Anadys Pharmaceuticals 10Q 2007 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, 2007


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		(I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION)		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 filer þ 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, 2007:


Class		Number of Shares Outstanding

Common Stock, $0.001 par value		28,651,106

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, 2007 and December 31, 2006		3
Condensed Consolidated Statements of Operations — Three and nine months ended September 30, 2007 and 2006		4
Condensed Consolidated Cash Flow Statements — Nine months ended September 30, 2007 and 2006		5
Notes to Condensed Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		10
Item 3. Quantitative and Qualitative Disclosures About Market Risk		16
Item 4. Controls and Procedures		16

PART II. OTHER INFORMATION

Item 1A. Risk Factors		17
Item 6. Exhibits		32
SIGNATURES		33
EXHIBIT 10.48
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,
	2007			2006
	(Unaudited)			(Note)
Assets
Current assets:

Cash and cash equivalents	$	35,455		$	62,387
Securities available-for-sale		26,292			19,762
Accounts receivable		—			1,175
Prepaid expenses and other current assets		1,316			941

Total current assets		63,063			84,265

Property and equipment, net		2,968			3,749
Other assets, net		1,439			1,387


Total assets	$	67,470		$	89,401


Liabilities and Stockholders’ Equity
Current liabilities:

Accounts payable and accrued expenses	$	3,619		$	4,111
Current portion of deferred rent		540			467
Current portion of deferred revenue		50			4,633

Total current liabilities		4,209			9,211

Long-term portion of deferred rent		517			931
Long-term portion of deferred revenue		—			18,934

Commitments and contingencies

Stockholders’ equity:

Preferred stock, $0.001 par value; 10,000,000 shares authorized at September 30, 2007 and December 31, 2006; no shares issued and outstanding at September 30, 2007 and December 31, 2006		—			—
Common stock, $0.001 par value; 90,000,000 shares authorized at September 30, 2007 and December 31, 2006; 28,651,106 and 28,596,198 shares issued and outstanding at September 30, 2007 and December 31, 2006, respectively		29			29
Additional paid-in capital		278,509			274,798
Accumulated other comprehensive gain (loss)		58			(22	)
Accumulated deficit		(215,852	)		(214,480	)

Total stockholders’ equity		62,744			60,325


Total liabilities and stockholders’ equity	$	67,470		$	89,401

Note: The balance sheet at December 31, 2006, 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.

See accompanying notes to unaudited condensed consolidated 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,
	2007		2006			2007			2006
Revenues:

Collaborative agreements	$	21,489	$	1,139		$	23,892		$	4,228
Grants		—		6			—			41


Total revenues		21,489		1,145			23,892			4,269

Expenses:

Research and development		7,602		5,496			21,275			18,978
General and administrative		2,444		3,097			6,844			7,835


Total operating expenses		10,046		8,593			28,119			26,813

Interest income and other		864		1,189			2,855			3,471
Interest expense		—		—			—			(69	)


Net interest income and other		864		1,189			2,855			3,402


Net income (loss)	$	12,307	$	(6,259	)	$	(1,372	)	$	(19,142	)


Net income (loss) per share, basic and diluted	$	0.43	$	(0.22	)	$	(0.05	)	$	(0.67	)


Shares used in calculating net income (loss) per share, basic and diluted		28,651		28,562			28,637			28,489

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,
	2007			2006
Operating Activities:
Net loss	$	(1,372	)	$	(19,142	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		1,103			1,163
Share-based compensation expense		3,502			4,951
Rent expense related to warrants issued in connection with lease		36			38
Interest expense related to warrants issued in connection with debt		—			23
Loss on disposal of property and equipment		18			61
Changes in operating assets and liabilities:
Accounts receivable		1,175			4,522
Prepaid expenses and other current assets		(375	)		(293	)
Other assets, net		(52	)		195
Accounts payable and accrued expenses		(492	)		(29	)
Deferred revenue		(23,517	)		(5,127	)
Deferred rent		(341	)		(320	)


Net cash used in operating activities		(20,315	)		(13,958	)

Investing Activities:
Purchases of securities available-for-sale		(12,850	)		(11,961	)
Proceeds from sale and maturity of securities available-for-sale		6,400			2,750
Purchases of property and equipment		(340	)		(1,422	)


Net cash used in investing activities		(6,790	)		(10,633	)

Financing Activities:
Proceeds from exercise of stock options and employee stock purchase plan		173			820
Principal payments on long-term debt		—			(1,559	)


Net cash provided by (used in) financing activities		173			(739	)

Net decrease in cash and cash equivalents		(26,932	)		(25,330	)
Cash and cash equivalents at beginning of period		62,387			93,659


Cash and cash equivalents at end of period	$	35,455		$	68,329


Supplemental Disclosure of Non-Cash Investing and Financing Activities:

Unrealized gain on securities available-for-sale	$	80		$	41

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 related disclosures included in the Company’s 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on March 15, 2007. 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. Actual results may differ from these estimates under different assumptions or conditions.

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 applied 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 that 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 activities in which the Company deploys its internal capabilities such as its medicinal chemistry and screening capabilities to assist a collaborator in advancing their drug discovery effort.

3. Net Income (Loss) Per Share

The Company calculates basic and diluted net income (loss) per share for all periods presented in accordance with the Statement of Financial Accounting Standards (SFAS) No. 128,Earnings Per Share. Basic net income (loss) per share was calculated by dividing the net income (loss) for the period by the weighted-average number of common shares outstanding during the period, without consideration for common stock equivalents. Diluted net income (loss) per share was calculated by dividing the net income (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 income (loss) per common share because all such securities are anti-dilutive for all periods presented.


	For the three and nine months ended September 30,
	2007		2006
	(In thousands)
Historical outstanding anti-dilutive securities not included in diluted net income (loss) per share calculation:
Options to purchase common stock		5,259		3,684
Warrants		279		279

		5,538		3,963

4. Comprehensive Income (Loss)

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


	Three months ended September 30,					Nine months ended September 30,
	2007		2006			2007			2006
	(in thousands)					(in thousands)
Net income (loss)	$	12,307	$	(6,259	)	$	(1,372	)	$	(19,142	)
Unrealized gain on securities available-for-sale		105		116			80			41

Comprehensive income (loss)	$	12,412	$	(6,143	)	$	(1,292	)	$	(19,101	)

5. Share-Based Payment

The Company calculates share-based compensation expense for all periods presented in accordance with the Statement of Financial Accounting Standards (SFAS) No. 123(R),Share-Based Payment. Under the provisions of SFAS No. 123(R), 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 Company accounts 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 re-measured as the underlying options vest in accordance with EITF Issue No. 96-18.

A summary of the Company’s stock options and related information as of September 30, 2007 is as follows:


					Weighted-
					Average
					Remaining
			Weighted		Contractual		Aggregate
	Options		Average		Term in		Intrinsic Value
	Outstanding		Exercise Price		Years		(in thousands)
Balance at September 30, 2007		5,258,782	$	4.91		7.62	$	—

Exercisable at September 30, 2007		2,604,342	$	5.52		6.04	$	—

The Company has reported the following amounts of share-based compensation expense in the Statements of Operations for the three and nine months ended September 30, 2007 and 2006 (in thousands, except per share data):


	Three months ended September 30,				Nine months ended September 30,
	2007		2006		2007		2006
Research and development expense	$	969	$	644	$	2,188	$	2,249
General and administrative expense		423		1,366		1,314		2,702

Total share-based compensation expense	$	1,392	$	2,010	$	3,502	$	4,951


Net share-based compensation expense, per common share basic and diluted	$	0.05	$	0.07	$	0.12	$	0.17

As of September 30, 2007, there was an additional $6.9 million of total unrecognized compensation cost related to unvested share-based awards granted under the Company’s stock option plans. This unrecognized compensation cost is expected to be recognized over a weighted-average period of 2.65 years.

The following assumptions were used to estimate the fair value of options granted for the three and nine months ended September 30, 2007 and 2006:


	Three months ended September 30,						Nine months ended September 30,
	2007			2006			2007			2006
Stock Options:
Dividend yield		0.0	%		0.0	%		0.0	%		0.0	%
Expected volatility		70.72	%		65.00	%		70.54	%		65.00	%
Risk-free interest rate		4.34	%		4.87	%		4.43	%		4.86	%
Expected life of the option term (in years)		5.30			6.04			5.49			6.11

Stock-based compensation expense recognized in accordance with SFAS 123(R) is based on awards ultimately expected to vest, and therefore is reduced by expected forfeitures. The Company estimates forfeitures based upon historical forfeiture rates, and will adjust its estimate of forfeitures if actual forfeitures differ, or are expected to differ, from such estimates.

6. Income Taxes

In July 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109,(FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing the recognition threshold a tax position is required to meet before being recognized in the financial statements. The Company adopted the provisions of FIN 48 effective January 1, 2007.

At January 1, 2007, the Company had net deferred tax assets of $78.6 million. The deferred tax assets include $40.9 million related to federal and state tax net operating loss (NOL) carryforwards and $7.3 million related to federal and state research and development (R&D) credit carryforwards. Due to uncertainties surrounding the Company’s ability to generate future taxable income to realize its deferred tax assets, a full valuation allowance has been established to offset this amount. Additionally, utilization of the NOL and R&D credit carryforwards may be subject to a substantial annual limitation under Section 382 of the Internal Revenue Code of 1986, and similar state provisions due to ownership change limitations that have occurred previously or that could occur in the future. These ownership changes may limit the amount of NOL and R&D credit carryforwards that can be utilized to offset future taxable income and tax, respectively. In general, an ownership change, as defined by Section 382, results from transactions increasing

ownership of certain shareholders or public groups in the stock of the corporation by more than 50 percentage points over a three-year period. The Company has initiated an analysis of Section 382 through December 31, 2006 and based on this analysis the Company believes that multiple changes of ownership have occurred and therefore that its NOL and R&D credit carryforwards will be subject to annual limitations in future periods. Until the analysis is completed and any limitation known, no amounts are being presented as an uncertain tax position under FIN 48. Management believes that the amount subject to limitation could be significant. Any amounts that are determined will expire prior to their utilization due to such limitations will be removed from deferred tax assets with a corresponding reduction of the valuation allowance. In addition, future changes in the unrecognized tax benefit will have no impact on the effective tax rate due to the existence of the valuation allowance.

The Company’s practice is to recognize interest and/or penalties related to income tax matters in income tax expense. Upon adoption of FIN 48 on January 1, 2007, the Company did not record any interest or penalties.

The tax years since 1992 remain open to examination by the major taxing jurisdictions to which the Company is subject, as tax authorities may have the right to examine prior periods where net operating losses or tax credits were generated and carried forward.

For the year ended December 31, 2007, the Company is forecasting a cumulative net loss and as such the Company has not calculated a provision for income taxes for the three and nine months ended September 30, 2007.

7. Novartis Collaboration

During the third quarter, the Company and Novartis decided to discontinue the development of ANA975, a Phase 1b compound for the treatment of hepatitis C virus (HCV) infection. Also during the third quarter, the Company and Novartis concluded that no further activities will be pursued under the current collaboration. As a result, during the third quarter the Company recognized $21.0 million of previously deferred revenue representing the remaining unrecognized portion of the $20.0 million up-front payment and the $10.0 million IND milestone payment that were previously being recognized into revenue over the estimated development period of ANA975. This completes the recognition of the deferred revenue under the Novartis collaboration. Both amounts were received from Novartis in 2005.

8. Restructuring

On August 1, 2007, the Company announced a strategic restructuring following the decision it announced on July 26, 2007 regarding Novartis’ and its discontinuation of the development of ANA975 for the treatment of HCV. As part of the restructuring, the Company discontinued its involvement with the development of ANA380. The Company also halted its early stage discovery efforts. The Company now plans to direct its resources toward the development of ANA598, a NS5B polymerase inhibitor, for the treatment of HCV, and ANA773, a TLR7 agonist prodrug for the treatment of certain cancers. The strategic restructuring resulted in an immediate reduction in the Company’s workforce of approximately 33%. The Company subsequently identified several additional positions that will be eliminated in connection with its strategic restructuring, and has notified the affected employees. The Company expects the reduction to generate annual savings of between $4.0 million and $5.0 million. The Company provided cash severance payments, continuation of benefits and outplacement services to employees directly affected by the workforce reduction. The Company incurred a charge of approximately $0.7 million in severance costs and $0.1 million in continuation of benefits and outplacement services in connection with the workforce reduction. In addition, the Company incurred a noncash charge of $0.4 million associated with the modification of stock options for individuals included in the reduction in force. As of September 30, 2007, the Company had a remaining accrual of $0.2 million associated with this strategic restructuring.

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, 2006 included with the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on March 15, 2007. 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

Anadys Pharmaceuticals, Inc. is a biopharmaceutical company dedicated to improving patient care by developing novel medicines in the areas of hepatitis C and oncology. Our current product candidate portfolio consists of ANA598, a non-nucleoside NS5B polymerase inhibitor for the treatment of chronic hepatitis C virus (HCV) infection, and ANA773, an oral TLR7 prodrug agonist for the treatment of certain cancers. On June 20, 2007, we announced that we nominated ANA598 as a candidate for clinical development as an orally-administered direct antiviral for the treatment of chronic HCV infection. We plan to file an Investigational New Drug (IND) application for ANA598 during the first half of 2008, and subject to Food and Drug Administration (FDA) approval, initiate a Phase 1 clinical trial of ANA598 in the second quarter of 2008. We filed an IND application for ANA773 in the third quarter of 2007 and have received clearance from the FDA to proceed with a Phase 1 clinical trial in cancer patients. We are currently making arrangements to initiate a Phase 1 clinical trial of ANA773, which we plan to begin before the end of 2007. On July 26, 2007, we announced that we and our collaborator Novartis had decided to discontinue the development of ANA975 for the treatment of HCV infection. Following this decision, on August 1, 2007, we announced that we were effecting a strategic restructuring to focus our resources on the development of ANA598 and ANA773. As part of this restructuring, we discontinued further development of ANA380, a nucleotide analog we had been jointly developing with LG Life Sciences (LGLS) as a treatment for hepatitis B virus (HBV) infection. We are in the process of returning all rights to this compound to LGLS. We also halted our early stage discovery efforts. The strategic restructuring resulted in an immediate reduction in our workforce of approximately 33%. We subsequently identified several additional positions that will be eliminated in connection with our strategic restructuring, and have notified the affected employees. This reduction in force is expected to be completed in the second quarter of 2008. We expect the reduction in force to generate annual savings of between $4.0 million and $5.0 million. In the third quarter we incurred a charge of approximately $0.7 million in severance costs and $0.1 million in continuation of benefits and outplacement services in connection with the workforce reduction. In addition, we incurred a non-cash charge of $0.4 million associated with the modification of stock options for individuals included in the reduction in force.

Effective August 24, 2007, Lawrence C. Fritz, Ph.D. resigned as President and Chief Executive Officer and from the Board of Directors of the Company. On August 24, 2007, Steve Worland, Ph.D., the Company’s President, Pharmaceuticals, was appointed as the Company’s President and Chief Executive Officer and was also appointed to the Company’s Board of Directors.

We have incurred significant operating losses since our inception and, as of September 30, 2007, our accumulated deficit was $215.9 million. We expect to incur substantial losses for at least the next several years as we:

	•		continue the development of ANA598 for the treatment of HCV;

	•		continue the development of ANA773 for the treatment of certain cancers;

	•		develop methods for and scale-up manufacturing of ANA598 and ANA773 for clinical trials and potential commercialization;

	•		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.

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 financials 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 activities in which we deploy our internal capabilities such as our medicinal chemistry and screening capabilities to assist a collaborator in advancing their drug discovery effort.

Drug Development Costs.We review and accrue drug development costs based on work performed, relying 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 cost accruals 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 Statement of Financial Accounting Standards No. 123(R) (SFAS No. 123(R)),Share-Based Payment. Under the provisions of SFAS No. 123(R), 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 determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, the risk-free interest rate and the expected term of the awards. 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, 2007 and 2006

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.

Research and Development Expenses.Research and development expenses were $7.6 million for the three months ended September 30, 2007 compared to $5.5 million for the three months ended September 30, 2006. The $2.1 million increase is primarily due to an increase in external pre-clinical development costs for ANA773 and ANA598 and the effect of a one-time reimbursement of $1.1 million received during the three months ended September 30, 2006 for ANA975 costs previously incurred by us. The increase in pre-clinical development costs for ANA598 and ANA773 can be attributed to our continued focus towards bringing these compounds into clinical development. We anticipate costs associated with ANA598 and ANA773 to continue to increase as we proceed with the development of these two compounds. The increase in research and development expenses was partially offset by a decrease in development costs associated with ANA975 as a result of our decision with Novartis to discontinue the development of ANA975. For the next several quarters, we anticipate that we will continue to incur wind down costs associated with ANA975, which are not expected to be material. As a result of our decision to halt early stage discovery efforts, cost savings were achieved during the three months ended September 30, 2007. These cost savings were offset by severance related costs of $0.7 million associated with our strategic restructuring and reduction in force. Our non-cash share-based compensation expense was $1.0 million and $0.6 million for the three months ended September 30, 2007 and 2006, respectively.

Our research and development expenses noted above include $0.1 million due to Novartis for Anadys’ net share (19.5%) of ANA975 expenses incurred from July 1, 2007 through September 30, 2007. During the three months ended September 30, 2006, we recorded a $1.9 million offset to research and development expense which represented 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 of $1.1 million for costs previously incurred which became reimbursable during the three months ended September 30, 2006.

The following summarizes our research and development expenses for the three months ended September 30, 2007 and 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. Amounts due to Novartis for Anadys’ portion of ANA975 development costs have been included as a component of ANA975 expense.


	Three months ended September 30,
	2007		2006
	(In thousands)
ANA975	$	168	$	1,394
ANA773		2,080		936
ANA598		1,593		1,105
ANA380		119		227
Discovery stage programs		326		1,107
Infrastructure and support personnel		1,628		1,980
Severance related to reduction in force		719		—
Non-cash employee and non-employee share-based compensation		969		644
Reimbursement of ANA975 costs by Novartis		—		(1,897	)

Total research and development expense	$	7,602	$	5,496

General and Administrative Expenses.General and administrative expenses were $2.4 million for the three months ended September 30, 2007 compared to $3.1 million for the three months ended September 30, 2006. The $0.7 million decrease is primarily due to a decrease in share-based compensation expense partially offset by separation related costs of $0.5 million related to our previously announced strategic restructuring and related reduction in force and the departure of Lawrence C. Fritz, Ph.D., our former President and Chief Executive Officer. Non-cash share-based compensation expense for the three months ended September 30, 2007 and 2006 was $0.4 million and $1.4 million, respectively. In connection with Kleanthis G. Xanthopoulos’ resignation in 2006, we agreed to accelerate in full all of Dr. Xanthopoulos’ unvested stock options as of December 31, 2006. Share-based compensation expense for the three months ended September 30, 2006 includes $1.1 million of expense related to these options.

Interest Income and Other, net.Interest income was $0.9 million for the three months ended September 30, 2007 compared to $1.2 million for the three months ended September 30, 2006. The $0.3 million decrease in our interest income from the three months ended September 30, 2006 to the three months ended September 30, 2007 was the result of a lower average cash, cash equivalents and securities available-for-sale balance, which were invested in interest bearing securities, during the three months ended September 30, 2007 compared to the three months ended September 30, 2006.

Nine Months Ended September 30, 2007 and 2006

Revenue.During the third quarter, the Company and Novartis decided to discontinue the development of ANA975. Also during the third quarter, the Company and Novartis concluded that no further activities will be pursued under the current collaboration. As a result, during the third quarter the Company recognized $21.0 million of previously deferred revenue representing the remaining unrecognized portion of the $20.0 million up-front payment and the $10.0 million IND milestone payment that were previously being recognized into revenue over the estimated development period of ANA975. This completes the recognition of the deferred revenue under the Novartis collaboration. Both amounts were received from Novartis in 2005. Revenue for the nine months ended September 30, 2007 and 2006 was primarily attributable to the recognition of this revenue under the Novartis collaboration. We recorded revenue of $23.9 million for the nine months ended September 30, 2007 compared to $4.3 million for the nine months ended September 30, 2006. 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.

Research and Development Expenses. Research and development expenses were $21.3 million for the nine months ended September 30, 2007 compared to $19.0 million for the nine months ended September 30, 2006. The $2.3 million increase in research and development expenses was primarily related to an increase in external pre-clinical development costs for ANA773 and ANA598 and the effect of a one-time reimbursement of $1.1 million received during the nine months ended September 30, 2007 for ANA975 costs previously incurred by us. The increase in pre-clinical development costs for ANA598 and ANA773 can be attributed to our continued focus towards bringing these compounds into clinical development. We anticipate costs associated with ANA598 and ANA773 to continue to increase as we proceed with the development of these two compounds. The increase in research and development expenses was partially offset by a decrease in development costs associated with ANA975 as a result of our decision with Novartis to discontinue the development of ANA975. For the next several quarters, we anticipate that we will continue to incur wind down costs associated with ANA975, which are not expected to be material. As a result of our decision to halt early stage discovery efforts, cost savings were achieved during the nine months ended September 30, 2007. These cost savings were offset by severance related costs of $0.7 million associated with our strategic restructuring and reduction in force. Our non-cash share-based compensation expense was $2.2 million for each of the nine months ended September 30, 2007 and 2006.

Our research and development expenses noted above reflect an offset of $0.5 million as a reduction to research and development expense in the nine months ended September 30, 2007, which represents an estimate of Novartis’ net share (80.5%) of ANA975 expenses incurred from January 1, 2007 through September 30, 2007. During the nine months ended September 30, 2006, we recorded a $3.4 million offset to research and development expense which represented an estimate of Novartis’ net share of ANA975 expenses incurred from January 1, 2006 through September 30, 2006 as well as a one-time contractual obligation of $1.1 million for costs previously incurred which became reimbursable during the nine months ended September 30, 2006.

The following summarizes our research and development expenses for the nine months ended September 30, 2007 and 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.


	Nine months ended September 30,
	2007			2006
	(In thousands)
ANA975	$	1,020		$	4,027
ANA773		4,205			3,450
ANA598		5,506			2,941
ANA380		683			440
Discovery stage programs		1,761			3,729
Infrastructure and support personnel		5,707			5,565
Severance related to reduction in force		719			—
Non-cash employee and non-employee share-based compensation		2,188			2,249
Reimbursement of ANA975 costs by Novartis		(514	)		(3,423	)

Total research and development expense	$	21,275		$	18,978

General and Administrative Expenses.General and administrative expenses were $6.8 million for the nine months ended September 30, 2007 compared to $7.8 million for the nine months ended September 30, 2006. The $1.0 million decrease is primarily due to a decrease in share-based compensation expense partially offset by separation related costs of $0.5 million related to our previously announced strategic restructuring and related reduction in force and the departure of Lawrence C. Fritz, Ph.D., our former President and Chief Executive Officer. Non-cash share-based compensation expense for the nine months ended September 30, 2007 and 2006 was $1.3 million and $2.7 million, respectively. In connection with Kleanthis G. Xanthopoulos’ resignation in 2006, we

agreed to accelerate in full all of Dr. Xanthopoulos’ unvested stock options as of December 31, 2006. Share-based compensation expense for the nine months ended September 30, 2006 includes $1.8 million of expense related to these options.

Interest Income and Other, net.Interest income was $2.9 million for the nine months ended September 30, 2007 compared to $3.5 million for the nine months ended September 30, 2006. The $0.6 million decrease in our interest income from the nine months ended September 30, 2006 to the nine months ended September 30, 2007 was the result of a lower average cash, cash equivalents and securities available-for-sale balance, which were invested in interest bearing securities, during the nine months ended September 30, 2007 compared to the nine months ended September 30, 2006.

Liquidity and Capital Resources

Our cash, cash equivalents and available-for sale securities decreased by $20.4 million from December 31, 2006 to September 30, 2007 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, 2007. This decrease in cash, cash equivalents and securities available-for-sale includes the receipt of $1.8 million from Novartis during the nine months ended September 30, 2007 which represented Novartis’ share of ANA975 development costs for the period from July 1, 2006 to June 30, 2007.

Cash Flows from Operating Activities and Investing Activities:

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


	Nine months ended September 30,
	2007			2006
	(In thousands)
Net cash used in operating activities	$	(20,315	)	$	(13,958	)


Investing Activities:
Purchases of securities available-for-sale	$	(12,850	)	$	(11,961	)
Proceeds from sale and maturity of securities available-for-sale		6,400			2,750
Purchases of property and equipment		(340	)		(1,422	)


Net cash used in investing activities	$	(6,790	)	$	(10,633	)

Cash flows used in operating activities increased by $6.4 million from the nine months ended September 30, 2006 to the nine months ended September 30, 2007. The increase was primarily driven by the receipt of $5.9 million from Novartis during the nine months ended September 30, 2006 compared to $1.8 million during the nine months ended September 30, 2007.

Cash flows used in investing activities decreased by $3.8 million from the nine months ended September 30, 2006 to the nine months ended September 30, 2007. The overall decrease in the cash flows used in investing activities from the nine months ended September 30, 2006 to the nine months ended September 30, 2007 is primarily related to the timing of the purchases of investments as well as a decrease in purchases of property and equipment.

Cash Flows from Financing Activities:

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


	Nine months ended September 30,
	2007		2006
	(In thousands)
Financing Activities:
Proceeds from exercise of stock options and employee stock purchase plan	$	173	$	820
Principal payments on long-term debt		—		(1,559	)


Net cash provided by (used in) financing activities	$	173	$	(739	)

Cash flows provided by (used in) financing activities increased by $0.9 million from the nine months ended September 30, 2006 to the nine months ended September 30, 2007. The increase was primarily a result of the Company paying off the outstanding principal balances on our equipment financing lines of credit during the nine months ended September 30, 2006.

Future Cash Requirements

We expect our development expenses to be substantial as we continue the advancement of our current 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.

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;

	•		our ability to establish strategic collaborations;

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

	•		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 of drug supply;

	•		the success of the commercialization of ANA598, ANA773, or any other product candidates we may develop; and

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

We believe that our existing cash, cash equivalents, and securities available-for-sale will be sufficient to meet our projected operating requirements for at least the next twelve months. 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 likely will need to finance future cash needs through the sale of other equity securities, strategic collaboration agreements, project financing or 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, 2007 and 2006, 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 and Senior Vice President, Operations and Chief Financial Officer 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 and Senior Vice President, Operations and Chief Financial Officer 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 and Senior Vice President, Operations and Chief Financial Officer, 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.

There were no 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 quarterly report onForm 10-Q for the quarter ended June 30, 2007, as filed with the Securities and Exchange Commission.

Risks Related to Our Business

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. We have recently discontinued the development of ANA975 and ANA380, and our current product candidates ANA598 and ANA773 have not yet been studied in clinical trials. ANA598, ANA773 and any other compounds that we may in-license, may never be approved for commercial sales. These compounds will require extensive and costly development, preclinical testing and clinical trials prior to seeking regulatory approval 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 in our business operations, if ever.

We have incurred net operating losses since our incorporation in 1992, and through September 30, 2007 we have an accumulated deficit of $215.9 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. 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 the development costs of our product candidates, further our 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 in our business operations, if ever. Even if we do achieve profitability in our business operations, we may not be able to sustain or increase such profitability on an ongoing basis. Although our financial statements show that we were profitable during the third quarter of 2007, this is an anomaly due to the accounting treatment of the termination of our ANA975 development program and does not reflect profitability in our business operations. The third quarter 2007 profitability was attributable solely to the recognition of revenue associated with payments we had previously received from Novartis, the recognition of which was accelerated as a result of the termination of the ANA975 development program and other activities under our agreement with Novartis during the third quarter of 2007. This profitability is an accounting aberration for the third quarter of 2007 only, and should not be relied upon as an indication of future performance.

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

Our current product candidates, ANA598 and ANA773, were selected based on the presumption that intervention at their respective targets, HCV polymerase and TLR7, offers a therapeutic benefit. There can be no assurance that intervention at either target will offer sufficient benefit and acceptable toxicity to warrant continued development and approval. Much of our science focuses on the biology of a specific receptor, or protein, named Toll-Like Receptor-7, or TLR7, and on structure-based drug design. However, the interaction between small molecules and TLR7 represents a new mechanism of action for the treatment of disease, and there is no guarantee that an acceptable balance between therapeutic benefit and risk will be achieved with TLR7 agonists. For example, in June 2006 we suspended dosing of ANA975, a TLR7 agonist prodrug, in our then on-going ANA975 clinical trials due to information from 13-week toxicology studies in animals which showed intense immune stimulation. We subsequently conducted additional pre-clinical studies and were unable to identify an acceptable balance between therapeutic benefit and risk using a daily dosing schedule over 13-

weeks. Accordingly, we subsequently discontinued the development of ANA975 as a therapy for HCV infection. In addition, the use of a TLR7 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. No products acting at the HCV polymerase have been approved for marketing. Furthermore, neither ANA773 nor ANA598 have been studied in clinical trials. 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. If our approaches to drug discovery and development are not successful, we will not be able to establish or maintain a clinical development portfolio or generate product revenue.

Any set-back or failure of ANA598 or ANA773 will have a large negative impact on our business and stock price.

On August 1, 2007 we announced a re-structuring of our business and operations following the decision to discontinue the development of ANA975 as a treatment for HCV infection. As part of the restructuring of our business, we discontinued our further involvement with the development of ANA380, which we were jointly developing with LG Life Sciences LTD. as a treatment for HBV infection. We also discontinued our early-stage discovery programs. As a result of the restructuring, we have become substantially dependent on the future success of ANA598 and ANA773. If one or both of these compounds fail or have set-backs, our business and stock price will suffer.

*We recently terminated our ANA975 development program due to challenges seen in animal toxicology studies. To the extent that the ANA975 toxicology observations are mechanism related, our ANA773 program for cancer could be negatively impacted, causing our stock price to decline.

ANA975 is an oral prodrug of isatoribine, a TLR7 agonist. We have recently discontinued the development of ANA975 as a treatment for HCV infection due to intense immune stimulation in animals. To the extent that any of the ANA975 toxicology observations are mechanism related, rather than compound specific, we will need to determine whether the level of immune stimulation induced by TLR7 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 and schedule that provides therapeutic benefit without causing unacceptable adverse events, then the future development of ANA773 may be terminated, which would materially and adversely affect our business and cause our stock price to decline significantly.

*We recently filed an IND with the FDA to conduct clinical trials with ANA773 and intend to begin a Phase 1 clinical trial of ANA773 this year. If clinical sites do not move as quickly as we would like in starting the trial, this planned timing could be delayed, which could cause our stock price to decline.

We recently filed an IND with the FDA to conduct clinical trials with ANA773 in cancer patients. The FDA has accepted our IND and we are currently in discussions with clinical sites to conduct our Phase I clinical trial of ANA773. We are working towards initiating this clinical trial before the end of 2007; however there is no guarantee that we will be able to do so. We plan to conduct the clinical trial at various medical institutions. These institutions have specific procedures that need to be followed before clinical trials can begin, including obtaining approval from their respective Institutional Review Boards, and the completion of these procedures may take longer than we expect. In addition, once the clinical trial is approved for a particular site, the investigator at such site will need to screen and enroll patients. There is no guarantee that these institutions and investigators will devote adequate time and resources to our clinical trials, perform as contractually required or meet our desired timeline.

*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.

Our September 30, 2007 cash, cash equivalents and marketable securities balance was $61.7 million. We believe that this balance will be sufficient to satisfy our anticipated cash needs for at least the next fiscal year. However, we may need or choose to seek additional funding within this period of time. In addition, we will need to raise additional capital at least within the next few years to, among other things:

	•		fund our development programs;

	•		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 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 ANA598, ANA773 and any additional products; 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, project financing 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, project 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 may 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 ANA598 and ANA773, 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 collaborative agreements to assist in the development and commercialization 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.

* Our operating results may be harmed if our restructuring plans do not achieve the anticipated results or cause undesirable consequences.

In August 2007, we implemented a restructuring, including an immediate reduction of approximately one-third of our workforce and a subsequent identification of several additional positions that are scheduled to be eliminated in early 2008. Our restructuring activities may yield unintended consequences, such as attrition beyond our planned reduction in workforce and reduced employee

morale which may cause our employees to seek alternate employment. Additional attrition could have a material adverse effect on our financial performance. In addition, as a result of the restructuring and the reduction in our workforce, we face an increased risk of employment litigation.

*Since mid-2005, we have depended on one collaboration partner, Novartis, for substantially all our revenues and for the potential future commercialization of one of our lead product candidates. Although we and Novartis have discontinued the development of ANA975 for HCV, our collaboration agreement with Novartis has not yet been officially terminated.

We out-licensed rights to our product candidate ANA975 and certain other TLR7 agonist prodrugs under a development, license and commercialization agreement with Novartis, dated June 1, 2005, which we refer to as the collaboration agreement. Since mid-2005 we have derived substantially all of our 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. Although we and Novartis have discontinued the development of ANA975 for HCV, the collaboration agreement has not yet been officially terminated by Novartis. There is no guarantee that the parties will conduct any future activities under the collaboration or that the Agreement will or will not be terminated by Novartis. If the collaboration agreement is terminated in whole or in part and we are unable to enter similar arrangements with other collaborators, our business may be further harmed.

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.

Because the results of preclinical studies and initial clinical trials are not necessarily predictive of future results, we can provide no assurances that ANA598 or ANA773 will have favorable results in 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. 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 ANA598, ANA773, 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 ANA598 or ANA773, 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.

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 will require additional preclinical testing and extensive clinical trials prior to submission of any regulatory application for commercial sales. Previously, we have conducted only early-stage clinical trials on our own, and were involved with Phase 2a trials only as part of our collaboration with LG Life Sciences. 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, the number of other products under development competing for the same patients in trials 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 ANA773, since ANA773 has the same mechanism of action as 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.

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 in part on our ability to identify and obtain new products or product candidates through licenses from third parties. If our internal development programs that are focused on the development of small-molecule therapeutics for the treatment of HCV and cancer fail, 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.

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.

Even if we successfully complete clinical trials of ANA598, ANA773 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 ANA598, ANA773 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 ANA598, ANA773 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 ANA598, ANA773 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 ANA598, ANA773 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.

If ANA598 does not provide benefit within a treatment regimen that is more beneficial than a component of the current or future standard of care for HCV or otherwise provides patient benefit, that product likely will not be accepted favorably by the market. Similarly, if ANA773 does not provide benefit within a treatment regime that is more beneficial than any component of current or proposed therapy for the treatment of cancer, 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 viral resistance, arise with respect to use of our products.

Actions or inaction by our collaborators could prevent or delay us from operating within our fields of interest.

In our collaboration agreements with Novartis and LG Life Sciences, we have agreed not to conduct independently, or with any third party, activities directly competitive with the subject matter of our collaborations. In the event that, despite the discontinuation of the main programs under these collaborations, the entire agreements are not terminated, we will remain limited in our ability to independently conduct activities directed at the collaborations’ fields of interests. These limitations could last indefinitely if our

collaboration partners refuse or delay the conduct of wrap-up activities under the agreements. This would leave us in an uncertain contractual relationship for an indefinite duration, which in turn could have a negative impact on our operations and stock price.

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, the ownership or protection of intellectual property developed during the collaboration, or, with respect to terminating collaborations, the timing, scope and nature of termination or wind-down activities and/or amounts owed in financial reconciliations related to the termination or wind-down. For example, 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. Also, although we have discontinued the development of ANA975 with Novartis, our License and Co-Development Agreement remains in effect and subject to termination by Novartis. In addition, although we have decided to discontinue the development of ANA380, our Joint Development and License Agreement with LG Life Sciences for ANA380 remains in effect. We do not have rights to terminate the LG agreement in its entirety without cause and are in discussions with LG Life Sciences regarding the potential mutual termination of the Agreement. There is no guarantee that either Novartis or LG Life Sciences will not assert that we are in breach of the respective agreements or that we have liabilities under the respective agreements, or that Novartis or LG Life Sciences will raise any other allegations against us in connection with the winding down of the collaborations or termination of the agreements. 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 terminate an outstanding agreement, the main program of which has been discontinued;

	•		unwillingness on the part of a collaborator to pay us research funding, milestone payments or royalties we believe are due 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.

*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 relating to ANA598 and ANA773 to date, we plan to engage clinical investigators and medical institutions to enroll patients in planned 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 will 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 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 products.

Our ability to develop and commercialize products 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. 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.

*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 60 employees, and our success depends on our continued ability to attract, retain and motivate highly qualified management and scientific personnel. In particular, our programs depend on our ability to retain highly skilled chemists, biologists, and preclinical and clinical personnel in the fields of HCV and oncology. 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. We may also experience recruitment challenges due to our recent restructuring. 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. 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 currently carry “key person” insurance covering any members of senior management. If we lose the services of Steve Worland, Ph.D., our President and Chief Executive Officer, James T. Glover, our Senior Vice President, Operations and Chief Financial Officer, James L. Freddo, M.D., our Chief Medical 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 ANA598, ANA773 and our other product candidates, including results of preclinical studies and clinical trials and changes in regulatory status;

	•		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, 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.

We have limited experience in identifying acquisition targets, successfully completing potential acquisitions 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 or wildfire 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 addition, San Diego has experienced several severe wildfires during the past several years which have destroyed or damaged many businesses and residences in the San Diego area. In the event of an earthquake or a severe wildfire, if our facilities or the equipment in our facilities are significantly damaged or destroyed for any reason, or we are otherwise required to shut down our operations, we may

not be able to rebuild or relocate our facility or replace any damaged equipment, or otherwise recommence our business operations, 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 ANA598 or ANA773 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 ANA598, if approved, will be marketed in foreign countries with high incidences of HCV infection.

Other companies may obtain patents and/or regulatory approvals to use the same drugs to treat diseases other than HCV or cancer. 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 who have cancer.

If we fail to obtain and maintain patent protection and trade secret protection of ANA598 or ANA773, 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 and cancer. 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 cancer 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 with respect to ANA598 or ANA773, 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 ANA598 or ANA773, 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 or cancer that are approved faster, marketed better or demonstrated to be more effective than ANA598, ANA773, 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 and certain cancers. Potential competitors may develop treatments for HCV or certain cancers that are more effective or less costly than our product candidates or that would make our product candidates obsolete or non-competitive. Some of these products may use therapeutic approaches that compete directly with ANA598 or ANA773, In addition, less expensive generic forms of currently marketed drugs could lead to additional competition upon patent expiration or invalidations.

ANA598, a non-nucleoside polymerase inhibitor, was selected as a development candidate in June, 2007. If approved, ANA598 would likely be used in combination with the current standard of care and/or other direct antiviral agents such as protease inhibitors and polymerase inhibitors. Any product currently approved or approved in the future for the treatment of HCV infection could decrease or eliminate the commercial opportunity of ANA598. Other non nucleoside inhibitors would likely be the most direct competitors for ANA598. Non-nucleoside polymerase inhibitor programs are currently under clinical evaluation by Pfizer, Gilead and ViroChem. Further, a number of companies have non-nucleoside polymerase inhibitor research programs.

Other potential competitors are products currently approved for the treatment of HCV infection: Peg-Intron (pegylated interferon-alpha-2b), Rebetol (ribavirin), and Intron-A (interferon-alpha-2b), which are marketed by Schering-Plough, Pegasys (pegylated interferon-alpha-2a), Copegus (ribavirin USP), and Roferon-A (interferon-alpha-2a), which are marketed by Roche. Additional compounds in late state clinical trials for HCV include Albuferon, in development by Human Genome Sciences and Novartis, VX-950, in development by Vertex Pharmaceuticals and Janssen Pharmaceutica, SCH503034, in development by Schering-Plough, ITMN-191, in development by Intermune and Roche, and R-1626, in development by Roche.

ANA773 is a prodrug of a TLR7 agonist under evaluation for oncology indications. Any product currently approved or approved in the future for the treatment of cancer could decrease or eliminate the commercial opportunity of ANA773. Programs that most directly compete with ANA773 at this time are other TLR agonists under evaluation for oncology indications, including PF-3512676, in development by Coley and Pfizer, IMO-2055, in development by Idera and a cancer program in development by Dynavax.

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 ANA598, ANA773 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 ANA598, ANA773 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 cancer. 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 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 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.

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 ANA598 and ANA773;

	•		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

3.1⁽¹⁾		Form of Amended and Restated Certificate of Incorporation of the Registrant

3.2⁽¹⁾		Form of Amended and Restated Bylaws of the Registrant

4.1⁽²⁾		Form of Specimen Common Stock Certificate

10.47^{(3) #}		Separation Agreement and General Release of All Claims dated August 29, 2007 by and between the Registrant and Lawrence C. Fritz, Ph.D.

10.48^#		Amended Severance Agreement and General Release dated August 1, 2007 by and between the Registrant and Devron R. Averett, Ph.D.

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


⁽¹⁾		Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q filed on May 14, 2004

⁽²⁾		Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 19, 2004

⁽³⁾		Incorporated by reference to Exhibit 10.47 to the Registrant’s Current Report on Form 8-K filed on August 29, 2007

#		Indicates management contract or compensatory plan

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 1, 2007	ANADYS PHARMACEUTICALS, INC.
	By:	/s/ Stephen T. Worland, Ph.D.
	Stephen T. Worland, Ph.D.
	President and Chief Executive Officer


	By:	/s/ James T. Glover
	James T. Glover
	Senior Vice President, Operations and Chief Financial Officer

EXHIBIT INDEX


EXHIBIT
NO.		DESCRIPTION

3.1⁽¹⁾		Form of Amended and Restated Certificate of Incorporation of the Registrant

3.2⁽¹⁾		Form of Amended and Restated Bylaws of the Registrant

4.1⁽²⁾		Form of Specimen Common Stock Certificate

10.47^{(3) #}		Separation Agreement and General Release of All Claims dated August 29, 2007 by and between the Registrant and Lawrence C. Fritz, Ph.D.

10.48^#		Amended Severance Agreement and General Release dated August 1, 2007 by and between the Registrant and Devron R. Averett, Ph.D.

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


⁽¹⁾		Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q filed on May 14, 2004

⁽²⁾		Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 19, 2004

⁽³⁾		Incorporated by reference to Exhibit 10.47 to the Registrant’s Current Report on Form 8-K filed on August 29, 2007

#		Indicates management contract or compensatory plan

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

Anadys Pharmaceuticals (ANDS) Inactive 10-Q2007 Q3 Quarterly report

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