect our ability to develop our drug candidates or sell our products. Because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our product candidates or technologies may infringe. There also may be existing patents, of which we are not aware, that our product candidates or technologies may inadvertently infringe. Further, there may be issued patents and pending patent applications in fields relevant to our business, of which we may become aware from time to time, that we believe we do not infringe or that we believe are invalid or relate to immaterial portions of our overall drug discovery and development efforts. We cannot assure you that third parties holding any of these patents or patent applications will not assert infringement claims against us for damages or seeking to enjoin our activities. We also cannot assure you that, in the event of litigation, we will be able to successfully assert any belief we may have as to non-infringement, invalidity or immateriality, or that any infringement claims will be resolved in our favor.

There is a substantial amount of litigation involving patent and other intellectual property rights in the biotechnology and biopharmaceutical industries generally. Any litigation or claims against us, with or without merit, may cause us to incur substantial costs, could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. In addition, intellectual property litigation or claims could result in substantial damages and force us to do one or more of the following if a court decides that we infringe on another party’s patent or other intellectual property rights:

	•		cease selling, incorporating or using any of our product candidates or technologies that incorporate the challenged intellectual property;

	•		obtain a license from the holder of the infringed intellectual property right, which license may be costly or may not be available on reasonable terms, it at all; or

	•		redesign our processes or technologies so that they do not infringe, which could be costly and time-consuming and may not be possible.

If we find during clinical evaluation that our drug candidates for the treatment of HCV or HBV or in the other fields in which we are developing products should be used in combination with a product covered by a patent held by another company or institution, and that a labeling instruction is required in product packaging recommending that combination, we could be accused of, or held liable for, infringement of the third-party patents covering the product recommended for co-administration with our product. In that case, we may be required to obtain a license from the other company or institution to use the required or desired package labeling, which may not be available on reasonable terms, or at all.

If we fail to obtain any required licenses or make any necessary changes to our technologies, we may be unable to develop or commercialize some or all of our product candidates.

We may be involved in lawsuits or proceedings to protect or enforce our patent rights, trade secrets or know-how, which could be expensive and time- consuming.

The defense and prosecution of intellectual property suits and related legal and administrative proceedings can be both costly and time-consuming. Litigation and interference proceedings could result in substantial expense to us and significant diversion of effort by our technical and management personnel. Further, the outcome of patent litigation is subject to uncertainties that cannot be adequately quantified in advance, including the demeanor and credibility of witnesses and the identity of the adverse party. This is especially true in biotechnology related patent cases that may turn on the testimony of experts as to technical facts upon which experts may reasonably disagree and which may be difficult to comprehend by a judge or jury. An adverse determination in an interference proceeding or litigation, particularly with respect to ANA975, isatoribine or any other oral prodrug of isatoribine or to ANA380, to which we may become a party could subject us to significant liabilities to third parties or require us to seek licenses from third parties. If required, the necessary licenses may not be available on acceptable terms, or at all. Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from commercializing ANA975, ANA380 or our other product candidates, which could have a material and adverse effect on our results of operations.

Furthermore, because of the substantial amount of pre-trial document and witness discovery required in connection with intellectual property litigation, there is risk that some of our confidential information could be compromised by disclosure during this type of litigation. In addition, during the course of this kind of litigation, there could be public announcements of the results of hearings, motions or other interim proceedings or developments. If securities analysts or investors perceive these results to be negative, it could have a substantial adverse effect on the trading price of our common stock.

Confidentiality agreements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information and may not adequately protect our intellectual property.

We also rely on trade secrets to protect our technology, especially where we do not believe patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. In order to protect our proprietary technology and processes, we also rely in part on confidentiality and intellectual property assignment agreements with our corporate partners, employees, consultants, outside scientific collaborators and sponsored researchers and other advisors. These agreements may not effectively prevent disclosure of confidential information nor result in the effective assignment to us of intellectual property, and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information or other breaches of the agreements. In addition, others may independently discover our trade secrets and proprietary information, and in such case we could not assert any trade secret rights against such party. Enforcing a claim that a party illegally obtained and is using our trade secrets is difficult, expensive and time-consuming, and the outcome is unpredictable. In addition, courts outside the U.S. may be less willing to protect trade secrets. Costly and time-consuming litigation could be necessary to seek to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

Many competitors have significantly more resources and experience, which may harm our commercial opportunity.

The biotechnology and pharmaceutical industries are subject to intense competition and rapid and significant technological change. We have many potential competitors, including major drug and chemical companies, specialized biotechnology firms, academic institutions, government agencies and private and public research institutions. Many of our competitors have significantly greater financial resources, experience and expertise in:

	•		research and development;

	•		preclinical testing;

	•		clinical trials;

	•		regulatory approvals;

	•		manufacturing; and

	•		sales and marketing of approved products.

Smaller or early-stage companies and research institutions may also prove to be significant competitors, particularly through collaborative arrangements with large and established pharmaceutical or other companies. We will also face competition from these parties in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient registration for clinical trials, and acquiring and in-licensing technologies and products complementary to our programs or potentially advantageous to our business. If any of our competitors succeed in obtaining approval from the FDA or other regulatory authorities for their products sooner than we do or for products that are more effective or less costly than ours, our commercial opportunity could be significantly reduced.

*If our competitors develop treatments for HCV, HBV, cancer or in the other fields in which we are developing products that are approved faster, marketed better or demonstrated to be more effective than ANA975, ANA380 or any other products that we may develop, our commercial opportunity will be reduced or eliminated.

We believe that a significant number of drugs are currently under development and may become available in the future for the treatment of HCV, HBV, certain cancers and in other fields in which we are developing products. Potential competitors may develop treatments for HCV, HBV, certain cancers or for other disease areas in which we are developing products, or other technologies and products that are more effective or less costly than our product candidates or that would make our technology and product candidates obsolete or non-competitive. Some of these products may use therapeutic approaches that compete directly with ANA975, ANA380, or with ANA773. In addition, less expensive generic forms of currently marketed drugs could lead to additional competition upon patent expiration or invalidations.

ANA975 is also subject to competition in the treatment of HCV from a number of products already approved and on the market, including the following: Peg-Intron (pegylated interferon-alpha-2b), Rebetol (ribavirin), and Intron-A (interferon-alpha-2b), which are marketed by Schering-Plough, and Pegasys (pegylated interferon-alpha-2a), Copegus (ribavirin USP), and Roferon-A (interferon-alpha-2a), which are marketed by Roche. We expect new products for the treatment of HCV will be introduced that may lead to further competition for ANA975. Additional compounds in late stage clinical trials include, but are not limited to, Viramidine, in development by Valeant Pharmaceuticals, Albuferon, in development by Human Genome Sciences and Novartis, NM283

(valopicitabine dihydrochloride), in development by Idenix Pharmaceuticals and Novartis, VX-950, in development by Vertex Pharmaceuticals and Janssen Pharmaceutica, SCH503034, in development by Schering-Plough, and ITMN-191, in development by Intermune.

Similarly, both ANA975 and ANA380 are also subject to competition in the treatment of HBV from other products already approved and on the market. Current small-molecule treatments for HBV include lamivudine (Zeffix/ Epivir HBV) from GlaxoSmithKline, adefovir (Hepsera) from Gilead and entecavir (Baraclude) from Bristol-Myers Squibb. Telbivudine, a small molecule treatment for HBV being developed by Idenix Pharmaceuticals and Novartis has recently been approved by the US FDA and is currently under regulatory review by the EMEA and the Chinese health authority. In addition, interferon-alpha therapy (Intron-A) from Schering-Plough and Pegasys (pegylated interferon-alpha-2a) from Roche have been endorsed by various regulators for the treatment of HBV. Tenofovir (Viread), an approved HIV compound from Gilead, is in Phase III trials for HBV. Finally, several other compounds are being studied in Phase III clinical trials. We also face competition from a number of companies working in the field of cancer and in other disease areas in which we are developing products. Many other competitors are developing products for the treatment of our target diseases. If successful, we will compete with these products and others in varying stages of the drug development process.

If we cannot establish pricing of our product candidates acceptable to the government, insurance companies, managed care organizations and other payors, any product sales will be severely hindered.

The continuing efforts of the government, insurance companies, managed care organizations and other payors of health care costs to contain or reduce costs of health care may adversely affect:

	•		our ability to set a price we believe is fair for any products we or our collaborators may develop;

	•		our ability to generate adequate revenues and gross margins; and

	•		the availability of capital.

In certain foreign markets, the pricing of prescription pharmaceuticals is subject to government control. In the U.S., given recent federal and state government initiatives directed at lowering the total cost of health care, the U.S. Congress and state legislatures will likely continue to focus on health care reform, the cost of prescription pharmaceuticals and on the reform of the Medicare and Medicaid systems. The trend toward managed health care in the U.S., which could significantly influence the purchase of health care services and products, as well as legislative proposals to reform health care, control pharmaceutical prices or reduce government insurance programs, may result in lower prices for our product candidates. While we cannot predict whether any legislative or regulatory proposals affecting our business will be adopted, the announcement or adoption of these proposals could have a material and adverse effect on our potential revenues and gross margins.

If we cannot arrange for reimbursement policies favorable to our product candidates, their sales will be severely hindered.

Our ability to commercialize ANA975, ANA380 or any other product candidates successfully will depend in part on the extent to which governmental authorities, private health insurers and other organizations establish appropriate reimbursement levels for the cost of ANA975, ANA380 or any other products and related treatments. Third-party payors are increasingly challenging the prices charged for medical products and services, including treatments for HCV and HBV. Also, the trend toward managed health care in the U.S. as well as legislative proposals to reform health care, control pharmaceutical prices or reduce government insurance programs, may also result in exclusion of our product candidates from reimbursement programs. The cost containment measures that health care payors and providers are instituting and the effect of any health care reform could materially and adversely affect our ability to earn product revenue and generate significant profits and could impact our ability to raise capital.

Product liability claims may damage our reputation and, if insurance proves inadequate, the product liability claims may harm our results of operations.

We face an inherent risk of product liability exposure for claimed injuries related to the testing of our product candidates in human clinical trials, and will face an even greater risk if we or our collaborators sell our product candidates commercially. If we cannot successfully defend ourselves against product liability claims, we will incur substantial liabilities. Regardless of merit or eventual outcome, product liability claims may result in:

	•		decreased demand for our product candidates;

	•		injury to our reputation;

	•		withdrawal of clinical trial participants;

	•		the inability to establish new collaborations with potential collaborators;

	•		substantial costs of related litigation;

	•		substantial monetary awards to patients; and

	•		the inability to commercialize our product candidates.

We currently have product liability insurance that covers our on-going clinical trials and plan to increase and expand this coverage as we commence larger scale trials. We also intend to expand our insurance coverage to include the sale of commercial products if marketing approval is obtained for any of our product candidates. However, insurance coverage is increasingly expensive. We may not be able to maintain insurance coverage at a reasonable cost and we may not be able to obtain insurance coverage that will be adequate to satisfy any liability that may arise.

Any claims relating to our improper handling, storage or disposal of biological, hazardous and radioactive materials could be time-consuming and costly.

Our research and development involves the controlled use of hazardous materials, including chemicals that cause cancer, volatile solvents, including ethylacetate and acetonitrile, radioactive materials and biological materials including plasma from patients infected with HCV, HBV or other infectious diseases that have the potential to transmit disease. Our operations also produce hazardous waste products. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these materials and waste products. If we fail to comply with these laws and regulations or with the conditions attached to our operating licenses, the licenses could be revoked, and we could be subjected to criminal sanctions and substantial liability or required to suspend or modify our operations. Although we believe that our safety procedures for handling and disposing of these materials comply with legally prescribed standards, we cannot completely eliminate the risk of accidental contamination or injury from these materials. In the event of contamination or injury, we could be held liable for damages or penalized with fines in an amount exceeding our resources, and our clinical trials could be suspended. In addition, we may have to incur significant costs to comply with future environmental laws and regulations. We do not currently have a pollution and remediation insurance policy.

Our business and operations would suffer in the event of system failures.

Despite the implementation of security measures, our internal computer systems are vulnerable to damage from computer viruses, unauthorized access, natural disasters, terrorism, war and telecommunication and electrical failures. Any system failure, accident or security breach that causes interruptions in our operations could result in a material disruption of our drug discovery programs. To the extent that any disruption or security breach results in a loss or damage to our data or applications, or inappropriate disclosure of confidential or proprietary information, we may incur liability as a result, our drug discovery programs may be adversely affected and the further development of our product candidates may be delayed. In addition, we may incur additional costs to remedy the damages caused by these disruptions or security breaches.

Risks Related to Our Common Stock

Future sales of our common stock may cause our stock price to decline.

Our current stockholders hold a substantial number of shares of our common stock that they are able to sell in the public market. Significant portions of these shares are held by a small number of stockholders. Sales by our current stockholders of a substantial number of shares or the expectation that such sale may occur, could significantly reduce the market price of our common stock. Moreover, the holders of up to approximately 8,000,000 shares of common stock, including shares issued upon the exercise of certain of our warrants, have rights, subject to some conditions, to require us to file registration statements to permit the resale of their shares in the public market or to include their shares in registration statements that we may file for ourselves or other stockholders.

*Our stock price may be volatile.

The market price of our common stock may fluctuate significantly in response to a number of factors, most of which we cannot control, including:

	•		changes in the regulatory status of our product candidates, including the status and results of our clinical trials for ANA975 and ANA380;

	•		significant contracts, new technologies, acquisitions, commercial relationships, joint ventures or capital commitments;

	•		disputes or other developments relating to proprietary rights, including patents, trade secrets, litigation matters, and our ability to patent or otherwise protect our product candidates and technologies;

	•		developments under our collaboration agreements with our collaborators;

	•		conditions or trends in the pharmaceutical and biotechnology industries;

	•		fluctuations in stock market prices and trading volumes of similar companies or of the markets generally;

	•		variations in our quarterly operating results;

	•		changes in securities analysts’ estimates of our financial performance;

	•		failure to meet or exceed securities analysts’ or investors’ expectations of our quarterly financial results, clinical results or our achievement of milestones;

	•		changes in accounting principles including the implementation of SFAS No. 123R,Share-Based Payment,which we adopted effective January 1, 2006. We expect that this accounting change will have a negative impact on our operating losses and potential earnings in future periods;

	•		sales of large blocks of our common stock, or the expectation that such sales may occur, including sales by our executive officers, directors and significant stockholders;

	•		additions or departures of key personnel;

	•		discussion of our business, products, financial performance, prospects or our stock price by the financial and scientific press and online investor communities such as chat rooms;

	•		regulatory developments in the U.S. and foreign countries;

	•		economic and political factors, including wars, terrorism and political unrest; and

	•		technological advances by our competitors.

Our largest stockholders may take actions that are contrary to your interests, including selling their stock.

A small number of our stockholders hold a significant amount of our outstanding stock. These stockholders may support competing transactions and have interests that are different from yours. In addition, the average number of shares of our stock that trade each day is generally low. As a result, sales of a large number of shares of our stock by these large stockholders or other stockholders within a short period of time could adversely affect our stock price.

Anti-takeover provisions in our organizational documents and Delaware law may discourage or prevent a change in control, even if an acquisition would be beneficial to our stockholders, which could affect our stock price adversely and prevent attempts by our stockholders to replace or remove our current management.

Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may delay or prevent a change in control, discourage bids at a premium over the market price of our common stock and adversely affect the market price of our common stock and the voting and other rights of the holders of our common stock. These provisions include:

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

	•		prohibiting our stockholders from calling a special meeting of stockholders;

	•		permitting the issuance of additional shares of our common stock or preferred stock without stockholder approval;

	•		prohibiting our stockholders from making certain changes to our amended and restated certificate of incorporation or amended and restated bylaws except with 66 2/3% stockholder approval; and

	•		requiring advance notice for raising matters of business or making nominations at stockholders’ meetings.

We are also subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for five years unless the holder’s acquisition of our stock was approved in advance by our board of directors. Although we believe these provisions collectively provide for an opportunity to receive higher bids by requiring potential acquirers to negotiate with our board of directors, they would apply even if the offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.

We have never paid cash dividends on our capital stock and we do not anticipate paying dividends in the foreseeable future.

We have paid no cash dividends on any of our classes of capital stock to date, and we currently intend to retain our future earnings, if any, to fund the development and growth of our business. In addition, the terms of any future debt or credit facility may preclude us from paying any dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of potential gain for the foreseeable future.

Item 6. Exhibits


EXHIBIT
NO.		DESCRIPTION

31.1		Certification of President and Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended

31.2		Certification of Senior Vice President, Operations and Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended

32		Certifications of President and Chief Executive Officer and Senior Vice President, Operations and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Date: November 2, 2006		ANADYS PHARMACEUTICALS, INC.

		By: /s/ Kleanthis G. Xanthopoulos, Ph.D.

		Kleanthis G. Xanthopoulos, Ph.D.
		President and Chief Executive Officer

		By: /s/ James T. Glover

		James T. Glover
		Senior Vice President, Operations and Principal
		Financial Officer

		By: /s/ Jennifer K. Crittenden

		Jennifer K. Crittenden
		Vice President, Finance and Chief Accounting Officer

EXHIBIT INDEX


EXHIBIT
NO.		DESCRIPTION

31.1		Certification of President and Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended

31.2		Certification of Senior Vice President, Operations and Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended

32		Certifications of President and Chief Executive Officer and Senior Vice President, Operations and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Good

Anadys Pharmaceuticals (ANDS) Inactive 10-Q2006 Q3 Quarterly report

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