Aspreva Pharmaceuticals (ASPV) 10-Q 2006 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2006

or

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

For the transition period from _______ to ___________

Commission File Number 000-51169

ASPREVA PHARMACEUTICALS CORPORATION

(Exact name of registrant as specified in its charter)

British Columbia, Canada (State or other jurisdiction of incorporation or organization) 98-0435540 (I.R.S. Employer Identification No.)

1203 - 4464 Markham Street,

Victoria, British Columbia,

Canada V8Z 7X8

(Address of principal executive office)

(250) 744-2488

(Registrant’s telephone number, including area code)

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: Yes x  No o

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:

Large Accelerated Filer o Accelerated Filer o Non-accelerated Filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes o No x

As of July 20, 2006, the registrant had 34,788,031 common shares outstanding.

ASPREVA PHARMACEUTICALS CORPORATION

FORM 10-Q

For the Quarterly Period Ended June 30, 2006

TABLE OF CONTENTS

	Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)	3
Consolidated Balance Sheets - June 30, 2006 and December 31, 2005	3
Consolidated Statements of Operations - Three and Six-month periods ended June 30, 2006 and 2005	4
Consolidated Statements of Cash Flows - Three and Six-month periods ended June 30, 2006 and 2005	5
Notes to Consolidated Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3. Quantitative and Qualitative Disclosures About Market Risk	22
Item 4. Controls and Procedures	23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings	24
Item 1A. Risk Factors	24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	35
Item 3. Defaults Upon Senior Securities	35
Item 4. Submission of Matters to a Vote of Security Holders	35
Item 5. Other Information	36
Item 6. Exhibits	37
SIGNATURE	38

2

PART I - FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

ASPREVA PHARMACEUTICALS CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands of U.S. dollars)

(unaudited)

	June 30,			December 31,
	2006			2005
ASSETS
Current assets
Cash and cash equivalents	$	34,701		$	14,759
Marketable securities (Note 3)		157,476			97,280
Accounts receivable		56,165			48,246
Prepaid expenses		2,928			2,005
Deferred income tax asset		1,045			1,896
Foreign currency contracts (Note 8)		-			2,377
Total current assets		252,315			166,563
Property and equipment, net of accumulated depreciation of $1,190 (2005 - $856)		2,683			2,687
Deferred income tax asset		2,910			2,889
Restricted cash		756			716
TOTAL ASSETS	$	258,664		$	172,855
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	10,735		$	8,463
Accrued liabilities		15,948			8,806
Unearned royalty advance		6,532			6,079
Foreign currency contracts (Note 8)		508			-
Current portion under capital leases		467			441
Current portion of deferred lease inducement		126			121
Total current liabilities		34,316			23,910
Long-term portion under capital leases		174			419
Long-term portion of deferred lease inducement		445			480
Total liabilities		34,935			24,809
Commitments and contingencies (Notes 7 and 12)
Shareholders’ equity (Note 6)
Common shares
Authorized: unlimited
Issued and outstanding		147,085			142,464
June 30, 2006  - 34,765,107
December 31, 2005  - 34,156,231
Additional paid-in capital		10,166			9,618
Retained earnings (deficit)		67,177			(5,531	)
Accumulated other comprehensive income (loss)		(699	)		1,495
Total shareholders’ equity		223,729			148,046
TOTALLIABILITIES AND SHAREHOLDERS’ EQUITY	$	258,664		$	172,855

See accompanying notes to consolidated financial statements.

3

ASPREVA PHARMACEUTICALS CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(in thousands of U.S. dollars, except per share amounts)

(unaudited)

	Three months ended June 30						Six months ended June 30
		2006			2005			2006			2005
Royalty revenue	$	51,693		$	14,671		$	114,373		$	14,671
Expenses
Research and development		12,218			7,152			22,032			11,197
Marketing, general and administrative		10,753			7,025			16,864			12,376
Total expenses		22,971			14,177			38,896			23,573
Operating income (loss)		28,722			494			75,477			(8,902	)
Other income (expense)
Interest and other income		2,114			711			4,414			1,163
Interest and other expense		(9	)		(54	)		(23	)		(94	)
Total other income		2,105			657			4,391			1,069
Income (loss) before income taxes		30,827			1,151			79,868			(7,833	)
Income tax expense
Current		2,415			-			6,459			-
Deferred		456			-			701			-
Total income tax expense		2,871			-			7,160			-
Net income (loss) for the period		27,956			1,151			72,708			(7,833	)
Net income (loss) per common share (Note 5)
Basic		0.81			0.03			2.11			(0.29	)
Diluted		0.78			0.03			2.03			(0.25	)

See accompanying notes to consolidated financial statements.

4

ASPREVA PHARMACEUTICALS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands of U.S. dollars)

(unaudited)

	Three months ended June 30						Six months ended June 30
		2006			2005			2006			2005
Operating Activities
Net income (loss) for the period	$	27,956		$	1,151		$	72,708		$	(7,833	)
Adjustment to reconcile net income (loss) to cash provided by operating activities:
Depreciation and amortization		181			123			333			234
Deferred taxes		(87	)		-			830			-
Stock-based compensation		2,241			1,597			3,214			3,184
Amortization of lease inducement		(31	)		(11	)		(61	)		(14	)
Net change in non-cash working capital items related to operations:
Accounts receivable		11,399			(14,667	)		(7,782	)		(14,919	)
Investment tax credits receivable		-			-			-			261
Prepaid expenses		(90	)		729			(923	)		1,152
Deposits		(38	)		-			(40	)		-
Accounts payable		535			(182	)		2,757			(2,329	)
Accrued liabilities		5,842			1,142			7,142			510
Net cash flows from (used in) operating activities		47,908			(10,118	)		78,178			(19,754	)
Investing Activities
Purchases of marketable securities		(98,278	)		(43,593	)		(153,893	)		(99,545	)
Redemptions of marketable securities		40,295			4,073			94,250			36,386
Purchase of property and equipment		(275	)		(167	)		(329	)		(175	)
Net cash flows used in investing activities		(58,258	)		(39,687	)		(59,972	)		(63,334	)
Financing Activities
Issuance of common shares		551			-			1,955			91,731
Share issue costs		-			-			-			(7,314	)
Payments on capital lease obligations		(110	)		(105	)		(219	)		(207	)
Net cash flows from (used in) financing activities		441			(105	)		1,736			84,210
Effect of exchange rate changes on cash and cash equivalents		-			15			-			(27	)
Net (decrease) increase in cash and cash equivalents		(9,909	)		(49,895	)		19,942			1,095
Cash and cash equivalents, beginning of the period		44,610			54,497			14,759			3,507
Cash and cash equivalents, end of the period	$	34,701			4,602			34,701			4,602

See accompanying notes to consolidated financial statements.

5

ASPREVA PHARMACEUTICALS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(all tabular amounts in thousands of U.S. dollars other than share or per share data or unless otherwise stated)

June 30, 2006

1. Nature of Business and Basis of Presentation

Unless the context otherwise required, all references to “Aspreva”, “we”, “our” and “us” refer to Aspreva Pharmaceuticals Corporation and its subsidiaries.

We were incorporated on December 20, 2001 under the Canada Business Corporation Act and continued under the Business Corporations Act (British Columbia) on November 19, 2004. Our principal business is to identify, develop and commercialize new indications for approved drugs and drug candidates for patients living with less common diseases.

We have prepared these consolidated financial statements in accordance with U.S. generally accepted accounting principles for interim financial statements and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for annual financial statements. The financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005 filed with the United States Securities and Exchange Commission on March 2, 2006.

In the opinion of management, these consolidated financial statements include all normal and recurring adjustments considered necessary to present fairly our financial position, results of operations and cash flows. Interim results are not necessarily indicative of the operating results for the full year or for any other subsequent interim period.

2.  Significant Accounting Policies

Our significant accounting policies are the same as described in Note 2 to our Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2005 filed with the United States Securities and Exchange Commission on March 2, 2006 other than the adoption of  SFAS 123 (R) as decribed below. The following is a summary of the significant accounting policies used in the preparation of these financial statements.

Stock-Based Compensation Expense

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), or SFAS 123(R)), Share Based Payment, which supersedes our previous accounting under Statement No. 123, or SFAS 123, Accounting for Stock-Based Compensation. SFAS 123 (R) requires the recognition of compensation expense, using a fair-value based method, for costs related to all share-based payments to employees, including grants of stock options. SFAS 123 (R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. We use the Black-Scholes option-pricing model to determine the fair value for our awards. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the service period in the statement of income. We adopted SFAS 123 (R) using the modified prospective transition method which recognizes the grant-date fair value of compensation for new and unvested awards beginning in the fiscal period in which the recognition provisions are first applied. The modified prospective transition method does not require the restatement of prior periods to reflect the impact of SFAS123 (R). Since we previously accounted for stock-based compensation under the fair value provisions of SFAS 123, adoption of SFAS 123 (R) did not have a significant impact on our financial position or consolidated statement of operations.

Revenue Recognition

Pursuant to our agreement with Hoffmann - La Roche Inc. and F. Hoffmann - La Roche Ltd., collectively Roche, commencing April 1, 2005, we became entitled to a royalty based on an equal sharing of incremental net sales of CellCept in non-transplant indications above a negotiated baseline less a distribution fee, payable on a quarterly basis. This baseline was originally set in July 2003 at 134 million Swiss Francs, or CHF, and is subject to an annual price index adjustment. Roche and Aspreva reset the baseline for 2006 to CHF 130.5 million, after taking into account the price index adjustment and, for the time being, excluding Japan as a licensed territory under the agreement. We follow the provisions of the Securities and Exchange Commission’s Staff Accounting Bulletin No. 104, or SAB 104, Revenue Recognition, which sets forth criteria that must be met in order to recognize revenue: (i) there is persuasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectibility is reasonably assured.

Roche and Aspreva have developed a proprietary sales tracking methodology to audit net sales of CellCept and to determine the portion attributable to sales from use in non-transplant indications. The results of this audit lag actual net sales by approximately six months. Roche and Aspreva use actual total CellCept sales results and estimates of the quarterly split between net sales attributed to transplant and non-transplant indications to calculate the royalty payment payable to us at the end of each quarter. We record a portion of this royalty payment as revenue within quarterly financial results, with the balance recorded as unearned royalty advance and subject to a subsequent reconciliation.

Once the six month lag period has passed, and audited results can be obtained, Aspreva and Roche employ a mechanism to reconcile audited amounts against the royalty previously paid to us. This reconciliation process is undertaken quarterly, based on the most recent available audit information. This reconciliation mechanism, however, will limit reconciliation payments to either Roche or Aspreva to a maximum amount of CHF 4.0 million per quarter. If the results of the reconciliation indicate that the CHF 4.0 million collar has been exceeded in favor of the same party for two consecutive quarters, we and Roche have agreed upon a mechanism to review the sales tracking methodology and/or our methodology for estimating royalty payments and introduce appropriate changes. The terms of this collar may be changed prospectively at any time by the joint committee formed under our agreement with Roche, on which we have equal representation.

6

We record all but CHF 4.0 million of the royalty payment as revenue within quarterly financial results. In subsequent quarters, consistent with the timing of the reconciliation described above, the remaining CHF 4.0 million of the royalty payment, as well as any additional payments to us or from us to Roche as a result of such reconciliation will be recorded in the period the reconciliation is completed. Thus, at any period end we will carry a maximum of CHF 4.0 million for each quarter that has not then been reconciled, classified as unearned royalty advance on the balance sheet. At June 30, 2006, there was CHF 8.0 million ($ 6.5 million) recorded in unearned royalties as the first quarter of 2006 and the second quarter of 2006 have not been reconciled.

In December 2005, Aspreva and Roche made minor changes to the sales tracking methodology with a goal to reduce future quarterly reconciliation payments. In June 2006, Aspreva and Roche agreed the final audited results for the net sales relating to the fourth quarter of 2005. The resulting reconciliation payment of ($279,000), which is payable to Roche within 45 days of quarter-end, was determined utilizing the revised sales tracking methodology.

For the three month period ended June 30, 2006, we recorded royalty revenue of $51.7 million, which is comprised of $48.7 million for the second quarter initial royalty payment ($52.0 million less $3.3 million collar recorded as unearned royalty advance) and $3.3 million (CHF 4 million) offset by $279,000 payable to Roche arising from the reconciliation of audited net sales data to the initial royalty payment for the fourth quarter of 2005. The net of the initial royalty payment and reconciliation payment are recorded in accounts receivable as of June 30, 2006, and are payable to us within 45 days of June 30, 2006.

3. Marketable Securities

Available for sale debt securities

		Cost		Accrued interest		Gross unrealized gains		Gross unrealized losses			Approximate market and carrying value
June 30, 2006	$	156,287	$	1,232	$	42	$	(85	)	$	157,476
December 31, 2005	$	96,687	$	740	$	2	$	(149	)	$	97,280

4. Stock-Based Compensation

We have a stock option plan, the Aspreva 2002 Incentive Stock Option Plan, or the Plan. The Plan has been amended since its adoption, most recently in May 2006 to increase the number of common shares reserved for issuance to directors, officers, employees and consultants to 4,031,000. The exercise price of the options is determined by the Board (or a committee thereof) but generally will be at least equal to the fair value of the shares at the grant date. The stock options typically have a ten year term and vest ratably over a period of two to four years from the date of grant. As at June 30, 2006 1,258,000 common shares were available for future grants. The stock options expire at various dates from April 2013 to May 2016. We issue new shares to satisfy stock option exercises.

Included within the statements of operations are the following charges for stock-based compensation:

	Three months ended June 30				Six months ended June 30
		2006		2005		2006		2005
Research and development expense	$	784	$	567	$	1,125	$	1,154
Marketing, general and administrative expense		1,457		1,030		2,089		2,030
Total stock-based compensation	$	2,241	$	1,597	$	3,214	$	3,184

We measure stock-based awards using the Black-Scholes option pricing model and amortize the fair value of granted stock options to the consolidated statement of operations over the vesting period of the options using the accelerated method. We estimated the fair value of options using the following assumptions:

	Three months ended June 30					Six months ended June 30
		2006		2005			2006		2005
Expected stock price volatility		70	%	70	%		70	%	83	%
Average risk-free interest rate		4	%	4	%		4	%	4	%
Expected option life in years		5.0		5.0			5.0		5.5
Dividend yield		0	%	0	%		0	%	0	%

Given our short history we do not have sufficient historical data to determine volatility, therefore our expected volatility is based on comparable companies’ historical stock prices. As provided in Staff Accounting Bulletin No. 107 our computation of expected option life has been calculated to be the mid-point between the vesting date and the end of the contractual period.

As required by SFAS 123 (R), previously recorded stock-based compensation expense totaling $0.8 million was reversed in the six months ended June 30, 2006 to reflect the impact of actual stock option forfeitures within the period.

7

Stock option transactions for the six-month period ended June 30, 2006, and the number of stock options outstanding as of June 30, 2006, are summarized below:

	Number of Shares			Weighted Average Exercise Price	Weighted Average remaining contractual term (years)		Aggregate Intrinsic Value
All dollar figures in Canadian dollars
Outstanding at December 31, 2005	2,271,576		$	7.38
Options granted	552,000			29.29
Options forfeited	(206,867	)		5.60
Options exercised	(379,191	)		3.73
Outstanding at March 31, 2006	2,237,518		$	13.57
Options granted	60,000			33.13
Options forfeited	(10,000	)		14.95
Options exercised	(158,317	)		3.10
Outstanding at June 30, 2006	2,129,201		$	14.89	8.8	$	33,139
Exercisable at June 30, 2006	518,812		$	8.61	8.1	$	11,256

Net cash proceeds from the exercise of stock options and warrants $2.0 million and nil for the six months ended June 30, 2006 and 2005, respectively.

The intrinsic value of stock options exercised during the six months ended June 30, 2006 was Cdn $15.4 million ($13.5 million). No options were exercised during the six-month period ended June 30, 2005. 

The estimated fair value of stock options vested during the three-month periods ended June 30, 2006 and 2005 was $1.9 million and $0.5 million, respectively. The estimated fair value of stock options vested during the six-month periods ended June 30, 2006 and 2005 was $3.7 million and $0.9 million, respectively.

The weighted average estimated fair value of stock options granted during the three-month periods ended June 30, 2006 and 2005 was $18.08 and $8.46 per share, respectively. The weighted average estimated fair value of stock options granted during the six-month periods ended June 30, 2006 and 2005 was $15.60 and $8.99 per share, respectively, based on the assumptions in the Black-Scholes valuation model discussed above.

The unamortized amount of stock-based compensation relating to unvested stock options granted and shares distributed from the Trust as at June 30, 2006 is $12.5 million, which will be amortized over the weighted average period of 3.7 years.

The following table summarizes information regarding options outstanding at June 30, 2006:

	Options Outstanding				Options Exercisable
				Weighted
				Average
		Weighted	Number of	Remaining		Number of		Weighted
		Average	Common Shares	Contractual Life		Common Shares		Average
Price Range		Exercise Price	Issuable	(Years)		Issuable		Exercise Price
(Exercisable in Canadian dollars)
$0.78	$	0.78	80,240	7.1		63,298	$	0.78
$5.60 - $7.79	$	5.69	951,624	8.1		321,057	$	5.61
$14.95 - $17.45	$	16.65	486,015	9.1		107,510	$	17.15
$27.57 - $33.13	$	29.66	611,322	9.7		26,947	$	28.68
$0.78 - $33.13	$	14.89	2,129,201	8.8		518,812	$	8.61

5. Net Income (Loss) per Common Share

We calculate net income (loss) per common share in accordance with SFAS 128, Earnings per Share, which requires the presentation of basic and diluted net income (loss) per common share using the treasury stock method.

8

The denominators for basic and diluted net income (loss) per common share for the three and six-month periods ended June 30, 2006 and 2005 were calculated as follows:

	Three months ended June 30			Six months ended June 30
		2006	2005		2006	2005
Weighted average shares outstanding used for basic net income (loss) per common share		34,676,544	34,028,378		34,527,315	26,733,886
Effect of dilutive stock options		1,226,628	1,405,330		1,120,270	-
Effect of dilutive warrants		108,271	237,205		106,475	-
Weighted average shares outstanding used for diluted net income (loss) per common share		36,011,443	35,670,913		35,754,060	26,733,886

Diluted loss per common share is equivalent to basic loss per common share for the six-month period ended June 30, 2005, as the outstanding options and warrants are anti-dilutive to the loss per common share.

Due to their anti-dilutive nature, the following potentially issuable shares were omitted from the calculation of diluted net income (loss) per common share for these periods:

	Three months ended June 30			Six months ended June 30
		2006	2005		2006	2005
Stock options		-	2,041,134		336,000	2,041,134
Warrants		-	230,360		-	230,360
Total		-	2,271,494		336,000	2,271,494

6. Shareholders’ Equity

Statement of Shareholders’ Equity

The following table summarizes the activity in our shareholders’ equity from December 31, 2005 to June 30, 2006:

	Number of Shares		Common Shares		Additional Paid-In Capital			Accumulated Other Comprehensive Income/(Loss)			Retained Earnings/ (Deficit)			Total Shareholders’ Equity
Balance, as of December 31, 2005	34,156,231	$	142,464	$	9,618		$	1,495		$	(5,531	)	$	148,046
Shares issued on:
Exercise of options	379,191		2,939		(1,714	)		-			-			1,225
Exercise of warrants	42,818		330		(151	)		-			-			179
Stock-based compensation expense	-		-		973			-			-			973
Unrealized gains on derivative financial instruments	-		-		-			100			-			100
Reclassification of unrealized loss on marketable securities, net of tax	-		-		-			16			-			16
Unrealized gains on marketable securities, net of tax	-		-		-			94			-			94
Net income for the period	-		-		-			-			44,752			44,752
Balance, as of March 31, 2006	34,578,240	$	145,733	$	8,726		$	1,705		$	39,221		$	195,385
Shares issued on:
Exercise of options	158,317		1,129		(701	)		-			-			428
Exercise of warrants	28,550		223		(100	)		-			-			123
Stock-based compensation expense	-		-		2,241			-			-			2,241
Unrealized gains on derivative financial instruments	-		-		-			(2,355	)		-			(2,355	)
Reclassification of unrealized gain on marketable securities, net of tax	-		-		-			(63	)		-			(63	)
Unrealized gain on marketable securities, net of tax	-		-		-			14			-			14
Net income for the period	-		-		-			-			27,956			27,956
Balance, as of June 30, 2006	34,765,107	$	147,085	$	10,166		$	(699	)	$	67,177		$	223,729

Comprehensive Income

Comprehensive income was $25.6 million and $1.6 million for the three-month periods ended June 30, 2006 and  2005, respectively. Comprehensive income for the six-month period ended June 30, 2006 was $70.5 million and comprehensive loss for the six-month period ended June 30, 2005 was $7.4 million.

Warrants

In March 2004, we issued warrants entitling the holders to acquire 230,360 common shares at an exercise price of C$4.76 per share. Of these, 71,368 warrants were exercised during the six-month period ended June 30, 2006. As of June 30, 2006, we had 123,322 warrants outstanding. These warrants will expire, if unexercised, in September 2006.

7. Contractual Obligations and Commitments

We have agreements with clinical sites and contract research organizations for the conduct of our clinical trials. We make payments to these sites and organizations based upon the number of patients enrolled and the period of follow-up in the trials. At June 30, 2006, we have commitments to these groups amounting to $23.0 million over the next three years.

9

Occasionally, we enter into agreements with third parties in the ordinary course of business that include indemnification provisions that are customary in the industry. Those indemnifications generally require us to compensate the other party for certain damages and costs incurred as a result of third party claims or damages arising from these transactions. These indemnification provisions may survive termination of the underlying agreement. The nature of the indemnification obligation prevents us from making a reasonable estimate of the maximum potential amount we could be required to pay. Historically, we have not made any indemnification payments under such agreements and no amount has been accrued in the accompanying consolidated financial statements with respect to these indemnification obligations.

8. Derivative Financial Instruments

We use derivative financial instruments to hedge our royalty payments. Our royalty payments are received from Roche in Swiss francs, or CHF, on a quarterly basis 45 days after each quarter end. Sales of CellCept are denominated in multi-currencies and are converted to CHF by Roche for the purpose of calculating amounts to be paid to us. To the extent the Swiss franc increases in value relative to these other currencies, the total aggregate CHF value of CellCept sales decreases and the amount that we are entitled to may be reduced. To mitigate this risk, at the beginning of each quarter, we enter into noon average rate contracts, or NARCs, to sell U.S. dollars and Euros and buy CHF. The NARCs are designed to hedge our direct exposures of forecasted transactions and pursuant to SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities qualify as cash flow hedges. Forward contracts to sell CHF are entered with settlement dates that coincide with the date we receive our royalty payments from Roche. The forward contracts entered into are based on forecasts and as such they are initially designated as cash flow hedges. For the period from the quarter end to the settlement date, the hedges are re-designated and are treated as fair value hedges. Any change in value between quarter end and settlement date is recorded in other income or expense as a foreign exchange gain or loss.

As a result of our global operations with offices in Canada and the Europe we incurred significant amount of our research and development and general and administrative expenditures in Canadian dollars, euros and pounds sterling. In order to hedge against the impact of fluctuations in the value of the Canadian dollar, euro and pounds sterling relative to the U.S. dollar, we enter into short-term forward contracts to purchase Canadian dollars, euros and pounds sterling. Forward hedges relating to forecasted expenditures are cash flow hedges.

The following is a summary of the derivative instruments in place at June 30, 2006:

Type of hedge	Currency Exchanged	Settlement dates	Total Notional Amount	Average Settlement Amount
Forward Contract	Sell USD buy CAD	July 2006 - July 2007	12,240 USD	0.8789
Forward Contract	Sell USD buy GBP	July 2006 - July 2007	9,382 USD	1.7932
Forward Contract	Sell CHF buy GBP	August 2006 - May 2007	4,388 CHF	2.2234
Forward Contract	Sell CHF buy CAD	August 2006 - May 2007	1,674 CHF	1.1116
Forward Contract	Sell USD buy Euro	July 2006 - July 2007	567 USD	1.2974
Forward Contract	Sell CHF buy USD	August 2006 - August 2007	148,186 CHF	1.2302
NARC	Sell USD buy CHF	August 2006 - November 2007	47,356 USD	0.7976
NARC	Sell Euro buy CHF	August 2006 - November 2007	12,282 Euro	0.6392

The fair value of the derivative financial instruments is the estimated amount that we would receive or pay to terminate a contract at the reporting date. At June 30, 2006, the fair value of our forward contracts totaled $(1.5) million and $1.0 million in respect of the NARCs. Of this, $(0.7) million relates to cash flow hedges (recorded in Other Comprehensive Income); and $0.2 million relates to fair value hedges (recorded in the second quarter revenue).

We do not use derivative financial instruments for speculative or trading purposes, nor do we hold or issue leveraged derivative financial instruments. All activity is governed by a board approved hedging policy and is monitored for compliance on an ongoing basis. We are exposed to credit loss in the event of non-performance by the counter-parties to the foreign exchange forward contracts and NARCs, however, we do not anticipate non-performance by any counter party.

9. Income Taxes

The provision for income taxes was $7.2 million for the six months ended June 30, 2006, resulting in an effective global tax rate of 9.0% for the period. The difference between the effective tax rate and the statutory Canadian federal income tax rate of 34.1% relates to differing foreign tax rates, changes in our deferred income tax valuation allowance and utilization of tax pools. We believe the overall effective global tax rate for us will be less than 20%.

10. Supplemental Cash Flow

Supplemental cash flow information is as follows:

		Three months ended June 30				Six months ended June 30
		2006		2005		2006		2005
Equipment acquired under capital leases	$	-	$	-	$	-	$	140
Income taxes paid		50		-		269		-
Interest paid		11		13		23		25

11. Related Party Transactions

We retain Farris, Vaughan, Wills & Murphy LLP, a law firm where R. Hector MacKay-Dunn, Q.C., is a senior partner. Mr. MacKay-Dunn is a member of our board of directors and acts as our Corporate Secretary. In the six months ended June 30, 2006 and 2005, we incurred legal fees payable to Farris, Vaughan, Wills & Murphy LLP, of $270,000 and $560,000, respectively, all of which, excluding $36,000 in accrued liabilities, has been paid as of June 30, 2006. In 2006, these fees relate primarily to general corporate legal advice while in 2005 these fees related primarily to services undertaken in conjunction with our initial public offering.

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12. Contingencies

From time to time, we may be involved in litigation relating to claims arising out of our operations. We are not currently involved in any material legal proceedings.

13. Comparative Figures 

Certain of the prior year’s figures including cash and cash equivalents have been reclassified to conform to the presentation adopted in the current period. 

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Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis by our management of our financial condition and results of operations in conjunction with our audited consolidated financial statements and related notes thereto included as part of our Annual Report on Form 10-K for the year ended December 31, 2005 and our unaudited consolidated financial statements for the six-month period ended June 30, 2006. Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles and are presented in U.S. dollars.

Forward-Looking Statements

The information in this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and/or forward-looking information under applicable Canadian provincial securities laws, or collectively forward-looking statements which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management are forward-looking statements. The words “anticipates”, “believes”, “estimates”, “expects”, “intends”, “may”, “plans”, “projects”, “will”, “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set forth in Item 1A “Risk Factors” in this Quarterly Report on Form 10-Q. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make. We do not assume any obligation to update any forward-looking statements, other than as required by applicable law.

Overview

We are an emerging global pharmaceutical company focused on identifying, developing, and upon approval, commercializing existing approved drugs and drug candidates for new indications. Our focus is on delivering effective, evidence-based treatments to manage less common diseases.

Our initial focus in autoimmune disease led us to identify the potential efficacy of the drug CellCept, (mycophenolate mofetil) in the treatment of autoimmune diseases. In July 2003, we entered into our first collaboration with Hoffmann - La Roche Inc. and F. Hoffmann - La Roche Ltd, or collectively Roche, for exclusive world-wide rights, excluding Japan, to develop and, upon regulatory approval, commercialize CellCept, for all autoimmune indications. CellCept is an immunosuppressant or “anti rejection” drug currently approved by the U.S. Food and Drug Administration, or FDA, for use in the prevention of rejection in patients receiving heart, kidney and liver transplants. We currently have three clinical development programs underway to evaluate CellCept in the treatment of the following autoimmune diseases: lupus nephritis, myasthenia gravis and pemphigus vulgaris. CellCept is not currently approved by the FDA for use in these autoimmune indications.

We continue our intense focus on building our portfolio beyond CellCept and on leveraging the clinical, medical affairs and commercial infrastructure that we have built. Potential opportunities include single and multiple product partnerships with both large and mid size pharmaceutical and biotechnology companies, specialty autoimmune products in various stages of development and may include strategic acquisitions if the appropriate opportunity arises. We also anticipate that our Roche relationship will be expanded.

Collaborative Agreements

Under the terms of our collaboration agreement with Roche, we agreed to conduct three clinical programs in lupus nephritis, myasthenia gravis and pemphigus vulgaris. We are responsible for assembling the filings for the relevant regulatory authorities, and Roche are responsible for submitting applications to the regulatory authorities and will be the holder of any regulatory submissions and resulting regulatory approvals.

Pursuant to our collaboration agreement with Roche we are entitled to a royalty based on an equal sharing of incremental net sales of CellCept in non-transplant indications above a negotiated baseline less a distribution fee, payable on a quarterly basis. This baseline is subject to an annual price index adjustment and Roche and Aspreva agreed that the baseline for 2006 would be CHF 130.5 million, excluding, for the time being, Japan as a licensed territory under the agreement.

Our collaboration agreement with Roche currently excludes Japan as a licensed territory and thus excludes that region from our revenue sharing arrangement. In April 2006, Aspreva entered into a collaboration agreement with Chugai Pharmaceuticals Co., Ltd., for the development of CellCept in Japan for certain autoimmune indications. Chugai, a global pharmaceutical company, has the rights to CellCept in Japan where it is currently approved for the suppression of organ rejection in transplant patients. Pursuant to the collaboration agreement, Chugai plans to meet with Japanese regulatory authorities during the third quarter of this year to discuss how Aspreva’s existing clinical trial data may be used in support of the development of CellCept for certain autoimmune indications. Our discussions continue with Chugai and we will confirm this agreement following Chugai's final decision whether or not to proceed on this collaboration agreement following  meetings with the Japanese regulatory authorities.

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Clinical Development Program

Our clinical development for CellCept focuses on three specific autoimmune indications: lupus nephritis, myasthenia gravis and pemphigus vulgaris. If we and Roche obtain regulatory approval for the use of CellCept in any of these indications, we will also be responsible for the promotion of CellCept for the approved autoimmune indications.

Our clinical programs have been designed to utilize portions of existing clinical data provided by investigator initiated trials (IITs). We expect to use the results of an IIT conducted by Dr. Ellen Ginzler of State University of New York, or SUNY Downstate Medical Center in Brooklyn, New York, to support our supplemental New Drug Application, or sNDA, with the FDA for the use of CellCept in the treatment of lupus nephritis. The results of Dr. Ginzler’s study (as published in the November 24, 2005 issue of the New England Journal of Medicine) are supportive of the potential efficacy and safety of CellCept in the induction phase of lupus nephritis, adding to the existing body of data that supports the potential benefit of CellCept in the treatment of lupus nephritis. CellCept is not currently approved by any regulatory agency for any indication outside of transplant, and although the results of Dr. Ginzler’s study are encouraging, a separate prospective, adequate and well-controlled study such as our international phase III lupus nephritis study is necessary to provide substantive evidence of the potential safety and efficacy of CellCept in patients with lupus nephritis. Similarly we expect to use an IIT conducted by Dr. Sanders of Duke University to support our application for the use of CellCept in the treatment of myasthenia gravis. Dr. Sanders'  IIT is a prospective, multi-center, double-blinded, placebo-controlled trial designed to assess CellCept in combination with prednisone in the treatment of acquired myathenia gravis. Dr. Sander’s study is structured slightly differently from our myasthenia gravis study including a shorter length of therapy (12 weeks vs. 36 weeks) and lack of steroid tapering. Dr. Sanders and Duke University are currently compiling the results from their study. The results will be released as appropriate by Duke University and Dr. Sanders once they have fully completed their analysis. Concurrently, we are analyzing the data from our database which is derived from his study and this data will be included as supporting evidence in our application for the use of CellCept in the treatment of  myasthenia gravis.

Lupus Nephritis

Systemic lupus erythematosus, commonly referred to as lupus, is a complex autoimmune disease affecting numerous organs and tissues. The immune system, which typically fights off viruses and bacteria, loses the ability to differentiate between foreign substances, or antigens, and its own cells and tissues. The involvement of the kidney, known as lupus nephritis, is considered to be the most serious manifestation of lupus.

The Lupus Foundation of America estimates that between 500,000 and 1.5 million Americans have lupus. This wide range demonstrates the challenge that exists when trying to determine the true prevalence of less common diseases such as lupus. Our analysis of various sources of data estimates to be about 600,000 diagnosed lupus patients currently within the U.S. healthcare system. Clinicians estimate that one third to one half of lupus patients have lupus nephritis which equals approximately 200,000 Americans with lupus nephritis. We believe that approximately 11% of diagnosed patients with lupus nephritis are currently being treated with CellCept. We believe current dosing of CellCept is 1.7 grams, and will increase as a result of clinical data at higher dosing levels.

In July 2005, we initiated enrolment of patients in our international phase III trial of CellCept in the treatment of lupus nephritis. Our trial is designed to enroll 358 patients with biopsy-proven lupus nephritis. Enrollment into this study is currently over 66% of our design. We expect to complete the induction phase of this trial in early 2007, and expect data lock on this trial in May 2007. We expect, if the data is supportive, to be filing regulatory submissions, including a sNDA with the FDA, as well as appropriate filings with the European Union and Canadian regulatory authorities, for lupus nephritis in November 2007.

In March 2006, Roche and Aspreva agreed not to pursue an application for orphan drug designation for CellCept in the treatment of lupus nephritis, a subset of systemic lupus erythematosus, or SLE, as the FDA determined that CellCept is not eligible for orphan drug designation for lupus nephritis as the potential use of CellCept in SLE is not limited to patients with lupus nephritis only and consequently the size of the broader patient population is significantly greater than the 200,000 maximum allowed for an orphan drug designation.  We do not expect that the decision will harm the potential future commercialization of CellCept for lupus nephritis.

Myasthenia Gravis

Myasthenia gravis is a debilitating, chronic autoimmune neuromuscular disease in which the body produces auto−antibodies which prevent the nerves from sending messages to the muscles. According to the Myasthenia Gravis Foundation, myasthenia gravis affects approximately 70,000 to 100,000 people worldwide, including approximately 36,000 people in the United States. Although myasthenia gravis can affect any voluntary muscle, it frequently involves muscles controlling eye movements, chewing, swallowing, coughing and facial expressions, and can be life−threatening in some of the affected patients. Complete remission is infrequent and long−term immunosuppression is usually required. Current treatments of myasthenia gravis include the use of cholinesterase inhibitors, steroids and other immunosuppressant drugs such as azathioprine.

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In November 2005, we completed enrollment of 176 patients in our international phase III trial of CellCept in the treatment of myasthenia gravis. We expect to complete the induction phase of this trial in late 2006 with data lock in October 2006. We intend to submit a sNDA to the FDA, as well as appropriate filings with the European Union and Canadian regulatory authorities in May 2007. In January 2006, we received orphan drug designation with the FDA for CellCept in the treatment of myasthenia gravis.

Pemphigus Vulgaris

Pemphigus vulgaris is a rare dermatological autoimmune disease that, according to the International Pemphigus Foundation, affects approximately 40,000 people worldwide. Symptoms include painful and life-threatening blistering of the skin and mucous membranes which can cover much of the body.

In March 2006, we completed enrollment of 77 patients in our international phase III trial of CellCept in the treatment of pemphigus vulgaris. We expect to complete the induction phase of this trial in 2007 with datalock in May 2007. We intend to submit a sNDA to the FDA, as well as appropriate filings with the European Union and Canadian regulatory authorities, in December 2007. In June 2006, we received orphan drug designation with the FDA for CellCept in the treatment of pemphigus vulgaris.

Preliminary Studies

There is a large and growing amount of data relating to the use of CellCept for the treatment of many different autoimmune diseases, and we are particularly interested in the potential of CellCept in the treatment of cardiovascular disease in autoimmune patients and multiple sclerosis patients.

Cardiovascular disease is of interest because of its link to lupus. Studies have shown that cardiovascular disease is responsible for up to 30% of all deaths in patients with lupus; the risk of heart attack is 50 times greater in lupus patients; and sub-clinical atherosclerosis, or the thickening and hardening of the arteries, occurs in 40% of lupus patients. Third party preliminary data suggests that CellCept may have potentially beneficial cardiovascular characteristics; a hypothesis that is supported by studies of cardiac transplant patients. Some of these potential benefits include the inhibition of smooth muscle proliferation and the suppression of T-cell adhesion and penetration. We have funded an two IITs for the treatment of CellCept in cardiovascular disease. The protocols for these IITs have been established, and the trials are currently recruiting patients. Results are anticipated in 2007.

Emerging literature also suggests that CellCept may be effective in the treatment of multiple sclerosis. There have been several small published studies that report that multiple sclerosis patients treated with CellCept have experienced an improvement in lesions, as measured by magnetic resonance imaging, a decreased rate of relapse and a reduced expanded disability status scale rating. We have committed to fund an IIT to investigate the use of CellCept in mono and combination therapy with Avonex in patients with relapse-remitting multiple sclerosis. The trial has been initiated and patient recruitment has begun. The study is expected to complete by the end of 2007.

We believe that the results of these preliminary studies will enable us to determine the value in pursuing future development programs in the use of CellCept to treat cardiovascular disease and multiple sclerosis.

Based on our analysis of existing clinical trial and scientific data, we believe that CellCept also has the potential to be effective in treating a variety of autoimmune diseases.

Commercialization

We do not currently have an approved drug in any market. We intend to design our future commercialization activities to comply with the laws and regulations enforced by applicable regulatory authorities. Our overall commercialization strategy is to target a small subset of specialty physicians who treat a majority of patients with the greatest underserved medical needs.

Prior to regulatory approval of CellCept for any autoimmune indications, we will conduct extensive market research regarding specialty physician prescribing practices and product positioning, and will undertake a market preparation program. We currently are fielding a team of medical liaison physicians and other medical professionals who interact with potential future presenters and medical advisors to help us identify knowledge gaps in the potential use of CellCept and to assist us in our clinical development planning. We currently have 12 such field based medical advisors deployed in the U.S. and major EU markets.

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Critical Accounting Policies and Significant Judgments and Estimates

The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported revenues and expenses during the reporting periods. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Significant accounting policies are more fully described in the notes to our audited consolidated financial statements and notes thereto, included as part of our Annual Report on Form 10-K for the year ended December 31, 2005. However, we believe the following accounting policies relating to revenue recognition, stock-based compensation, clinical trial accounting, provision for income taxes and derivative instruments are the most critical accounting policies for assessing our financial performance.

Revenue Recognition

Pursuant to our collaboration agreement with Roche, commencing April 1, 2005, we became entitled to a royalty based on an equal sharing of incremental net sales of CellCept in non-transplant indications above a negotiated baseline less a distribution fee, payable on a quarterly basis. This baseline was originally set in July 2003 at CHF 134 million, and is subject to an annual price index adjustment. Roche and Aspreva have reset the baseline to CHF 130.5 million for 2006, after taking into account the price index adjustment and, for the time being, excluding Japan as a licensed territory under the agreement. The baseline will be reset on an annual basis during the first quarter of each year.

We follow the revenue recognition criteria outlined in Staff Accounting Bulletin No. 104, Revenue Recognition. To summarize key requirements outlined in Staff Accounting Bulletin No. 104 relating specifically to CellCept:

• royalties are based upon Roche’s ex-factory sales;

• pricing of the transaction is agreed within the contract based upon Roche’s underlying ex-factory sales price; and

• collectibility is reasonably assured and contractual arrangement has been agreed and executed with Roche.

Any future non-CellCept royalty revenue will be recognized based on the terms of the specific collaboration agreements.

Roche and Aspreva have developed a proprietary sales tracking methodology to audit net sales of CellCept and determine the portion attributable to sales from use in non-transplant indications. The results of this audit lag actual net sales by approximately six months. Roche and Aspreva use actual total CellCept sales results and estimates of the quarterly split between net sales attributed to transplant and non-transplant indications to calculate the initial royalty payment payable to us at the end of each quarter. We record a portion of this initial royalty payment as revenue within quarterly financial results, with the balance recorded as unearned royalty advance and subject to a subsequent reconciliation.

Once the six month lag period has passed, and audited results can be obtained, Aspreva and Roche employ a mechanism to reconcile audited amounts against the initial royalty payment previously paid to us. This reconciliation process is undertaken quarterly, based on the most recent available audit information. This reconciliation mechanism, however, will limit reconciliation payments to either Roche or Aspreva by an amount of CHF 4.0 million per quarter. If the results of the reconciliation indicate that the CHF 4.0 million collar has been exceeded in favor of the same party for two consecutive quarters, we and Roche have agreed upon a mechanism to review the sales tracking methodology and/or our methodology for estimating royalty payments and introduce appropriate changes. The terms of this collar may be changed prospectively at any time by the joint committee formed under our agreement with Roche, on which we have equal representation.

We record all but CHF 4.0 million of the initial royalty payment as revenue within quarterly financial results. In subsequent quarters, consistent with the timing of the reconciliation described above, the remaining CHF 4.0 million of the royalty payment, as well as any additional payments to us or from us to Roche as a result of such reconciliation will be recorded in the period the reconciliation is completed. Thus, at any period end we carry a maximum of CHF 4.0 million for each quarter that has not then been reconciled, classified as unearned royalty advance on the balance sheet. Roche and Aspreva have agreed to settle any royalty payment and reconciliation amount in cash, and we expect to settle such amounts within 45 days of each quarter end.

In June 2006, Aspreva and Roche agreed to the final audited results for the net sales relating to the fourth quarter of 2005. The audit results indicate that the minor changes made to the sales tracking methodology in December 2005 are effective as the reconciliation payment related to the fourth quarter of 2005 is a payment of $279,000 payable to Roche within 45 days of quarter end.

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Stock-Based Compensation

Stock-based compensation expense, which is a non-cash charge, results in part from estimating the fair value of employee stock options granted using the Black-Scholes option pricing model. The exercise price for option grants are based on the market value of our common shares.

Prior to January 1, 2006, we accounted for employee stock options using the fair value method in accordance with Statement of Financial Accounting Standards No. 123, or SFAS123, Accounting for Stock-Based Compensation. As of January 1, 2006 we adopted Statement of Financial Accounting Standards SFAS 123(R), Share-based Payment, a revision of SFAS 123, using the modified prospective method to account for employee stock options. The Black-Scholes option pricing model requires the input of the fair value of our stock at the date of grant of the stock options as well as the input of several subjective assumptions including: the expected life of the option, the expected volatility at the time the options are granted, and the expected forfeiture rate at the time the options were granted. Our current estimate of expected stock price volatility is 70%, expected option life is five years, and expected forfeiture rate is 3%. The estimated fair value of our options as calculated by the Black-Scholes option pricing model is amortized, using the accelerated method, over the vesting period, which is generally two to four years.

Changes in the inputs and assumptions can materially affect the measure of the estimated fair value of our employee stock options. Also, the accounting estimate of stock-based compensation expense is reasonably likely to change from period to period as further stock options are granted and adjustments are made for stock option forfeitures and cancellations.

Included within the statements of operations are the following charges for stock-based compensation:

			Three months ended June 30				Six months ended June 30
			2006		2005		2006		2005
	(in millions)
Research and development expense		$	0.8	$	0.6	$	1.1	$	1.2
Marketing, general and administrative expense			1.4		1.0		2.1		2.0

Total stock-based compensation $ 2.2 $ 1.6 $ 3.2 $ 3.2

Clinical Trial Accounting

We record expenses for clinical research organizations, investigators and other vendors based upon the estimated amount of work completed on each trial. These estimates may or may not match the actual services performed by the organizations as determined by patient enrollment levels and related activities. We monitor patient enrollment levels and related activities to the extent possible through internal reviews, correspondence and discussions with contract research organizations and review of contractual terms. However, if we have incomplete or inaccurate information, we may underestimate activity levels associated with various trials at a given point in time. In this event, we could record significant research and development expenses in future periods when the actual activity level becomes known. All such costs are charged to research and development expenses as incurred. To date, we have not experienced material changes in these estimates.

Provision for Income Taxes

We have established a wholly-owned subsidiary, Aspreva Pharmaceuticals SA, a Swiss company, which is the principal party to our agreement with Roche. We have obtained a tax ruling from the Swiss tax authorities pursuant to which, certain income attributable to the exploitation of the CellCept rights we acquired from Roche and certain income attributable to the exploitation of rights we may acquire in the future from other third parties, will be subject to a reduced tax rate in Switzerland.

We believe that our effective overall global corporate tax rate realized through this structure will be less than 20%.

We believe that our agreement with Roche should not be classified as a partnership for U.S. federal income tax purposes. If this belief is incorrect, the income of our Swiss subsidiary that is from sources within the United States, if any, could be taxable in the United States on a net income basis. In such event, our effective tax rate and our tax liability could increase.

If we fail to maintain our tax structure, or one or more of the various taxation authorities successfully assert that more profits should be allocated to their respective tax jurisdictions, this may result in a higher overall effective tax rate. The foregoing analysis only applies to our agreement with Roche. Any future collaborations that we enter into may be structured differently and may result in different tax consequences.

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We account for income taxes under the liability method. Deferred tax assets and liabilities are recognized for the differences between the financial statement and income tax bases of assets and liabilities, and for operating losses and tax credit carry forwards. A valuation allowance is provided for the portion of deferred tax assets that is more likely than not to be unrealized. Deferred tax assets and liabilities are measured using the enacted tax rates and laws.

Deferred tax assets arise from unused tax losses from prior periods, timing differences, credits available for research and development and share issue costs. We anticipate utilizing all loss carry forwards within 2006, and the balance of our recognized deferred tax assets of $4.0 million, comprised of Canadian tax credits, by 2009.

Derivative Instruments

We utilize foreign exchange forward contracts and other derivative instruments to manage our exposure to foreign exchange fluctuations.

We account for our derivative instruments in accordance with SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities. Derivative instruments are recorded as assets or liabilities, measured at fair value. Derivatives that are not hedges, or are not designated as hedges, are adjusted to fair value through income. If the derivative is a hedge, depending upon the nature of the hedge, changes in the fair value of the derivatives are either offset against the fair value of assets, liabilities or firm commitments through income, or recognized in other comprehensive income (loss) until the hedged item is recognized in income. The ineffective portion of a derivative’s change in fair value is immediately recognized in income.

Results of Operations

Presented below is a comparison of our results of operations for the three and six-month periods ended June 30, 2006 and 2005.

Royalty Revenue

In accordance with the terms of our agreement with Roche commencing April 1, 2005, we became entitled to a royalty based on an equal sharing of incremental net sales of CellCept in non-transplant indications above a negotiated baseline less a distribution fee, payable on a quarterly basis. This baseline was originally set in July 2003 at CHF 134 million, and is subject to an annual price index adjustment. Roche and Aspreva have reset the baseline to CHF 130.5 million for 2006, after taking into account the price index adjustment and, for the time being, excluding Japan as a licensed territory under the agreement.

Under this agreement with Roche, we and Roche calculate and record the royalty payment due to us at the end of each quarter. We recognize a portion of this royalty payment as revenue within our quarterly financial results, and record CHF 4.0 million of the royalty payment due to us as unearned royalty advance on our consolidated balance sheets. This amount is subject to a subsequent reconciliation between Roche and Aspreva at which time the remaining CHF 4.0 million (approximately $3.3 million) of the royalty payment, as well as any additional payments to us or from us resulting from the reconciliations, will be recorded in the period the reconciliation is completed.

The following summarizes the royalty revenue we have earned to date under our agreement with Roche:

	Three months ended
		June 30, 2005		September 30, 2005		December 31, 2005		March 31, 2006		June 30, 2006
				In millions
Initial quarterly payment less collar	$	14.7	$	16.8	$	39.0	$	46.5	$	48.7
Reconciliation amount		-		-		6.0		16.2		3.0
Total royalty revenue	$	14.7	$	16.8	$	45.0	$	62.7	$	51.7

Currently 49% of our revenue is derived from US markets, 19% from major European markets (UK, Spain, Italy, France and Germany) and the remainder from rest of world markets.

In December 2005, Aspreva and Roche made minor changes to the sales tracking methodology with a goal of reducing future volatility in quarterly reconciliation payments in the future. As a result, large reconciling amounts, such as experienced in the three-month period ended March 31, 2006, are not expected to recur.

Research and Development Expenses

From inception to June 30, 2006, we have incurred total research and development expenses of $63.5 million. Research and development expenses include clinical development expenditures for the use of CellCept to treat lupus nephritis, myasthenia gravis and pemphigus vulgaris; preliminary studies of CellCept efficacy in multiple sclerosis and cardiovascular indications; regulatory affairs expenses related to CellCept; and expenses related to our business development team which is working to identify potential new drug opportunities. We expense research and development costs as they are incurred.

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Clinical expenses primarily include clinical trial costs, salaries and related costs for clinical and regulatory personnel, supplies and materials, consultant services and facilities. Business development expenses primarily include salaries and related costs for business development personnel, and consultant services related to our efforts to identify other drug opportunities.

A majority of our research and development expenditures to date have been related to the clinical development of CellCept for autoimmune indications. We currently have rights to one clinical product, CellCept, and are focused on the use of CellCept to treat three specific autoimmune indications: lupus nephritis, myasthenia gravis and pemphigus vulgaris. In addition, we are funding preliminary studies for the use of CellCept in the treatment of multiple sclerosis and cardiovascular disease. Estimated spending in these two programs is expected to be between $5 million and $7 million over the next three years.

We anticipate completing our Phase III clinical trials for the use of CellCept in the induction phase of lupus nephritis in early 2007, in the treatment of myasthenia gravis in late 2006, and in the treatment of pemphigus vulgaris in 2007. However, we may not be able to complete such clinical trials on schedule as our patient enrollment may be slower than expected, the results from a clinical trial may not be favorable, or the FDA or other regulatory agencies may require additional clinical trials. Further, data from clinical trials is subject to varying interpretation, and may be deemed insufficient by the regulatory agencies reviewing applications for marketing approvals. As such, clinical development and regulatory programs are subject to risks and changes that may significantly impact our expense projections and development timelines.

The following table shows the allocation of research and development expenses:

			Annual total		Annual total		Annual total		For the six months ended June 30,				Total from inception to June 30
			2003		2004		2005		2005		2006		2006
	��						(in millions)
Lupus nephritis		$	0.1	$	4.9	$	11.9	$	5.2	$	8.8	$	25.7
Myasthenia gravis			0.4		2.2		11.3		3.8		6.1		20.0
Pemphigus vulgaris			0.4		1.3		3.3		1.0		2.0		7.0
Other			-		-		0.7		-		1.7		2.4
Clinical development expenditures			0.9		8.4		27.2		10.0		18.6		55.1
Business development expenditures			0.3		1.7		3.0		1.2		3.4		8.4
Total		$	1.2	$	10.1	$	30.2	$	11.2	$	22.0	$	63.5

Research and development expenses were $12.2 million for the three-month period ended June 30, 2006, compared to $7.2 million for the three-month period ended June 30, 2005. The increase of $5.0 million was due to a $3.8 million increase in our clinical development programs and $1.2 million increase in our business development operations. Clinical development costs increased as a result of: a $2.0 million increase in our lupus nephritis program costs reflecting the continued increase in activity as recruitment increased from 0% in the second quarter of 2005 to over 66% of target enrollment as at June 30, 2006; a $313,000 increase in our myasthenia gravis program as a consequence of achieving full patient enrollment and thus peak myasthenia gravis  project spend rate; a $281,000 increase in our pemphigus vulgaris  program costs due to achieving full enrollment and thus peak pemphigus vulgaris  project spend rate; and $1.2 million increase in the funding of other programs including preliminary studies for the use of CellCept in the treatment of cardiovascular disease in autoimmune patients and multiple sclerosis patients.

Included in the above we incurred an increase of $1.3 million in salaries and related costs as we continue to build out our global business development and clinical teams in our Canadian, European and U.S. offices. Stock-based compensation increased by $217,000 from the second quarter in 2005.

Research and development expenses were $22.0 million for the six-month period ended June 30, 2006, compared to $11.2 million for the six-month period ended June 30, 2005. The increase of $10.8 million was due to a $8.6 million increase in our clinical development programs and $2.2 million increase in our business development operations. Clinical development costs increased as a result of: a $3.6 million increase in our lupus nephritis program costs reflecting the continued increase in recruitment activity; a $2.3 million increase in our myasthenia gravis  program as a consequence of achieving full patient enrollment and thus peak myasthenia gravis project spend rate; a $1.0 million increase in our pemphigus vulgaris  program costs due to achieving full enrollment and thus peak pemphigus vulgaris  project spend rate; and $1.7 million increase in the funding of other programs including preliminary studies for the use of CellCept in the treatment of cardiovascular disease in autoimmune patients and multiple sclerosis patients.

Included in the above we incurred an increase of $2.0 million in salaries and related costs as we continue to build out our global business development and clinical teams in our Canadian, European and U.S. offices. Stock-based compensation decreased by $29,000 from the first six months of 2005 as a result of the forfeiture in the period of previously expensed options.

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The total number of employees engaged in research and development increased from 27 at June 30, 2005 to 58 at June 30, 2006, which includes 11 employees in our business development function.

Marketing, General and Administrative Expenses

Marketing, general and administrative expenses consist primarily of costs and salaries associated with building our infrastructure, costs of general corporate activities, and salaries and related costs for personnel in executive, finance, accounting, corporate compliance and operational functions. Prior to regulatory approval of CellCept for any autoimmune indications, we limit our marketing activity to conducting extensive market research regarding specialty physician prescribing practices and product positioning, and undertaking a market preparation program. We currently are fielding a team of 17 medical liaison physicians and other medical professionals who interact with potential future presenters and medical advisors to help us identify knowledge gaps in the potential use of CellCept and to assist us in our clinical development planning.

Marketing, general and administrative expenses were $10.8 million for the three-month period ended June 30, 2006, compared to $7.0 million for the three-month period ended June 30, 2005. The increase of $3.8 million was primarily due to additional salary and related expenses as we increased the number of employees undertaking marketing, general and administrative activities, including the build out of our European and U.S. operations. Stock-based compensation increased by $427,000 over the second quarter of 2005. Also contributing to the increase are professional and consulting fees related to our Sarbanes-Oxley compliance program.

For the three month period ended June 30, 2006, our marketing costs represented 47% of total marketing, general and administrative expenses. We expect our marketing infrastructure expenses to continue to increase as we continue to build out our U.S. and European operations. Our marketing program costs will increase significantly immediately prior to and after obtaining regulatory approvals. We expect the growth in our general and administrative expenses to keep pace with overall company activity as we continue to build our operations to support our business, incur the additional costs of being a publicly traded company, and support our agreement with Roche and additional collaborations.

Marketing, general and administrative expenses were $16.9 million for the six-month period ended June 30, 2006, compared to $12.4 million for the six-month period ended June 30, 2005. The increase of $4.5 million was primarily due to additional salary and related expenses and professional and consulting fees related to our Sarbanes-Oxley compliance program.

The total number of employees engaged in marketing, general and administrative activities increased from 50 at June 30, 2005 to 72 at June 30, 2006.

Interest and Other Income

Interest and other income was $2.1 million for the three-month period ended June 30, 2006, compared to $711,000 for the three-month period ended June 30, 2005. The increase of $1.4 million was due to several factors. We had significantly higher average investment balances during the three-month period ended June 30, 2006 comprised of royalty revenue receipts and proceeds from our initial public offering. In the three-month period ended June 30, 2005, we had not yet received royalty proceeds. Additionally, net foreign exchange losses amounted to $97,000 in the three-month period ended June 30, 2006 compared to a loss of $40,000 in the three-month period ended June 30, 2005.

Interest and other income was $4.4 million for the six-month period ended June 30, 2006, compared to $1.2 million for the six-month period ended June 30, 2005. The increase of $3.2 million was due to several factors. We had significantly higher average investment balances during the six-month period ended June 30, 2006 comprised of royalty revenue receipts and proceeds from our initial public offering. In the six-month period ended June 30, 2005, we did not have royalty revenue and the proceeds from our initial public offering were received in March 2005. Additionally, net foreign exchange gains amounted to $769,000 in the six-month period ended June 30, 2006 compared to a loss of $137,000 in the six-month period ended June 30, 2005. The net foreign exchange gains resulted from the stronger Canadian dollar and British pound sterling (relative to the U.S. dollar) when we translated our June 30, 2006 Canadian dollar and British pound sterling denominated marketable securities and cash balances.

Interest and Other Expense 

Interest and other expense was $9,000 for the three-month period ended June 30, 2006, compared to $54,000 for the three-month period ended June 30, 2005.

Interest and other expense was $23,000 for the six-month period ended June 30, 2006, compared to $94,000 for the six-month period ended June 30, 2005.

Income Taxes

The provision for income taxes was $2.9 million for the three months ended June 30, 2006, resulting in an effective global tax rate of 9.3% for the period.

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The provision for income taxes was $7.2 million for the six months ended June 30, 2006, resulting in an effective global tax rate of 9.0% for the period.

For both periods, the difference between the effective tax rate and the statutory Canadian federal income tax rate of 34.1% relate to differing foreign tax rates, changes in our future income tax valuation allowance and utilization of tax pools.

Cash Flows

Operating activities

Net cash from operating activities was $47.9 million for the three-month period ended June 30, 2006, compared to net cash used in operating activities of $10.1 million for the three-month period ended June 30, 2005. The increase of $58.0 million in net cash from operating activities reflects the receipt of the $61.5 million royalty receivable from Roche that was outstanding at March 31, 2006.

Net cash from operating activities was $78.2 million for the six-month period ended June 30, 2006, compared to net cash used in operating activities of $19.8 million for the six-month period ended June 30, 2005. The increase of $98.0 million in net cash from operating activities includes the receipt of the $44.4 million royalty receivable from Roche that was outstanding at December 31, 2005, and the $61.5 million royalty receivable from Roche that was outstanding at March 31, 2006.

Investing activities    

Net cash used in investing activities was $58.3 million for the three-month period ended June 30, 2006, while net cash used in investing activities was $39.7 million for the three-month period ended June 30, 2005. Purchases of investments in marketable securities during the three-month period ended June 30, 2006 were $98.3 million, and were mainly offset by proceeds from sales of short-term investments in marketable securities of $40.3 million. Royalty revenue received in the three-month period ended June 30, 2006 was sufficient to fund our current operations, which allowed us to put more of our investments into higher rate, longer term maturities as compared to the three-month period ended June 30, 2005.

Net cash used in investing activities was $60.0 million for the six-month period ended June 30, 2006, while net cash used in investing activities was $63.3 million for the six-month period ended June 30, 2005. Purchases of investments in marketable securities during the six-month period ended June 30, 2006 were $153.9 million, and were mainly offset by proceeds from sales of short-term investments in marketable securities of $94.3 million. Royalty revenue received in the six-month period ended June 30, 2006 was sufficient to fund our current operations, which allowed us to put more of our investments into higher rate, longer term maturities as compared to the six-month period ended June 30, 2005.

Financing activities  

Net cash from financing activities was $441,000 for the three-month period ended June 30, 2006, reflecting cash received upon the exercise of warrants and employee stock options. Net cash used in financing activities was $105,000 for the three-month period ended June 30, 2005, reflecting payments on lease obligations.

Net cash from financing activities was $1.7 million for the six-month period ended June 30, 2006, reflecting cash received upon the exercise of warrants and employee stock options. Net cash from financing activities was $84.2 million for the six-month period ended June 30, 2005, mainly reflecting the net proceeds of our initial public offering in March 2005.

Liquidity and Capital Resources

Sources of Liquidity

As of June 30, 2006, we had working capital of $218.0 million, which included $192.2 million in cash, cash equivalents and marketable securities. In aggregate, our cash resources increased by $80.2 million from $112.0 million at December 31, 2005. We also had $56.2 million in accounts receivable at June 30, 2006, of which $51.5 million is due from Roche and payable within 45 days of June 30, 2006.

We expect to continue to devote substantial resources to continue the development of CellCept for the treatment of lupus nephritis, myasthenia gravis and pemphigus vulgaris, and to continue to pursue other collaborations. The investment in CellCept development includes funding Phase III clinical trials as well as regulatory expenses to support approval. In addition, we are expanding our infrastructure to prepare for the potential commercialization of CellCept for these indications.

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We expect that our available cash resources, and the revenue from our agreement with Roche, will be sufficient to support our current and planned programs and operations for at least 12 months. If our resources are insufficient to satisfy our liquidity requirements or if we pursue new indications for CellCept or enter into new indication partnerships, we may need to raise additional external funds through the sale of additional equity or debt securities. The sale of additional equity and debt securities may result in additional dilution to our stockholders. Additional financing may not be available in amounts or on terms acceptable to us or at all. If we are unable to obtain this additional financing, we may be required to reduce the scope of, delay or eliminate some or all of our planned research, development and commercialization activities, which could harm our business.

Contractual Obligations and Commitments

As of June 30, 2006, there was no material change in our capital lease or operating lease obligations or any other long-term liabilities reflected on our consolidated balance sheet as compared to such obligations and liabilities at December 31, 2005.

We also have agreements with clinical sites, and contract research organizations for the conduct of our clinical trials. We make payments to these sites and organizations based upon the number of patients enrolled and the period of follow-up in the trials. At June 30, 2006, we have commitments to these groups amounting to $19.6 million over the next three years. In addition we have contractual commitments for investigator initiated trials totaling $3.4 million over the next three years.

Credit Facilities

We have various agreements with a Canadian chartered bank providing for revolving demand facilities and a lease line in the aggregate amount of $3.6 million. As of June 30, 2006, we had $641,000 of outstanding indebtedness under our credit facilities. The Canadian chartered bank may cancel or restrict the availability of any unutilized portion of our facilities at any time and from time to time without notice. Our credit facilities are secured by a security agreement constituting a first ranking security interest in all our personal property.

Off-Balance Sheet Arrangements

Since inception we have not engaged in material off-balance sheet activities, including the use of structured finance, special purpose entities or variable interest entities.

Related Party Transactions

For a description of our related party transactions during the six-month period ended June 30, 2006, please see Note 11 of our Notes to Consolidated Financial Statements.

Recent Accounting Pronouncements

None.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risks

We are exposed to market risk, including changes to interest rates and foreign currency exchange rates.

We maintain risk management control systems to monitor the risks associated with foreign currency exchange rates. To reduce the volatility relating to these exposures, we enter into various derivative hedging transactions pursuant to our investment and risk management policies and procedures. We do not use derivatives for speculative or trading purposes, nor do we hold or issue leveraged derivative financial instruments. Though we intend for our risk management control systems to be comprehensive, there are inherent risks that may only be partially offset by our hedging programs should there be unfavorable movements in foreign currency exchange rates.

Interest Rate Risk

Our material interest-bearing assets consisted of cash, cash equivalents and marketable securities. The balance of our interest-bearing portfolio, including cash, cash equivalents and investments, was $192.2 million, or 76% of total current assets at June 30, 2006. Interest income related to this portfolio was $3.6 million for the six-month period ended June 30, 2006. Our interest income is sensitive to changes in the general level of interest rates, primarily U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest-bearing portfolio.

Foreign Currency Exchange and Foreign Economic Conditions Risk

Financial risk is the risk to our results of operations that arises from fluctuations in interest rates and foreign exchange rates and the degree of volatility of these rates. Foreign exchange risk arises as our investments, which finance operations, are substantially denominated in U.S. dollars, our royalty payments are received in Swiss francs and our expenses are denominated in several foreign currencies, including U.S. dollars, Canadian dollars, pounds sterling and Euros. Interest rate risk arises due to our investments being in fixed interest highly liquid investments.

If exchange rates change by 10%, we do not believe that it would have a material impact on our results of operations or cash flows to date. However, future exchange rate fluctuations may affect our future operating results.

To mitigate the risk of foreign exchange fluctuations against the U.S. dollar, we have entered into a number of foreign exchange forward contracts and noon average rate contracts.

Counterparties Credit Risks

We could be exposed to losses related to the financial instruments described in Note 8 to the Notes to Consolidated Financial Statements should one of our counterparties default. We attempt to mitigate this risk through credit rating monitoring procedures.

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Item 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures

We maintain “disclosure controls and procedures” (as such term is defined under Securities Exchange Act Rule 13a-15(e)) that are designed to ensure that information required to be disclosed in our reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and in reaching a reasonable level of assurance our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

We have carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2006. Based upon their evaluation and subject to the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were reasonably effective in ensuring that information required to be disclosed by us in this Quarterly Report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and Form 10-Q.

Changes in internal controls

There were no changes in our internal controls over financial reporting during the three-month period ended June 30, 2006 that have materially affected or are reasonably likely to materially affect our internal controls over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 1A. RISK FACTORS

Risks Related to Our Business

We anticipate that substantially all of our revenue for the foreseeable future will be from royalties based on sales of CellCept and we may not be able to sustain our profitability.

Our operating results may fluctuate from period to period for a number of reasons. In budgeting our operating expenses, some of which are fixed in the short term, we assume that revenues will continue to grow. Even a relatively small revenue shortfall or a small increase in operating expenses may cause our results to be below expectations. A revenue shortfall or increase in operating expenses could arise from any number of factors including:

• lower than expected revenues on commercial sales of CellCept;

• higher than expected operating expenses as we further develop CellCept for autoimmune indications, seek additional collaborations and operate as a public company;

• higher than expected levels of marketing expenses and the expenses of potentially launching CellCept and any future products for our targeted indications; and

• fluctuations in currency exchange rates.

We anticipate that substantially all of our revenue for the foreseeable future will be from royalties based on sales of CellCept pursuant to our agreement with Roche. Our revenue is dependent on Roche and our mutual ability to track product sales arising from the use of CellCept by transplant patients. The methodology for accurately tracking sales of CellCept that has been agreed to may be a source of dispute with Roche, which may negatively affect our revenue and our relationship.

If we and Roche are unable to successfully manage our collaboration, the development and commercialization of CelICept for autoimmune indications may be delayed or prevented.

Our collaboration with Roche involves a complex sharing of control over decisions, responsibilities, costs and benefits. Development and promotional activities related to CellCept in the autoimmune indications are approved by a joint committee, consisting of an equal number of our representatives and Roche's representatives. In the event that the joint committee is unable to reach consensus on an issue, the dispute will be referred to senior management of both parties. Unless and until senior management reaches agreement on such dispute, neither party will have the right to implement any changes to the status quo that would result from resolution of such matter. Ultimate decision making authority is vested in us as to some matters and in Roche as to other matters. Although we are responsible for compiling and preparing all applications for regulatory approval of CellCept in autoimmune indications, Roche has the ultimate decision making authority to submit these applications to the appropriate regulatory authorities. If Roche does not approve the application we prepared, or requires that we revise or modify the application, this could result in delays in receipt of regulatory approvals. In addition, Roche may develop and commercialize, either alone or with others, products that are similar to, or competitive with, CellCept. Roche may also change the focus of its development and commercialization efforts and dedicate fewer resources to CellCept or our collaboration.

If we do not satisfy our obligations under the Roche agreement or if the agreement is terminated we may be forced to limit or cease our operations.

Our agreement with Roche requires us to use commercially reasonable efforts to conduct three clinical trial programs for CellCept in autoimmune indications pursuant to an agreed upon development plan. Roche may allege that we are in breach of a material obligation under our agreement and seek to litigate the allegation. If Roche is successful in such litigation, Roche may either be awarded damages based upon such breach or the agreement might be terminated. After 2011, either party may terminate the agreement if there is a lack of non-transplant sales over the baseline for a prolonged period. In addition, if CellCept is withdrawn from or recalled in any given country, either party may terminate the agreement with respect to that country. If the agreement is terminated in its entirety or in a given country we may be forced to limit or cease our operations.

Our agreement with Roche contains provisions requiring us to comply with applicable laws and regulations, including restrictions on the promotion of approved drugs for off label uses. If it were determined by the FDA or other regulatory authority that we violated the rules relating to off label promotion in connection with our pre-approval communications regarding CellCept, we may be deemed by Roche to be in material breach of the agreement. If we fail to cure any material breach of the agreement, Roche may commence legal action for damages and/or seek to terminate our agreement.

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If Roche does not manufacture, distribute, price or sell CellCept at levels which generate sufficient revenue for us to operate, we may have to limit or cease our operations.

We do not own or operate any manufacturing or distribution facilities. Roche, not Aspreva, controls the manufacture of CellCept and we have no alternative supplier. If we are unable to obtain adequate supplies of CellCept from Roche for our clinical trials, they could be delayed or prevented. In addition, if there is a shortage of CellCept, Roche may decide to allocate available supplies of CellCept to purchasers for use in transplant indications and not autoimmune or other indications, thereby reducing our revenues. Roche is solely responsible for distributing and selling CellCept, and setting the price, including all discounts and rebates, of CellCept.

Roche's control over the manufacture, distribution, pricing and sale of CellCept exposes us to a number of risks which are outside our control including:

• Roche may fail to comply with FDA-mandated current good manufacturing practices or similar regulations in other jurisdictions resulting in mandated production halts or limitations;

• Roche may experience manufacturing quality or control issues which halt or limit CellCept production;

• a manufacturing plant may be closed as a result of a natural disaster or work stoppage;

• Roche may experience short or long-term supply problems, or problems distributing CellCept, including difficulties importing or exporting supplies or products;

• Roche may decrease its efforts to market and promote CellCept for the transplant indications thus lowering the visibility of CellCept in the market; and

• Roche may set a low price for CellCept or give discounts or rebates that effectively lower the price of CellCept, which in either case could reduce our revenues.

However, we may in the future outsource the manufacturing of supply for our clinical trials to third parties other than Roche, subject to approval from Roche and the FDA.

The expiration of Roche's patents covering CellCept may reduce our revenue as competitors may seek to sell generic versions of CellCept.

Roche owns the patents covering the composition of matter of CellCept. The United States patent covering CellCept expires in May 2009. Counterparts of this patent expire in most European countries in late 2010 or early 2011, but in some instances expire as early as 2007. Roche patents covering the process for manufacture of CellCept expire in the United States in July 2012, and in most other countries in July 2013. We and Roche expect that following expiration of all these patents competitors may manufacture and sell generic versions of CellCept, at a lower price, which would reduce CellCept's revenues. In certain jurisdictions, including most Canadian provinces, legislation mandates generic substitution for brand name drugs. If competitors devise a means to manufacture CellCept which does not infringe Roche's patents covering the process for manufacture, competitors may seek to sell generic versions of CellCept upon expiration of the composition of matter patents, which occurs in some countries as early as 2007.

If we obtain an orphan drug designation and FDA approval of CellCept for an indication, we would be entitled to seven years of marketing exclusivity for that orphan drug indication. In January 2006, we were granted orphan drug designation for CellCept’s use in myasthenia gravis. In June 2006, we were granted orphan drug designation for CellCepts’ use in pemphigus vulgaris. In April 2006, Roche and Aspreva agreed not to pursue orphan drug designation for CellCept's use in lupus nephritis. However, if a competitor obtained approval of a generic form of CellCept for another indication, such as transplant use, physicians would not be prevented from prescribing the generic drug for the orphan indication during the period of marketing exclusivity. Such prescribing practices could adversely affect the sales of CellCept for the orphan indication.

We may incur significant liability if it is determined that we are promoting the "off-label" use of drugs or are otherwise found in violation of federal and state regulations in the United States or elsewhere.

Physicians may prescribe drug products for uses that are not described in the product's labelling and that differ from those approved by the FDA or other applicable regulatory agencies. Such off-label uses are common across medical specialities. We are aware that some physicians are prescribing CellCept for the treatment of certain autoimmune diseases, although neither we nor Roche are permitted to promote CellCept for the treatment of any autoimmune diseases, and the FDA and other regulatory agencies have not approved the use of CellCept for any autoimmune indications. Although the FDA and other regulatory agencies do not regulate a physician's choice of treatments, the FDA and other regulatory agencies do restrict communications on the subject of off-label use. Companies may not promote drugs for off-label uses. Accordingly, prior to approval of any autoimmune indications for CellCept, we may not promote CellCept for such indications. The FDA and other regulatory agencies actively enforce regulations prohibiting promotion of off-label uses and the promotion of products for which marketing clearance has not been obtained. A company that is found to have improperly promoted off-label uses may be subject to significant liability, including civil and administrative remedies as well as criminal sanctions.

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Notwithstanding the regulatory restrictions on off-label promotion, the FDA and other regulatory authorities allow companies to engage in truthful, non-misleading, and non-promotional speech concerning their products. We engage in medical education activities and communicate with investigators and potential investigators regarding our clinical trials. Although we believe that all of our communications regarding CellCept are in compliance with the relevant regulatory requirements, the FDA or another regulatory authority may disagree, and we may be subject to significant liability, including civil and administrative remedies as well as criminal sanctions.

We and our collaborators are also subject to the U.S. federal False Claims Act and U.S. federal Anti-Kickback law. We have developed a comprehensive compliance program that seeks to establish internal controls to facilitate adherence to the rules and program requirements to which we are and will become subject. If, however, we are determined to have violated these and other laws, we could incur significant penalties and be subject to criminal prosecution. Roche might deem any such determination by a governmental authority to constitute a material breach of our agreement. In addition, management's attention could be diverted and our reputation and our ability to enter into future collaborations could be damaged.

If CellCept and any future products do not gain meaningful market acceptance we are not likely to generate significant revenues or sustain profitability.

The degree of market acceptance for any product that we commercialize will depend on a number of factors, including:

• acceptance by physicians and patients of each product as safe and effective;

• potential advantages over existing or alternative therapies, including cost;

• actual or perceived safety of similar classes of products;

• relative convenience and ease of administration;

• reimbursement policies of government and third-party payors;

• effectiveness of our sales, marketing and medical education efforts; and

• scope of the product label approved by the FDA and other regulatory agencies.

Hospitals or physicians may not choose to administer CellCept or any future product to the entire intended market, if at all. If CellCept and any future products do not achieve meaningful acceptance in their intended markets or if the intended market is smaller than anticipated, we are not likely to generate significant revenues or maintain profitability.

Any failure or delay in obtaining additional capital may curtail the development or commercialization of CellCept or any future products.

We expect that our future need for additional capital will be substantial. The extent of this need will depend on many factors, some of which are beyond our control, including:

• our ability to develop and obtain regulatory approval for CellCept and any future products in our targeted indications;

• our ability to establish marketing and sales capabilities and the costs of launching CellCept and any future products for our targeted indications;

• the extent of costs associated with protecting and expanding our patent and other intellectual property rights;

• market acceptance of CellCept and any future products for our targeted indications;

• future payments, if any, we receive or make under existing or future collaborative arrangements;

• the timing of regulatory approvals needed to market products for our targeted indications;

• the need to acquire licenses for new products or compounds; and

• compliance with rules and regulations implemented by the U.S. Securities and Exchange Commission, Canadian provincial securities regulatory authorities, the NASDAQ Global Market and the Toronto Stock Exchange.

We have no committed sources of additional capital. Funds may not be available to us in the future on favorable terms, if at all, and we may be required to delay, reduce the scope of, or eliminate research and development efforts or clinical trials for CellCept or other future products. We may also be forced to curtail or restructure our operations, obtain funds by entering into arrangements with collaborators on unattractive terms or relinquish rights to technologies or product candidates that we would not otherwise relinquish in order to continue our operations.

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If we are not successful in establishing additional collaborations we will not be able to grow our business.

Our long-term success depends upon our ability to identify drugs and drug candidates with significant potential and to acquire the rights for those indications from multiple collaborators, thus creating multiple sources of revenue. We face intense competition from other companies for collaborative arrangements with pharmaceutical and biopharmaceutical companies, and there are no barriers prohibiting other companies from adopting our business model. Pharmaceutical and biopharmaceutical companies may also decide to pursue new indications for their products themselves, rather than enter into collaborative arrangements to develop new indications. In addition, accurate sales tracking may be difficult or impossible under future collaborations which may preclude a collaboration or lead to disputes once a collaboration has been established. We currently only have two collaborations. If we are unable to enter into additional collaborations, we will continue to be dependent upon Roche for substantially all our revenues, and we will be limited in our ability to grow our business. In addition, the fact that we are collaborating with Roche, or other potential collaborators, may be viewed negatively by other potential collaborators, making them less likely to enter into arrangements with us.

The terms and conditions of any future collaboration agreements may be less favorable than our agreement with Roche.

Our strategy is to seek collaborations with pharmaceutical and biopharmaceutical companies to develop and commercialize new indications. Any new collaborations that we may secure will likely involve drugs or drug candidates, or collaborators, with characteristics different from CellCept or Roche. These characteristics may include:

• costs to manufacture, distribute and sell;

• patent terms;

• expenditures by our collaborators on research and development;

• size and difficulty of development programs for potential product indications;

• competitive threats; and

• other factors relevant to the development and commercialization of such products.

We expect that any new collaborations will be highly negotiated, and the above characteristics all may play a role in the financial terms of such collaborations, possibly resulting in any or all of the following:

• our payment of upfront or milestone fees for product rights;

• greater clinical trial expenses;

• longer timelines to approval;

• lower revenue sharing percentages;

• shorter agreement periods; or

• less than global product rights.

In addition, any new collaboration agreement may provide that we only begin sharing revenue with our collaborator after some long period of time after entering into such collaboration, or after some specific action or approval over which we may have limited control.

If we fail to establish sufficient marketing and sales promotion capabilities, or enter into successful arrangements with third parties to conduct these activities, we may be unable to generate sufficient revenue to continue our operations.

Roche is solely responsible for distributing and selling CellCept. If we obtain approval of CellCept for autoimmune indications, or any future products, we intend to market and promote them through our own sales promotion force in the United States and certain other countries. We currently have no sales promotion capabilities, limited marketing capabilities, limited infrastructure to support such activities, and have limited experience in the commercialization of pharmaceutical products. We may not be able to attract and retain qualified marketing or sales promotion people or be able to establish an effective sales promotion force.

In countries where we do not have a sales promotion force, we may establish relationships with third parties. However, we may not be able to enter into such arrangements on favorable terms or at all and to the extent that we enter into such arrangements, our revenue will depend on their efforts, which may not be successful.

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If product liability lawsuits are successfully brought against us, we will incur significant liabilities and may be required to limit the commercialization of our product candidates.

Our use of CellCept and other products in clinical trials, and our future promotion of any products, may expose us to product liability claims and associated adverse publicity. We have a global product clinical trial insurance policy, with aggregate coverage of $10.0 million, for countries not requiring a local insurance policy (including USA and Canada). In addition, we have policies in varying amounts for all the other countries in which we are conducting clinical trials, and which do not fall within the scope of our global policy. Our insurance coverage may not protect us against any or all of the product liability claims which could be brought against us in the future. Prior to the commercialization of CellCept in autoimmune indications, we expect to obtain product liability insurance for potential claims associated with our promotion of CellCept. However, we may not be able to obtain or maintain adequate insurance coverage at a commercially reasonable cost or in sufficient amounts or scope to protect us against potential losses. Roche is obligated to indemnify us for any product liability claims, except if the claims arise due to false or misleading promotional activity on our part. In the event a product liability claim is brought against us, we may be required to pay legal and other expenses to defend the claim and, if such a claim is successful, damage awards not covered by our insurance. We may also be obligated to indemnify our collaborators. Defending any product liability claim or claims could require us to expend significant financial and managerial resources.

If our competitors are able to develop and market products that are preferred over CellCept or other product candidates that we may develop, we may not be able to generate sufficient revenues to continue our operations.

We may not be able to contend successfully with competitors. The biotechnology and pharmaceutical industries are highly competitive and subject to significant and rapid technological change as researchers learn more about diseases and develop new technologies and treatments. Our current and potential competitors generally include major multinational pharmaceutical companies, biopharmaceutical firms, specialty pharmaceutical companies, universities and other research institutions.

In the transplant market, CellCept currently competes with Novartis' product, Myfortic. If CellCept is approved for any autoimmune indications, Novartis may choose to also pursue clinical trials and regulatory approval for the same indications. If approved, CellCept will also compete with immunosuppressants, such as steroids and cytotoxic agents, including cyclophosphamide, cyclosporine and azathioprine. A cytotoxic agent is an anti-cancer substance that acts by killing or preventing the division of cells. In addition, we are aware of several companies that have products in development or on the market that may be competitive with CellCept in lupus nephritis, myasthenia gravis and pemphigus vulgaris. Some of the companies have commenced clinical trials for products targeting the same markets and indications that we are addressing.

The existence of these products, other products or treatments of which we are not aware, or products or treatments that may be developed in the future may reduce the marketability of CellCept and any future products, particularly to the extent such products:

• are more effective;

• have fewer or less severe adverse side effects;

• have better patient compliance;

• receive better reimbursement terms;

• are accepted by more physicians;

• are more adaptable to various modes of dosing;

• have better distribution channels;

• are easier to administer; or

• are less expensive.

Some of our competitors, either alone or together with their collaborators, have substantially greater financial resources and larger research, development and regulatory staffs than we do. In addition, many of our competitors, either alone or together with their collaborators, have significantly greater experience than we do in discovering, developing, manufacturing and marketing products. Additional mergers and acquisitions in the pharmaceutical and biotechnology industries may result in even more resources being concentrated in our competitors.

If we are unable to effectively manage our expected future growth, we may be unable to develop or commercialize CellCept or any other product candidate successfully.

In the six-month period ended June 30, 2006, we increased our number of employees by 24 and, as of June 30, 2006, we had 130 employees. In order to continue the development and potential commercialization of CellCept for autoimmune indications and enter into new collaborations we will need to expand our clinical development, regulatory, marketing and sales promotion capabilities. We currently have operations in Canada, the United States, the United Kingdom, and Switzerland. Our ability to manage our global operations and expected growth will require us to continue to improve our operational, financial and management controls, reporting systems and procedures. We may not be able to make such improvements in an efficient or timely manner and may discover deficiencies in existing systems and controls. Our ability to develop and commercialize products for new indications and compete effectively, and our future financial performance will depend, in part, on our ability to manage any future growth effectively.

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We depend on our executive officers, and if we are not able to retain them or recruit additional qualified personnel, we may be unable to successfully develop or commercialize CellCept.

Our success depends upon the continued contributions of our executive officers and scientific and technical personnel. We are highly dependent on Richard M. Glickman, our Chief Executive Officer, Noel F. Hall, our President, Bruce Cousins, our Chief Financial Officer and Dr. Richard Jones, our Senior Vice President, Clinical and Regulatory Affairs. Dr Reinhard Bailden, Executive Vice President, Clinical and Regulatory Affairs, announced plans for retirement in July 2006. This retirement will be effective September 2006. Due to the specialized knowledge that each of our executive officers possess with respect to CellCept and our operations, the loss of service of any of our executive officers could delay or prevent the successful completion of the clinical trials necessary for the commercialization of CellCept for lupus nephritis, myasthenia gravis or pemphigus vulgaris and could harm our relationship with Roche. We carry key man life insurance coverage of $1.3 million for each of Richard M. Glickman and Noel F. Hall. We do not carry key man life insurance for any of our other executive officers.

We have employment agreements with each of our executive officers; however, each may terminate their employment upon notice and without cause or good reason. We currently are not aware that any executive officer is planning to leave or retire.

Our success also depends in part on our ability to attract and retain highly qualified scientific, commercial and administrative personnel. In order to pursue our product development and commercialization strategies, we will need to attract and hire additional personnel with experience in a number of disciplines, including clinical testing, government regulation, sales and marketing, drug reimbursement and information systems. There is intense competition for personnel in the fields in which we operate. We have not experienced difficulty to date in attracting and retaining the personnel we require. If, however, we are unable to continue to attract new employees and retain existing employees, we may be unable to continue our development and commercialization activities.

We may incur losses associated with currency fluctuations and may not be able to effectively hedge our exposure.

Our operations are in many instances conducted in currencies other than the U.S. dollar and fluctuations in the value of currencies relative to the U.S. dollar could cause us to incur currency exchange losses. All amounts paid by Roche to us will be in Swiss Francs. In addition, we currently conduct some operations and incur a portion of our expenses in Canadian dollars, pounds sterling and other foreign currencies. Although we have implemented currency hedging techniques to mitigate the impact of currency fluctuations on our financial results, these techniques do not eliminate the effects of currency fluctuations with respect to anticipated revenues or cash flows, and, as they are short term in nature, do not protect us from prolonged periods of currency fluctuations.

CellCept net sales are denominated in multiple currencies and will be converted to Swiss Francsby Roche for the purpose of calculating amounts to be paid to us. To the extent the Swiss Franc increases in value relative to these other currencies, the total aggregate value of CellCept's net sales will decrease and the amount, if any, that we are entitled to may be reduced.

Risks Related to Regulatory Matters

We will not be able to commercialize our product candidates if our clinical trials do not demonstrate safety and efficacy in humans.

We are currently not authorized to market CellCept for autoimmune indications in any jurisdiction, and we may never be authorized to market CellCept for any autoimmune indication. The development and commercialization of CellCept for autoimmune indications, and any future products, are subject to extensive and rigorous regulation by the U.S. federal government, principally the FDA, other federal, state and local agencies, and governmental authorities elsewhere. Prior to marketing CellCept for any autoimmune indication, we must conduct, at our own expense, extensive clinical trials to demonstrate with substantial evidence to the satisfaction of the FDA and other regulatory authorities that CellCept is safe and effective for the indication. We have no prior experience as a company in conducting clinical trials. Preclinical studies and clinical trials are expensive, can take many years and have uncertain outcomes. In addition, the regulatory approval procedures vary among countries and additional testing may be required in some jurisdictions. It may take several years to complete the requisite clinical trials, and a product candidate may fail any stage of testing. Difficulties and risks associated with clinical trials may result in our failure to receive regulatory approval to market CellCept for autoimmune indications or our inability to commercialize any future products for new indications. The FDA, other regulatory authorities, our collaborators, or we may suspend or terminate clinical trials at any time. The commencement and completion of our clinical trials could be delayed or prevented by several factors, including:

• delays in obtaining regulatory approvals to commence or continue a study;

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• delays in identifying and reaching agreement on acceptable terms with prospective clinical trial sites;

• insufficient quantities of the study drug;

• slower than expected rates of patient recruitment and enrollment or the inability to reach full enrollment;

• inconclusive or negative interim results during clinical trials, including lack of effectiveness or unforeseen safety issues;

• death of, or serious adverse effects experienced by, one or more patients during a clinical trial even if the reasons are not related to the study drug, including the advanced stage of the patient's disease or medical condition;

• uncertain dosing issues;

• inability to monitor patients adequately during and after treatment;

• inability or unwillingness of contract laboratories to follow good laboratory practices;

• inability or unwillingness of clinical investigators to follow our clinical protocols or good clinical practices generally; and

• inability or unwillingness of other third parties to perform data collection and analysis in a timely or accurate manner.

  Delays or failures in obtaining regulatory approvals may:

• delay or prevent the commercialization of any product that we develop for new indications;

•  diminish any competitive advantages;

•  reduce or eliminate revenue from the sale of CellCept and any future products; and

•  adversely affect our ability to attract new collaborators.

The results of early clinical trials do not necessarily predict the results of later clinical trials. Drugs in later clinical trials may fail to show desired safety and efficacy traits despite having progressed through initial clinical trials. We are aware that Roche conducted three phase III clinical trials for CellCept in the treatment of rheumatoid arthritis which did not demonstrate efficacy. Even if we believe the data collected from clinical trials of drugs are promising, such data may not be sufficient to support approval by the FDA or any other regulatory authority. The FDA or other regulatory authorities could also interpret our data differently, which could delay, limit or prevent regulatory approval.

We expect to rely in part on the results of CellCept clinical trials that were previously performed by or on behalf of Roche and on clinical trials that were previously performed or are being performed by third-party physicians. These trial results may not be predictive of the results of the clinical trials that we plan to conduct for the purposes of our targeted indications. In addition, the results of prior clinical trials may not be acceptable to the FDA or other regulatory authorities because the data may be incomplete, outdated or not otherwise acceptable for inclusion in our submissions for regulatory approval for CellCept in autoimmune indications.

Even if CellCept or any future product candidate receives regulatory approval, we and our collaborators may still face development and regulatory difficulties that may delay or impair future sales.

If we or our collaborators obtain regulatory approval for CellCept for any of our targeted indications, or any other product, we and our collaborators will continue to be subject to extensive regulation by the FDA, other federal authorities, certain state agencies and regulatory authorities elsewhere. These regulations will impact many aspects of our operations and the drug manufacturer's operations including manufacture, record keeping, quality control, adverse event reporting, storage, labelling, advertising, promotion, sale and distribution, export and personnel. The FDA and state agencies may conduct periodic inspections to assess compliance with these requirements. We, together with our collaborators, will be required to conduct post-marketing surveillance of the product. We also may be required to conduct post-marketing studies. Our or our collaborators' failure to comply with applicable FDA and other regulatory requirements, or the later discovery of previously unknown problems, may result in restrictions including:

• delays in commercialization;

• refusal by the FDA or other similar regulatory agencies to review pending applications or supplements to approved applications;

• product recalls or seizures;

• warning letters;

• suspension of manufacturing;

• withdrawals of previously approved marketing applications;

• fines and other civil penalties;

• injunctions, suspensions or revocations of marketing licenses;

• refusals to permit products to be imported to or exported from the United States; and

• criminal prosecutions.

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Post-approval marketing laws and regulations in other jurisdictions generally provide for the same types of sanctions that may be imposed in the United States.

We may experience delays in patient enrollment, which would delay regulatory approval of CellCept in autoimmune indications and possibly reduce our revenues.

Our ability to obtain, and the timing of, regulatory approval for CellCept in any autoimmune indication depends in part on our ability to successfully complete clinical trials of CellCept in that autoimmune indication. The ability to complete clinical trials depends, in part, on the rate of patient enrollment and patient retention, which is a function of many factors, some of which are beyond our control. In particular, because some of our clinical trials will be blinded so that some patients receive CellCept and others receive another drug or a placebo, and because CellCept is marketed for transplant indications and prescribed by physicians, patients may not want to participate in a clinical trial in which they could receive a placebo or drug other than CellCept.

If third-party clinical research organizations do not perform in an acceptable and timely manner, our clinical trials could be delayed or unsuccessful.

We have limited experience as a company in conducting and managing clinical trials, and rely on third parties, including contract research organizations, outside consultants and principal investigators to assist us in managing, monitoring and conducting our clinical trials. We rely on these parties to assist in the recruitment of sites for participation in clinical trials, to maintain positive relations with the clinical sites and to ensure that these sites conduct the trials in compliance with the protocol and our instructions. If these third parties fail to perform satisfactorily or do not adequately fulfill their obligations to us, our clinical trials may be delayed or unsuccessful. The FDA or other regulatory agencies may inspect some of our clinical sites or our third-party vendors' sites, to determine if our clinical trials are being conducted according to current good clinical practices. If the FDA or another applicable regulatory agency determines that our third-party vendors are not in compliance with applicable regulations, we may be required to delay, repeat or terminate such clinical trials. Any delay, repetition or termination of our clinical trials could prevent or delay the commercialization of CellCept for autoimmune indications and any other future product candidate.

If government and third-party payors fail to provide coverage and adequate reimbursement rates for our product candidates, our revenues and potential for profitability will be reduced.

In the United States and elsewhere, our product revenues will depend principally upon the reimbursement rates established by third-party payors, including government health administration authorities, managed-care providers, public health insurers, private health insurers and other organizations. These third-party payors are increasingly challenging the price, and examining the cost effectiveness, of medical products and services. In addition, significant uncertainty exists as to the reimbursement status, if any, of newly approved drugs, pharmaceutical products or product indications. We may need to conduct post-marketing clinical trials in order to demonstrate the cost-effectiveness of products. Such studies may require us to commit a significant amount of management time and financial and other resources. CellCept is included in various drug compendia as a commercially approved drug in connection with the prevention of organ rejection and certain third party payors provide reimbursement for this use of CellCept because of such inclusion. However, CellCept or other future products may not be reimbursed or covered by any of these third-party payors for our targeted indications.

In some countries other than the United States, particularly the countries of the European Union and Canada, the pricing of prescription pharmaceuticals is subject to governmental control. In these countries, obtaining pricing approval from governmental authorities can take six to twelve months or longer after the receipt of regulatory marketing approval of a product for an indication. To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of a product that is the subject of a collaboration with us to other available therapies. If reimbursement of such products is unavailable or limited in scope or amount or if pricing is set at unsatisfactory levels our revenues could be reduced.

Domestic and foreign governments continue to propose and pass legislation designed to reduce the cost of healthcare, including drugs. In the United States, there have been, and we expect that there will continue to be, federal and state proposals to implement similar governmental control. In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical products. For example, the Medicare Prescription Drug Improvement and Modernization Act of 2003 reforms the way Medicare will cover and reimburse for pharmaceutical products. The legislation expands Medicare coverage for drug purchases by the elderly and has resulted in a new reimbursement methodology based on average sales prices for certain drugs. In addition, the new legislation provides authority for limiting the number of outpatient drugs that will be covered in any therapeutic class. As a result of the new legislation and the expansion of federal coverage of drug products, we expect that there will be additional pressure to contain and reduce costs. The Medicaid program has recently been modified and state healthcare laws and regulations will soon be amended to conform to the federal changes. The new laws and regulations will reduce Medicaid reimbursement. Cost control initiatives could decrease the established reimbursement rates that we receive for any products in the future, which would limit our revenues and profitability. Legislation and regulations affecting the pricing of pharmaceutical products, including CellCept, may change at any time, which could further limit or eliminate reimbursement rates for CellCept or other products.

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Risks Related to Intellectual Property

We may incur significant expenses or be prevented from developing or commercializing products as a result of an intellectual property infringement claim.

Our commercial success depends in part on our ability to operate without infringing the patents and other proprietary rights of third parties. Infringement proceedings in the pharmaceutical and biotechnology industries are lengthy, costly and time-consuming and their outcome is uncertain. If we become involved in any patent litigation, interference or other administrative proceedings, we will incur substantial expense and the efforts of our technical and management personnel will be significantly diverted. As a result of such litigation or proceedings we could lose our proprietary position and be restricted or prevented from developing, manufacturing and selling the affected products, incur significant damage awards, including punitive damages, or be required to seek third-party licenses that may not be available on commercially acceptable terms, if at all.

Although Roche has an extensive patent estate covering the composition of matter, methods of treatment and manufacture of CellCept, it is possible that a third party may be issued a patent covering some aspect of CellCept or its use. If this happens, we and Roche may be restricted from developing and commercializing CellCept for autoimmune indications. If a third party brings an infringement claim against us based solely upon the development or promotion of CellCept in autoimmune indications, Roche has the right under our agreement to deduct 50% of its cost in defending such action, plus any amounts paid in settlement or in a judgment against Roche or Aspreva, from the calculation of CeIlCept's net sales prior to determining our share of such sales. Roche is obligated to indemnify us if the infringing activity relates to the development and commercialization of CellCept in both transplant and non-transplant indications.

If we or our collaborators are unable to adequately protect or enforce our intellectual property, our competitive position could be impaired.

Our commercial success depends in part on our ability to: 

• obtain patents or rights to patents and maintain their validity;

• protect our trade secrets; and

• effectively enforce our proprietary rights or patents against infringers.

Patent applications may not result in patents being issued. Until a patent is issued, the claims covered by the patent may be narrowed or removed entirely and therefore we may not obtain adequate patent protection. As a result, we may face unanticipated competition, or conclude that, without patent rights, the risk of bringing products to the market is too great. Even if we or our collaborators are issued patents covering our products we cannot predict with certainty whether we or our collaborators will be able to ultimately enforce our patents or proprietary rights. Any patents that we own or license may be challenged, invalidated or circumvented and may not provide us with protection against competitors. We or our collaborators may be forced to engage in costly and time-consuming litigation in order to protect our intellectual property rights. In addition, our collaborators may choose not to enforce or maintain their intellectual property rights, and we may be forced to incur substantial additional costs to maintain or enforce such rights. Patent rights may not provide us with adequate proprietary protection or competitive advantages against competitors with similar products or technologies. The laws of certain foreign countries do not protect our intellectual property rights to the same extent as do the laws of the United States.

In addition to patents, we rely on trade secrets and proprietary know-how. We seek protection, in part, through confidentiality and non-disclosure agreements. These agreements may not provide meaningful protection of our technology or adequate remedies in the event of unauthorized use or disclosure of confidential and proprietary information and, in any event, others may develop independently, or obtain access to, the same or similar information. Our failure or inability to protect our trade secrets and proprietary know-how could impair our competitive position.

Our stock price is volatile and purchasers of our common shares could incur substantial losses.

Our stock price is volatile. Since our initial public offering on March 4, 2005 and through July 20, 2006, our common shares have traded on the NASDAQ Global Market between $11.00 and $34.89 per share. The stock market in general and the market for biopharmaceutical and biotechnology companies in particular have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. The price for our common shares may be influenced by many factors, including:

• our ability to develop and obtain regulatory approval for CellCept and any future products in our targeted indications;

• our ability to establish marketing and sales capabilities and the costs of launching CellCept and any future products for our targeted indications;

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• market acceptance of CellCept and any future products for our targeted indications;

• developments concerning our collaboration with Roche;

• our success in establishing additional collaborations;

• regulatory developments in the United States, Canada and other countries;

• developments or disputes concerning patents or other proprietary rights;

• public concern over CellCept or any future products;

• litigation;

• the departure of key personnel;

• future sales of our common shares;

• variations in our financial results or those of companies that are perceived to be similar to us;

• investors’ perceptions of us; and

• general economic, industry and market conditions.

If there are substantial sales of our common shares, our stock price could decline.

If our existing shareholders sell a large number of our common shares or the public market perceives that existing shareholders might sell our common shares, the market price of our common shares could decline significantly.

Our executive officers, directors and major shareholders continue to have substantial control over us and will maintain the ability to control all matters submitted to shareholders for approval.

As of June 30, 2006, our directors and executive officers, together with their affiliates, beneficially owned approximately 25% of our outstanding common shares, including shares subject to outstanding stock options and warrants. These shareholders, acting together, can exercise significant influence over all matters requiring shareholder approval, including the election of directors and any amendment of our notice of articles or articles. This concentration of ownership could also have the effect of delaying or preventing a change in our control.

Our articles, our shareholder rights plan and certain Canadian laws could delay or deter a change of control.

Our authorized preferred capital stock is available for issuance from time to time at the discretion of our board of directors, without shareholder approval. Our articles grant our board of directors the authority, subject to the corporate law of British Columbia, to determine or alter the special rights and restrictions granted to or imposed on any wholly unissued series of preferred shares, and such rights may be superior to those of our common shares.

Also, pursuant to our shareholder rights plan, anyone who seeks to acquire 20% or more of our outstanding common shares is required to make a bid complying with specific provisions of the plan.

Limitations on the ability to acquire and hold our common shares may be imposed by the Competition Act (Canada). This legislation permits the Commissioner of Competition of Canada to review any acquisition of a significant interest in us. This legislation grants the Commissioner jurisdiction to challenge such an acquisition before the Canadian Competition Tribunal if the Commissioner believes that it would, or would be likely to, result in a substantial lessening or prevention of competition in any market in Canada. The Investment Canada Act (Canada) subjects an acquisition of control of a company by a non-Canadian to government review if the value of our assets as calculated pursuant to the legislation exceeds a threshold amount. A reviewable acquisition may not proceed unless the relevant minister is satisfied that the investment is likely to be a net benefit to Canada.

Any of the foregoing could prevent or delay a change of control and may deprive or limit strategic opportunities for our shareholders to sell their shares.

We may be a passive foreign investment company for U.S. tax purposes which may negatively affect U.S. investors.

For U.S. federal income taxation purposes, we will be a passive foreign investment company, or PFIC, if in any taxable year either: (a) 75% or more of our gross income consists of passive income; or (b) 50% or more of the value of our assets is attributable to assets that produce, or are held for the production of, passive income. If we meet either test, our shares held by a U.S. person in that year will be PFIC shares for that year and all subsequent years in which they are held by that person. Because in the past our gross income consisted mostly of interest, we have been a PFIC in prior taxable years. We may also be a PFIC in future taxable years. Gain realized by a U.S. investor from the sale of PFIC shares is taxed as ordinary income, as opposed to capital gain, and subject to an interest charge unless the U.S. person has timely made a certain tax election.

The PFIC rules are extremely complex. A U.S. person is encouraged to consult his or her U.S. tax advisor before making an investment in our shares.

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As a foreign private issuer, we are subject to different U.S. securities laws and rules than a domestic U.S. issuer, which may limit the information publicly available to our shareholders.

As a foreign private issuer we are not required to comply with all the periodic disclosure requirements of the Securities Exchange Act of 1934 and therefore there may be less publicly available information about Aspreva than if we were a U.S. domestic issuer. In addition, our officers, directors, and principal shareholders are exempt from the reporting and "short-swing" profit recovery provisions of Section 16 of the Securities Exchange Act of 1934 and the rules thereunder. However, under Canadian provincial securities laws, our officers, directors and principal shareholders are required to file reports in electronic format through the System for Electronic Disclosure by Insiders, or SEDI, disclosing changes in beneficial ownership of, or control or direction over, our common shares and other securities. Our shareholders can access such reports at www.sedi.ca.

You may be unable to enforce actions against us, or certain of our directors and officers, under U.S. federal securities laws.

We are a corporation organized under the laws of British Columbia, Canada. A majority of our directors and officers reside principally in Canada. Because all or a substantial portion of our assets and the assets of these persons are located outside the U.S., it may not be possible for you to effect service of process within the United States upon us or those persons. Furthermore it may not be possible for you to enforce against us or them in the United States, judgments obtained in U.S. courts based upon the civil liability provisions of the U.S. federal securities laws or other laws of the U.S. There is doubt as to the enforceability, in original actions in Canadian courts, of liabilities based upon the U.S. federal securities laws and as to the enforceability in Canadian courts of judgments of U.S. courts obtained in actions based upon the civil liability provisions of the U.S. federal securities laws. Therefore, it may not be possible to enforce those actions against us or certain of our directors and officers.

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

Use of Proceeds

Our initial public offering of common shares was effected through a registration statement on Form F-1 (File No. 333-122234) that was declared effective by the Securities and Exchange Commission on March 3, 2005, pursuant to which we sold all 8,280,000 of our common shares that were registered thereunder.

Our initial public offering of common shares commenced on March 4, 2005 and was completed after all of the shares of common stock that were registered were sold. The managing underwriters in our initial public offering were Merrill Lynch, Pierce, Fenner & Smith Incorporated, Banc of America Securities LLC, Pacific Growth Equities, LLC and BMO Nesbitt Burns Inc. The aggregate offering price of the 8,280,000 shares registered and sold was $91.7 million. Of this amount, $6.4 million was paid in underwriting discounts and commissions, and an additional $3.0 million of expenses was incurred, of which approximately $1.3 million was incurred during the year ended December 31, 2004 and $1.7 million was incurred during the six months ended June 30, 2005. Expenses of $1.1 million were incurred with Farris, Vaughan, Wills & Murphy LLP, Vancouver, British Columbia. R. Hector MacKay-Dunn, Q.C., a member of our board of directors and our Corporate Secretary is a senior partner of Farris, Vaughan, Wills & Murphy LLP. No other expenses were incurred, directly or indirectly, to directors, officers or persons owning 10% or more of our common stock, or to our affiliates.

We intend to use the net proceeds of the offering primarily to continue the development of CellCept for the treatment of lupus nephritis, myasthenia gravis and pemphigus vulgaris, and to continue to pursue other collaborations. The investment in CellCept development includes funding Phase III clinical trials as well as regulatory expenses to support approval. In addition, our infrastructure is being expanded to prepare for the potential commercialization of CellCept for these indications. The amounts we actually expend in these areas may vary significantly from our expectations and will depend on a number of factors, including operating costs and capital expenditures.

As of June 30, 2006, we had applied the aggregate net proceeds of $82.3 million from our initial public offering as follows:

Working capital:	$82.3 million
Temporary investments:	nil

Recent Sales of Unregistered Securities

From April 1, 2006 through June 30, 2006, an aggregate of 28,550 common shares were issued to 10 accredited investors at a price of $4.27 ($Cdn 4.76) per share upon the exercise of warrants. The offer and sale of such common shares were made outside of the United States pursuant to Regulation S of the Securities Act.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

The 2006 Annual and Special General Meeting of the shareholders of Aspreva Pharmaceuticals Corporation was held on Wednesday, May 24, 2006 for the following purposes:

1. to elect eight directors for the ensuing year;

2. to appoint Ernst & Young LLP as our auditor and independent registered public accounting firm for the ensuing year and to authorise the audit committee of our board of directors to fix the remuneration to be paid to the auditor and independent registered public accounting firm;

3. to amend the Aspreva 2002 Incentive Stock Option Plan to increase from 3,531,000 to 4,031,000 common shares in respect of which stock options may be granted thereunder; and

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4. to transact such other business as may properly come before the meeting, or at any adjournments or postponements thereof.

In addition, at the 2006 Annual and Special General Meeting our shareholders received our 2005 Annual Report and our audited consolidated financial statements for the year ended December 31, 2005, together with the report of the auditor and independent registered public accounting firm on those financial statements.

We are not subject to Section 14(a) of the Securities Exchange Act of 1934, as amended. There was no solicitation in opposition of management’s solicitations.

The final vote on the proposals was recorded as follows:

Proposal 1:

The following eight directors were elected for the ensuing year by the following vote:

Nominee	For	Withheld
Richard M. Glickman	26,063,152	94,565
Noel F. Hall	26,096,642	61,075
Kirk K. Calhoun, C.P.A.	26,147,642	10,375
Ronald M. Hunt	26,146,642	11,075
Julia G. Levy, Ph.D.	21,290,945	4,866,772
R. Hector MacKay-Dunn, Q.C.	25,873,782	283,935
George M. Milne, Ph.D.	26,147,692	10,025
Arnold L. Oronsky, Ph.D.	26,077,972	79,745

Proposal 2:

The appointment of Ernst & Young LLP as our auditor and independent registered public accounting firm for the ensuing year and to authorise the audit committee of our board of directors to fix the remuneration to be paid to the auditor and independent registered public accounting firm was approved by the following vote:

For	Against	Withheld
26,099,297	-	58,420

Proposal 3:

The amendment of the Aspreva 2002 Incentive Stock Option Plan to increase from 3,531,000 to 4,031,000 common shares in respect of which stock options may be granted thereunder was approved by the following vote:

For	Against	Withheld	Insiders	No-Vote
10,315,755	6,803,438	-	70,400	8,968,124

ITEM 5. OTHER INFORMATION

On June 13, 2006, we announced the appointment of Dr. William L. Hunter toour Board of Directors.  Dr. Hunter, 43, co-founded AngiotechPharmaceuticals, Inc. in 1992, and currently serves as President and ChiefExecutive Officer.  Dr. Hunter has previously served on the Boards of ActivePass Pharmaceuticals, Inc., Vigil Health Management, Viewpoint, Inc. and theCanadian Arthritis Network, and served on the Steering Committee for BIO2002.

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ITEM 6. EXHIBITS.

10.3(1)		Apreva 2002 Incentive Stock Plan
31.1		Certification of the Chief Executive Officer, as required by Rule 13a-14(a) of the Securities and Exchange Act of 1934, as amended.
31.2		Certification of the Chief Financial Officer, as required by Rule 13a-14(a) of the Securities and Exchange Act of 1934, as amended.
32.1*		Certification of the Chief Executive Officer, as required by Rule 13a-14(b) of the Securities and Exchange Act of 1934, as amended and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. Section 1350).
32.2*		Certification of the Chief Financial Officer, as required by Rule 13a-14(b) of the Securities and Exchange Act of 1934, as amended  and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. Section 1350).
(1)	Filed as an attachment to our Proxy Statement for our 2006 Annual and Special General Meeting of Shareholders held on May 24, 2006, as set forth in a Current Report on Form 8-K (File No. 000-51169), dated April 20, 2006, and filed with the U.S. Securities and Exchange Commission on April 20, 2006, and incorporated herein by reference.
* The certifications attached as Exhibits 32.1 and 32.2 accompany this quarterly report on Form 10-Q, are not deemed filed with the Security and Exchange Commission and are not to be incorporated by reference into any filing of Aspreva Pharmaceuticals Corporation under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-Q, irrespective of any general incorporation language contained in such filing.

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SIGNATURE

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.

	ASPREVA PHARMACEUTICALS CORPORATION
August 2, 2006	/s/ Bruce G. Cousins
	Bruce G. Cousins
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

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EXHIBIT INDEX

10.3(1)		Apreva 2002 Incentive Stock Plan
31.1		Certification of the Chief Executive Officer, as required by Rule 13a-14(a) of the Securities and Exchange Act of 1934, as amended.
31.2		Certification of the Chief Financial Officer, as required by Rule 13a-14(a) of the Securities and Exchange Act of 1934, as amended.
32.1*		Certification of the Chief Executive Officer, as required by Rule 13a-14(b) of the Securities and Exchange Act of 1934, as amended and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. Section 1350).
32.2*		Certification of the Chief Financial Officer, as required by Rule 13a-14(b) of the Securities and Exchange Act of 1934, as amended  and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. Section 1350).
(1)	Filed as an attachment to our Proxy Statement for our 2006 Annual and Special General Meeting of Shareholders held on May 24, 2006, as set forth in a Current Report on Form 8-K (File No. 000-51169), dated April 20, 2006, and filed with the U.S. Securities and Exchange Commission on April 20, 2006, and incorporated herein by reference.
* The certifications attached as Exhibits 32.1 and 32.2 accompany this quarterly report on Form 10-Q, are not deemed filed with the Security and Exchange Commission and are not to be incorporated by reference into any filing of Aspreva Pharmaceuticals Corporation under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-Q, irrespective of any general incorporation language contained in such filing.

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