Alexza Pharmaceuticals (ALXA) 10-Q 2007 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549
 

FORM 10-Q

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

For the quarterly period ended September 30, 2007

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 000-51820

 
ALEXZA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)  

Delaware	77-0567768
(State or other Jurisdiction of Incorporation or Organization)	(IRS Employer Identification No.)
1020 East Meadow Circle Palo Alto, California	94303
(Address of principal executive offices)	(Zip Code)

(Registrant’s telephone number, including area code):(650) 687-3900

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  þ          Noo

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

    Large accelerated filero            Accelerated filero            Non-accelerated filerþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso            No þ

Total number of shares of common stock outstanding as of October 26, 2007; 31,027,464.

The Exhibit index is set forth on page 2

ALEXZA PHARMACEUTICALS, INC.
TABLE OF CONTENTS

		page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)		3
	Condensed Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006		3
	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and 2006 and for the period from December 19, 2000 (inception) to September 30, 2007		4
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006 and for the period from December 19, 2000 (inception) to September 30, 2007		5
	Notes to Condensed Consolidated Financial Statements		7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		26
Item 4.	Controls and Procedures		27
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings		28
Item 1A.	Risk Factors		28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		44
Item 3.	Defaults Upon Senior Securities		45
Item 4.	Submission of Matters to a Vote of Security Holders		45
Item 5.	Other Information		45
Item 6.	Exhibits		45
SIGNATURES			46
EXHIBIT 10.35
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements(Unaudited)

ALEXZA PHARMACEUTICALS, INC.

(a development stage company)
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

	September 30,			December 31,
	2007			2006(1)
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	44,772		$	17,032
Marketable securities		35,674			25,591
Investments held by Symphony Allegro, Inc.		42,233			49,956
Prepaid expenses and other current assets		6,226			1,263
Total current assets		128,905			93,842
Property and equipment, net		23,221			11,136
Restricted cash		604			604
Employee note receivable, net of unamortized discount		—			83
Other assets		105			101
Total assets	$	152,835		$	105,766
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	7,682		$	5,933
Accrued clinical trial expenses		738			1,641
Other accrued expenses		5,260			3,849
Current portion of equipment financing obligations		4,109			2,770
Total current liabilities		17,789			14,193
Deferred rent		14,438			1,191
Noncurrent portion of equipment financing obligations		6,464			5,865
Noncontrolling interests in Symphony Allegro, Inc.		27,052			34,743
Stockholders’ equity:
Preferred stock		—			—
Common stock		3			2
Additional paid-in-capital		238,947			170,442
Deferred share-based compensation		(1,011	)		(1,703	)
Other comprehensive income		75			9
Deficit accumulated during development stage		(150,922	)		(118,976	)
Total stockholders’ equity		87,092			49,774
Total liabilities and stockholders’ equity	$	152,835		$	105,766

(1) Condensed consolidated balance sheet at December 31, 2006 has been derived from audited consolidated financial statements at that date.

See accompanying notes.

3

ALEXZA PHARMACEUTICALS, INC.
(a development stage company)

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)

													Period from
													December
													19, 2000
													(inception)
	Three Months Ended						Nine Months Ended						to
	September 30,						September 30,						September 30,
	2007			2006			2007			2006			2007
Revenue	$	—		$	329		$	—		$	1,028		$	6,945
Operating expenses:
Research and development		11,570			9,400			31,947			25,980			129,420
General and administrative		3,566			2,667			11,168			6,630			41,343
Acquired in-process research and development		—			—			—			—			3,916
Total operating expenses		15,136			12,067			43,115			32,610			174,679
Loss from operations		(15,136	)		(11,738	)		(43,115	)		(31,582	)		(167,734	)
Interest and other income, net		1,677			850			4,215			2,029			9,781
Interest expense		(258	)		(302	)		(737	)		(646	)		(2,380	)
Loss before noncontrolling interest in Symphony Allegro, Inc.		(13,717	)		(11,190	)		(39,637	)		(30,199	)		(160,333	)
Loss attributed to noncontrolling interest in Symphony Allegro, Inc.		2,965			—			7,691			—			9,411
Net loss	$	(10,752	)	$	(11,190	)	$	(31,946	)	$	(30,199	)	$	(150,922	)
Basic and diluted net loss per share	$	(0.35	)	$	(0.47	)	$	(1.15	)	$	(1.66	)
Shares used to compute basic and diluted net loss per share		30,975			23,638			27,775			18,194

See accompanying notes.

4

ALEXZA PHARMACEUTICALS, INC.
(a development stage company)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

							Period from
							December 19,
							2000
	Nine Months Ended						(inception) to
	September 30,						September 30,
	2007			2006			2007
Cash flows from operating activities:
Net loss	$	(31,946	)	$	(30,199	)	$	(150,922	)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss attributed to noncontrolling interest in Symphony Allegro, Inc.		(7,691	)		—			(9,411	)
Share-based compensation – consultants		57			109			482
Share-based compensation – employees		1,535			753			3,341
Amortization of deferred share-based compensation		446			545			1,577
Extinguishment of officer note receivable		—			—			2,300
Issuance of common stock for intellectual property		—			—			92
Charge for acquired in-process research and development		—			—			3,916
Amortization of assembled workforce		—			—			222
Amortization of debt discount and deferred interest		34			27			309
Amortization of premium (discount) on available-for-sale securities		(596	)		(712	)		403
Depreciation and amortization		2,884			2,623			10,333
Loss on disposal of property and equipment		—			—			43
Changes in operating assets and liabilities:
Grant and other receivables		—			(154	)		—
Prepaid expenses and other current assets		(4,963	)		688			(6,220	)
Other assets		45			5			(2,598	)
Accounts payable		1,749			(461	)		7,553
Accrued clinical and other accrued liabilities		694			1,306			2,484
Other liabilities		13,247			(819	)		17,828
Net cash used in operating activities		(24,505	)		(26,289	)		(118,268	)
Cash flows from investing activities:
Purchases of available-for-sale securities		(39,973	)		(57,222	)		(255,309	)
Maturities of available-for-sale securities		30,552			45,014			219,308
Purchases of available-for-sale securities held by Symphony Allegro, Inc.		—			—			(49,975	)
Maturities of available-for-sale securities held by Symphony Allegro, Inc.		7,723			—			7,742
Increase in restricted cash		—			(399	)		(604	)
Purchases of property and equipment		(14,969	)		(4,819	)		(33,335	)
Proceeds from disposal of property and equipment		—			—			3
Cash paid for merger		—			—			(250	)
Net cash used in investing activities		(16,667	)		(17,426	)		(112,420	)

See accompanying notes.

5

ALEXZA PHARMACEUTICALS, INC.
(a development stage company)
CONDENSED CONSOLDIATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

							Period from
							December 19,
							2000
	Nine Months Ended						(inception) to
	September 30,						September 30,
	2007			2006			2007
Cash flows from financing activities:
Proceeds from issuance of common stock, net of offering costs		65,982			44,902			110,892
Proceeds from exercise of stock options and stock purchase rights under the Employee Stock Purchase Plan		992			141			2,575
Repurchases of common stock		—			—			(8	)
Proceeds from issuance of convertible preferred stock		—			—			104,681
Proceeds from repayment of stockholder note receivable		—			—			29
Proceeds from purchase of noncontrolling interest by preferred shareholders in Symphony Allegro, Inc, net of fees		—			—			47,171
Proceeds from equipment financing obligations		4,453			3,683			17,571
Payments of equipment financing obligations		(2,515	)		(1,589	)		(7,451	)
Net cash provided by financing activities		68,912			47,137			275,460
Net increase in cash and cash equivalents		27,740			3,422			44,772
Cash and cash equivalents at beginning of period		17,032			16,787			—
Cash and cash equivalents at end of period	$	44,772		$	20,209		$	44,772

See accompanying notes.

6

ALEXZA PHARMACEUTICALS, INC.
(a development stage company)

NOTES TO CONDENSED CONSOLDIATED FINANCIAL STATEMENTS

1. The Company and Basis of Presentation

Business

Alexza Pharmaceuticals, Inc. (“Alexza” or the “Company”) was incorporated in the state of Delaware on December 19, 2000 as FaxMed, Inc. In June 2001, the Company changed its name to Alexza Corporation and in December 2001 became Alexza Molecular Delivery Corporation. In July 2005, the Company changed its name to Alexza Pharmaceuticals, Inc.

Alexza is an emerging pharmaceutical company focused on the development and commercialization of novel, proprietary products for the treatment of acute and intermittent conditions. The Company’s primary activities since incorporation have been establishing its offices, recruiting personnel, conducting research and development, conducting preclinical studies and clinical trials, performing business and financial planning, and raising capital. Accordingly, the Company is considered to be in the development stage and is considered to operate in one business segment.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required for complete financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s interim consolidated financial information. The results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results to be expected for the year ending December 31, 2007 or for any other interim period or any other future year.

The accompanying unaudited condensed consolidated financial statements and notes to condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2006 included in the Company’s Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on April 10, 2007.

Basis of Consolidation

The accompanying unaudited condensed consolidated financial statements include the accounts of Alexza and its variable interest entity, Symphony Allegro, Inc., for which Alexza is considered the primary beneficiary as defined in Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (revised 2003),Consolidation of Variable Interest Entities(“FIN 46R”). All significant intercompany balances and transactions have been eliminated.

Public Offerings

In March 2006, the Company completed its initial public offering of 6,325,000 shares of its common stock, including the full underwriters’ over-allotment option, at a public offering price of $8.00 per share. Net cash proceeds from the initial public offering were approximately $44.9 million, after deducting underwriting discounts and commissions and other offering expenses. In connection with the closing of the initial public offering, all of the Company’s shares of convertible preferred stock outstanding at the time of the offering were automatically converted into 15,197,712 shares of common stock.

In May 2007, the Company completed a public offering of 6,900,000 shares of its common stock, including the full underwriters’ over-allotment option, at a public offering price of $10.25 per share. Net cash proceeds from the public offering were approximately $66.0 million, after deducting underwriting discounts and commissions and other offering expenses.

7

2. Share-Based Compensation

The components of the share-based compensation recognized in the Company’s Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and 2006 are as follows (in thousands):

	Three Months Ended September 30,
	2007						2006
	G&A		R&D		Total		G&A		R&D		Total
Employee stock options granted prior to January 1, 2006	$	50	$	88	$	138	$	63	$	80	$	143
Employee stock options and restricted stock units granted on or subsequent to January 1, 2006		336		248		584		155		147		302
Employee Stock Purchase Plan		13		1		14		71		280		351
Non-employee stock option awards		—		26		26		3		57		60
	$	399	$	363	$	762	$	292	$	564	$	856

	Nine Months Ended September 30,
	2007						2006
	G&A		R&D		Total		G&A			R&D		Total
Employee stock options granted prior to January 1, 2006	$	152	$	294	$	446	$	189		$	356	$	545
Employee stock options and restricted stock units granted on or subsequent to January 1, 2006		726		493		1,219		251			189		440
Employee Stock Purchase Plan		86		230		316		152			603		755
Non-employee stock option awards		—		57		57		9			100		109
Variable share-based Compensation		—		—		—		(442	)		—		(442	)
	$	964	$	1,074	$	2,038	$	159		$	1,248	$	1,407

In December 2004, the FASB issued Statement of Financial Accounting Standard 123R,Share-Based Payment — An Amendment of FASB Statements No. 123 and 95(“SFAS 123R”). This revised standard addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. Under the new standard, companies are no longer able to account for share-based compensation transactions using the intrinsic-value method in accordance with Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees(“APB 25”). Instead, companies are required to account for such transactions using a fair-value method and recognize the expense in the statement of operations.

On January 1, 2006, the Company adopted SFAS 123R using the prospective transition method, as required by the statement. Under this transition method, beginning January 1, 2006, employee share-based compensation cost recognized includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of December 31, 2005, based on the intrinsic value in accordance with the provisions of APB 25, and (b) compensation cost for all share-based payments granted or modified subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R.

8

Employee Share-Based Awards Granted Prior to January 1, 2006

Compensation cost for employee stock options granted prior to January 1, 2006, the date the Company adopted SFAS 123R, were accounted for using the options’ intrinsic value on the measurement date, which is typically the date of grant. The Company recorded the total valuation of these options as a component of stockholders’ equity, which will be amortized over the vesting period of the applicable option on a straight line basis. During the three and nine months ended September 30, 2007, the Company reversed $22,000 and $246,000, respectively, of deferred stock-based compensation related to unvested options cancelled as a result of employee terminations. During the three and nine months ended September 30, 2006, the Company reversed $275,000 and $495,000, respectively, of deferred stock-based compensation related to unvested options cancelled as a result of employee terminations. The expected future amortization expense related to employee options granted prior to January 1, 2006 is as follows (in thousands):

Remainder of 2007	$	137
2008		547
2009		327
	$	1,011

Employee Share-Based Awards Granted On or Subsequent to January 1, 2006

Compensation cost for employee share-based awards granted on or after January 1, 2006, the date the Company adopted SFAS 123R, is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R and will be recognized over the vesting period of the applicable award on a straight-line basis. The Company issues employee share-based awards in the form of stock options and restricted stock units under the Company’s equity incentive plans, and stock purchase rights under the Company’s employee stock purchase plan.

Valuation of Stock Options, Stock Purchase Rights and Restricted Stock Units

During the three and nine months ended September 30, 2007, the weighted average fair value of the employee stock options granted was $6.05 and $6.26, respectively and $5.14 and $5.14, for the same periods in 2006, respectively. The weighted average fair value of stock purchase rights granted was $3.60 and $3.44 during the three and nine months ended September 30, 2007, respectively and $3.24 and $3.24 in the same periods in 2006, respectively. The weighted average fair value of restricted stock units granted was $8.89 during the three and nine months ended September 30, 2007 and $7.00 for the three and nine months ended September 30, 2006.

These estimated grant date fair values of the awards were calculated using the Black-Scholes valuation model, and the following assumptions:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2007			2006			2007			2006
Stock Option Plans
Weighted-average expected term	6.1		years	6.1		years	6.1		years	6.1		years
Expected volatility		73	%		80	%		73	%		80	%
Risk-free interest rate		4.82	%		4.77	%		4.78	%		4.73	%
Dividend yield		0	%		0	%		0	%		0	%
Employee Stock Purchase Plan
Weighted-average expected term	1.8		years	1.4		years	1.6		years	1.4		years
Expected volatility		53	%		53	%		53	%		53	%
Risk-free interest rate		4.78	%		4.77	%		4.78	%		4.77	%
Dividend yield		0	%		0	%		0	%		0	%

Weighted-Average Expected Life.Under the stock option plans, the expected term of options granted is determined using the “shortcut” method, as illustrated in the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107 (“SAB 107”). Under this approach, the expected term is presumed to be the average of the vesting term and the contractual term of the option. The shortcut approach is not permitted for options granted, modified or settled after December 31, 2007.

9

Under the Employee Stock Purchase Plan, the expected term of employee stock purchase plan shares is the average of the remaining purchase periods under each offering period.

Volatility.Since the Company is a relatively new public entity with minimal historical data on volatility of its stock, the expected volatility used for 2007 and 2006 is based on volatility of similar entities (referred to as “guideline” companies). In evaluating similarity, the Company considered factors such as industry, stage of life cycle, size, and financial leverage.

Risk-Free Interest Rate. The risk-free rate that the Company uses in the Black-Scholes option valuation model is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options or purchase rights.

Dividend Yield.The Company has never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and, therefore, used an expected dividend yield of zero in the valuation model.

Forfeiture Rate.The Company uses historical data to estimate pre-vesting option and restricted stock unit forfeitures and record stock-based compensation expense only for those awards that are expected to vest. All stock-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods. The Company’s estimated forfeiture rate is approximately 5.9%.

The estimated fair value of restricted stock units awards is calculated based on the market price of Alexza’s common stock on the date of grant, reduced by the present value of dividends expected to be paid on Alexza common stock prior to vesting of the restricted stock unit. The Company’s estimate assumes no dividends will be paid prior to the vesting of the restricted stock unit.

As of September 30, 2007, there was $7,589,000, $699,000 and $168,000 of total unrecognized compensation costs related to non-vested stock option awards, non-vested restricted stock units and stock purchase rights issued after January 1, 2006, respectively, which are expected to be recognized over a weighted average period of 3.3 years, 3.6 years and 0.5 years, respectively.

Nonemployee Stock Option Awards

The Company has granted options to purchase shares of common stock to nonemployees. The Company remeasures the nonemployee options vested during the quarters using the Black-Scholes valuation model. As of September 30, 2007, stock options to acquire 8,695 shares are subject to remeasurement of fair value. The stock compensation costs of these options granted to nonemployees are remeasured over the vesting terms as earned, and the resulting value is recognized as an expense over the period of service received.

Settlement and Modification of Stock Option Awards

In December 2005, the Company extinguished housing loans that were made to three executive officers, the Chief Executive Officer, Senior Vice President of Corporate and Business Development, and Senior Vice President of Research and Development, having an aggregate principal value of $2.3 million and agreed to pay $1.7 million of taxes related to the extinguishment on the officers’ behalf. In connection with the loan extinguishment agreements, the Company entered into a commitment with the officers to settle the loan extinguishment, prior to the closing of the Company’s initial public offering, by reducing the aggregate intrinsic value of certain stock option awards to acquire up to 490,908 common shares.

On March 7, 2006 (“the Settlement Date”), in settlement for the extinguishment of the officer housing loans, the Company increased the exercise price on the above mentioned stock option awards held by these officers from $1.10 per share to $8.00 per share, the initial public offering price, which reduced the aggregate intrinsic value of these options by $3.4 million. These options were accounted for as variable awards. As a result of changes in the Company’s stock price, the Company recorded a $442,000 reduction in compensation expense during the three months ended March 31, 2006. As the exercise price was fixed in March 2006, the contingency was resolved and variable accounting for these options ceased.

Also on the Settlement Date, the Company entered into amended loan extinguishment agreements with the above mentioned officers, whereby the Company was given the right to increase the exercise price of selected options to $8.00 per share, resulting in an additional reduction in aggregate intrinsic value of $0.6

10

million. This modification was accounted for under SFAS 123R, and resulted in no additional share-based compensation expense.

There was no share-based compensation capitalized at September 30, 2007 or 2006.

3. Share-Based Compensation Plans

2005 Equity Incentive Plan

In December 2005, the Company’s Board of Directors adopted the 2005 Equity Incentive Plan (the “2005 Plan”) and authorized for issuance thereunder 1,088,785 shares of common stock. The 2005 Plan became effective upon the closing of the Company’s initial public offering on March 8, 2006. The 2005 Plan is an amendment and restatement of the Company’s previous stock option plans. Stock options and restricted stock units issued under the 2005 Plan generally vest over 4 years, vesting is generally based on service time, and have a maximum contractual term of 10 years. The 2005 Plan provides for annual reserve increases on the first day of each fiscal year which commenced on January 1, 2007 and ends on January 1, 2015. The annual reserve increases are equal to the lesser of (i) 2% of the total number of shares of the Company’s common stock outstanding on December 31^st of the preceding calendar year, or (ii) 1,000,000 shares of common stock. The Company’s Board of Directors has the authority to designate a smaller number of shares by which the authorized number of shares of common stock will be increased prior to the last day of any calendar year. On January 1, 2007 an additional 476,386 (2% of the total number of shares of the Company’s common stock outstanding on December 31, 2006) shares of the Company’s common stock were reserved for issuance under this provision.

2005 Non-Employee Directors’ Stock Option Plan

In December 2005, the Company’s board of directors adopted the 2005 Non-Employee Directors Stock Option Plan (the “Directors Plan”) and authorized for issuance thereunder 250,000 shares of common stock. The Director’s Plan became effective immediately upon the closing of the Company’s initial public offering on March 8, 2006. The Directors Plan provides for the automatic grant of nonstatutory stock options to purchase shares of common stock to the Company’s non-employee directors. The Director’s Plan provides for an annual reserve increase to be added on the first day of each fiscal year, which commenced on January 1, 2007 and ends on January 1, 2015. The annual reserve increases are equal to the number of shares subject to options granted during the preceding fiscal year less the number of shares that revert back to the share reserve during the preceding fiscal year. The Company’s Board of Directors has the authority to designate a smaller number of shares by which the authorized number of shares of common stock will be increased prior to the last day of any fiscal year. On January 1, 2007 an additional 200,000 shares of the Company’s common stock were reserved for issuance under this provision.

The following table sets forth the summary of option activity under the Company’s stock plans for the nine months ended September 30, 2007:

	Outstanding Options
	Number of			Weighted Average
	Shares			Exercise Price
Balance at December 31, 2006		2,611,042		$	5.23
Options granted		975,956			9.16
Options exercised		(162,160	)		1.87
Options canceled		(103,185	)		5.81
Balance at September 30, 2007		3,321,653			6.53

11

Information regarding the stock options outstanding at September 30, 2007 is summarized below:

	Outstanding						Exercisable
			Remaining						Remaining
			Contractual		Aggregate				Contractual		Aggregate
Exercise	Number		Life		Intrinsic		Number		Life		Intrinsic
Price	of Shares		(in years)		Value		of Shares		(in years)		Value
$0.99 – 1.10		501,279		6.81	$	3,792,000		291,226		6.60	$	2,204,000
1.38 – 3.30		349,095		7.77		2,339,000		171,482		7.74		1,154,000
6.88 – 7.00		225,840		8.46		393,000		107,032		8.35		188,000
7.20 – 7.74		333,700		8.91		483,000		89,907		8.90		130,000
8.00 – 8.00		760,442		6.93		503,000		547,359		6.51		362,000
8.01 – 8.89		733,720		9.69		99,000		700		8.64		—
8.92 – 11.70		417,577		9.39		—		45,224		8.99		—
		3,321,653		8.22	$	7,609,000		1,252,930		7.12	$	4,038,000

The intrinsic value is calculated as the difference between the market value of the Company’s common stock as of September 28, 2007 and the exercise price of the option. The market value as of September 28, 2007, the last trading day in September 2007, was $8.66 as reported by NASDAQ Global Market.

The following table sets forth the summary of nonvested share units (restricted stock units) activity under the Company’s stock option plan for the nine months ended September 30, 2007:

				Weighted
	Number			Average
	of			Grant-Date
	Shares			Fair Value
Outstanding at December 31, 2006		34,080		$	7.00
Granted		74,575			8.89
Released		(8,245	)		7.00
Forfeited		(2,217	)		7.57
Outstanding at September 30, 2007		98,193		$	8.42

As of September 30, 2007, 261,656 shares remained available for issuance under the 2005 Plan and the Directors’ Plan.

2005 Employee Stock Purchase Plan

In December 2005, the Company’s Board of Directors adopted the 2005 Employee Stock Purchase Plan (“ESPP”) and authorized for issuance thereunder 500,000 shares of common stock. The ESPP allows eligible employee participants to purchase shares of our common stock at a discount through payroll deductions. The ESPP consists of a fixed offering period, generally twenty four months with four purchase periods within each offering period. Purchases are made on the last trading day of each October and April. The initial offering period began March 8, 2006 and will end on April 30, 2008. Employees purchase shares at each purchase date at 85% of the market value of our common stock at either the employee’s enrollment date or the end of the purchase period, whichever price is lower. In the three and nine months ended September 30, 2007, employees purchased 100,981 shares from the ESPP at a weighted average price of $6.83. There were no purchases made during the three or nine months ended September 30, 2006.

The ESPP provides for annual reserve increases on the first day of each fiscal year which commenced on January 1, 2007 and ends on January 1, 2015. The annual reserve increases are equal to the lesser of (i) 1% of the total number of shares of the Company’s common stock outstanding on December 31^st of the preceding calendar year, or (ii) 250,000 shares of common stock. The Company’s Board of Directors has the authority to designate a smaller number of share by which the authorized number of shares of common stock will be increased prior to the last day of any calendar year. On January 1, 2007 an additional 238,193 shares of the Company’s common stock (1% of the total number of shares of the Company’s common stock

12

outstanding on December 31, 2006) were reserved for issuance under this provision. As of September 30, 2007, 505,530 shares of common stock were available for issuance under the plan.

4. Net Loss per Share

Basic and diluted net loss per share is calculated by dividing the net loss by the weighted-average number of common shares outstanding for the period. The following items were excluded in the diluted net loss per share calculation for the three and nine months ended September 30, 2007 and 2006 as the inclusion of such shares would have had an anti-dilutive effect:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2007		2006		2007		2006
Stock options		3,321,653		2,525,760		3,321,653		2,525,760
Restricted stock units		98,193		34,680		98,193		34,680
Warrants to purchase common stock		2,015,720		15,720		2,015,720		40,009
Convertible preferred stock (as converted)		—		—		—		3,729,841

5. Comprehensive Loss

Comprehensive loss is comprised of net loss and unrealized gains (losses) on marketable securities. Total comprehensive loss for the three and nine months ended September 30, 2007 and 2006 is as follows (in thousands):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2007			2006			2007			2006
Net loss	$	(10,752	)	$	(11,190	)	$	(31,946	)	$	(30,199	)
Change in unrealized gain (loss) on marketable securities		70			3			66			50
Comprehensive loss	$	(10,682	)	$	(11,187	)	$	(31,880	)	$	(30,149	)

6. Other Accrued Expenses

Other accrued expenses consisted of the following (in thousands):

	September 30,		December 31,
	2007		2006
Accrued compensation		3,286	$	2,856
Accrued professional fees		602		349
Other		1,372		644
	$	5,260	$	3,849

7. Equipment Financing Obligations

During the nine months ended September 30, 2007, the Company borrowed an additional $4,453,000 under an existing equipment financing agreement. Under the existing agreement, equipment advances are to be repaid in 36 to 48 monthly installments of principal and interest. The interest rate, which is fixed for each draw, is based on the U.S. Treasuries of comparable maturities and ranges from 9.2% to 10.6%. The equipment purchased under the equipment financing agreement is pledged as security. As of September 30, 2007, the Company had $7,327,000 of remaining credit available under the agreement.

13

Future principal payments under the equipment financing agreements as of September 30, 2007 are as follows (in thousands):

Remainder of 2007	$	991
2008		4,208
2009		3,634
2010		1,492
2011		248
Total	$	10,573

8. Facility Lease

In February 2007, the Company entered into an agreement to extend the termination date on the lease of its two Palo Alto facilities from June 30, 2007 to March 31, 2008. Beginning July 1, 2007, monthly rent payments increased from $134,000 per month to $228,000 per month related to these facilities. In June 2007, the Company exercised its option to extend the lease on one of these facilities through June 30, 2008. Beginning April 1, 2008, monthly rent payments will decrease to $98,525 as a result of the reduction in leased space.

In August 2006, we entered into an agreement to lease 65,604 square feet for office, laboratory and manufacturing facilities in Mountain View, California. In May 2007, the Company entered into an agreement to lease an additional 41,290 square feet of space in Mountain View, California. In May 2007, the Company gained access to 21,956 square feet of the additional space and will obtain access to the remaining 19,334 square feet of space on or about June 1, 2008. Rent payments related to this additional facility will begin on January 1, 2008.

In August 2007, the Company amended the lease agreement for its Mountain View, California facility. The amendment provides the Company with up to an additional $6,600,000 of reimbursements for tenant improvements made by the Company. Minimum monthly payments will be increased for any reimbursements received by the Company for a period between 5 years and the term of the lease agreement. As of September 30, 2007, the Company had $2,333,000 remaining tenant improvement allowances available for reimbursement by the landlord.

In the three and nine months ended September 30, 2007 the Company requested tenant improvement reimbursements of $4,693,000 and $12,203,000, respectively, and recorded the amounts as defered rent. Such amounts will be amortized against rent expense over the life of the lease. As of September 30, 2007 the Company had an outstanding receivable from the landlord of $4.7 million related to tenant improvement reimbursements, which was included in prepaid and other current assets, and reimbursed to the Company by the landlord in October 2007.

Future minimum lease payments under the facility lease agreements as of September 30, 2007 are as follows (in thousands):

Remainder of 2007	$	1,099
2008		3,940
2009		4,157
2010		4,414
2011		4,536
Thereafter		30,166
Total	$	48,312

9.  Symphony Allegro, Inc.

On December 1, 2006 (the “Closing Date”), the Company entered into a series of related agreements with Symphony Allegro, Inc. providing for the financing of the clinical development of its AZ-002,Staccatoalprazolam, and AZ-004/104,Staccatoloxapine, product candidates (the “Programs”). Pursuant to the agreements, Symphony Allegro, Inc. (“Allegro”) has agreed to invest up to $50.0 million to fund the clinical development of these Programs, and the Company licensed to Allegro its intellectual property rights related to these Programs. Allegro is a wholly owned subsidiary of Symphony Allegro Holdings LLC (“Holdings”), which provided $50.0 million in funding to Allegro on December 18, 2006. The Company

14

continues to be primarily responsible for the development of these Programs and as a result, has incurred and may continue to incur expenses that are not funded by Allegro.

In accordance with FIN 46R, the Company determined that Allegro is a variable interest entity for which it is the primary beneficiary. As a result, the Company will include the financial condition and results of operations of Allegro in its financial statements. Accordingly, the Company has deducted the losses attributable to the noncontrolling interest in Allegro from the Company’s net loss in the consolidated statement of operations and the Company also reduced the noncontrolling interest holders’ ownership interest in Allegro in the consolidated balance sheet by Allegro’s losses. For the three and nine months ended September 30, 2007, the losses attributed to the noncontrolling interest holders were $3.0 million and $7.7 million, respectively. The Company also reduced the noncontrolling interest holders’ ownership interest in Allegro in the consolidated balance sheet by $2.85 million related to a structuring fee and related expenses that the Company incurred in connection with the closing of the Allegro transaction.

Pursuant to the agreements, the Company received an exclusive purchase option (the “Purchase Option”) that gives the Company the right, but not the obligation, to acquire all, but not less than all, of the equity of Allegro, thereby allowing the Company to reacquire all of the Programs. This Purchase Option is exercisable at any time, beginning on the one-year anniversary of the Closing Date and ending on the four-year anniversary of the Closing Date (subject to an earlier exercise right in limited circumstances), at predetermined prices. The Purchase Option exercise price may be paid for in cash or in a combination of cash and the Company’s common stock, at the Company’s sole discretion, provided that the common stock portion may not exceed 40% of the Purchase Option exercise price, or 10% of our common stock issued and outstanding as of the purchase option closing date.

Pursuant to the agreements, the Company issued to Holdings a five-year warrant to purchase 2,000,000 shares of the Company’s common stock at $9.91 per share. The warrants issued upon closing were assigned a value of $10.7 million in accordance with the Black-Scholes option valuation methodology, which has also been recorded as a reduction to the noncontrolling interest in Allegro. Pursuant to the agreements, the Company has no further obligation beyond the items described above and the Company has no obligation to the creditors of Allegro as a result of our involvement with Allegro.

10. Recent Accounting Pronouncements

Statement of Financial Accounting Standard No. 157

In September 2006, FASB issued SFAS No. 157,Fair Value Measurements(“FAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Management is currently evaluating the impact of the provisions of SFAS 157 on its financial position, results of operations and cash flows and does not believe the impact of the adoption will be material.

Staff Accounting Bulletin No. 108

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108 (“SAB 108”). Due to diversity in practice among registrants, SAB 108 expresses the SEC staff views regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether financial statement restatement is necessary. The impact of adopting SAB 108 on January 1, 2007 did not have a material impact on the Company’s results of operations or financial position.

FASB Interpretation No. 48

In July, 2006, the FASB issued Interpretation No. 48,Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109(“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with FASB Statement No. 109,Accounting for Income Taxesand prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.

15

Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

The Company’s adoption of the provisions of FIN 48 on January 1, 2007 did not have a material impact on the Company’s financial statements.

The Company adopted the accounting policy that interest recognized in accordance with Paragraph 15 of FIN 48 and penalties recognized in accordance with Paragraph 16 of FIN48 are classified as part of its income tax provision. The Company has not incurred any interest or penalties as of September 30, 2007.

The Company does not anticipate any significant change within 12 months of this reporting date of its uncertain tax positions. The Company does not anticipate any events which could cause the change to these uncertainties.

The Company is subject to taxation in the US and various states jurisdictions. There are no ongoing examinations by taxing authorities at this time. The Company’s various tax years starting with 2000 to 2006 remain open in various taxing jurisdictions.

As of the adoption date, the Company had $2 million of unrecognized tax benefits.

Emerging Issues Task Force Issue No. 07-3

In June 2007, the FASB ratified EITF Issue No. 07-3 (“EITF 07-3”),Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities. The scope of EITF 07-3 is limited to nonrefundable advance payments for goods and services to be used or rendered in future research and development activities pursuant to an executory contractual arrangement. This issue provides that nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities should be deferred and capitalized. Such amounts should be recognized as an expense as the related goods are delivered or the related services are performed.  EITF 07-3 is effective for fiscal years beginning after December 15, 2007 and earlier application is not permitted. The Company is currently evaluating the impact of the provisions of EITF 07-3 on its financial position, results of operations and cash flows and does not believe the impact of the adoption will be material.

16

PART I. FINANCIAL INFORMATION

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

This Quarterly Report onForm 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential” and similar expressions intended to identify forward-looking statements. Examples of these statements include, but are not limited to, statements regarding: the implications of interim or final results of our clinical trials, the progress of our research programs, including clinical testing, the extent to which our issued and pending patents may protect our products and technology, our ability to identify new product candidates, the potential of such product candidates to lead to the development of commercial products, our anticipated timing for initiation or completion of our clinical trials for any of our product candidates, our future operating expenses, our future losses, our future expenditures for research and development and the sufficiency of our cash resources. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us and described in Part II, Item 1A of this Quarterly Report onForm 10-Q and our other filings with the SEC. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report onForm 10-Q. You should read this Quarterly Report onForm 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

The following discussion and analysis should be read in conjunction with the unaudited financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report onForm 10-Q.

The names “Alexza” and “Staccato” are trademarks of Alexza Pharmaceuticals, Inc. We have registered the trademarks “Alexza Pharmaceuticals,” “Alexza” and “Staccato” with the U.S. Patent and Trademark Office. All other trademarks, trade names and service marks appearing in this Quarterly Report on Form 10-Q are the property of their respective owners.

Overview

We are developing novel, proprietary products for the treatment of acute and intermittent conditions. Our technology, theStaccatosystem, enables the precise delivery and rapid onset of therapeutic effect of many small molecule drugs. Our lead product candidates consist of the following:

• AZ-004 (Staccatoloxapine).We are developing AZ-004 for the treatment of acute agitation in patients with schizophrenia and bi-polar disorder. In March 2007, we announced positive initial results from a multi-center, randomized, double-blind, placebo-controlled Phase 2a clinical trial in 120 patients in an in-patient clinical setting. The 10 mg dose of AZ-004 met the primary endpoint of the clinical trial, which was a statistically significant reduction in the measure of agitation from baseline to the 2-hour post-dose time point, as compared to placebo. The 10 mg dose of AZ-004 also exhibited a rapid onset of effect, with a statistically significant improvement in the PANSS (Positive and Negative Symptom Scale) Excited Component (PEC) scores at 20 minutes post-dose, as compared to placebo. The effectiveness of the 10 mg dose was sustained throughout the 24-hour study period, as compared to placebo. We expect to begin the first of two Phase 3 trials late in the first quarter of 2008 and begin a second Phase 3 trial beginning in the second or third quarter of 2008. The two multi-center, randomized, double-blind, placebo-controlled, pivotal Phase 3 trials are anticipated to each enroll approximately 300 patients and utilize the same primary endpoint as the Phase 2a trial. Both Phase 3 trials will test two doses, 5mg and 10mg, against a placebo. AZ-004 has been licensed to Symphony Allegro, and we have the right to repurchase all rights to this product candidate, as discussed below.

17

• AZ-001 (Staccatoprochlorperazine).We are developing AZ-001 to treat patients suffering from acute migraine headaches. In March 2007, we announced positive initial results from an outpatient, multi-center, randomized, double blind, placebo-controlled Phase 2b clinical trial of AZ-001 in 400 migraine patients. All three doses of AZ-001 met the primary endpoint of statistically significant pain relief at two hours, compared to placebo. In the two highest doses studied, AZ-001 also showed a statistically significant difference in achieving a pain-free response at two hours, as compared with placebo. AZ-001 demonstrated rapid onset of pain relief, with statistically significant pain response in 15 minutes for the 7.5 mg dose and statistically significant pain responses for all three doses at 30 minutes. AZ-001 also showed a sustained pain-free response, with statistically significant elimination of pain at 24 hours post-dose at the two highest studied doses. Survival analysis for nausea, photophobia and phonophobia over the 2-hour period post-dose showed a statistically significant difference, compared to placebo. We expect to have an End of Phase 2 meeting with the U.S. Food and Drug Administration (FDA) in the second quarter of 2008.

• AZ-104(Staccatoloxapine). We are developing AZ-104 to treat patients suffering from acute migraine headaches. AZ-104 is a lower dose version of AZ-004. In June 2007, we announced the initiation of an in-clinic, multi-center randomized, double-blind, single administration, placebo controlled Phase 2a proof-of-concept clinical trial of approximately 160 migraine patients with or without aura. Three doses of AZ-104 (1.25, 2.5 and 5 mg) are being evaluated against placebo in the clinical trial. Using the IHS (International Headache Society) 4-point rating scale, the primary efficacy endpoint is pain-relief response at 2 hours post-administration. Secondary efficacy endpoints for the trial include additional pain response assessments and other symptom assessments at various time points. Safety evaluations are being made throughout the clinical trial period. We expect to complete enrollment in this trial by the end of 2007 and preliminary findings to be released in the first quarter of 2008. AZ-104 has been licensed to Symphony Allegro, and we have the right to repurchase all rights to this product candidate, as discussed below.

• AZ-002 (Staccatoalprazolam).We are developing AZ-002 for the acute treatment of panic attacks associated with panic disorder. In April 2006, we initiated an in-clinic, single-center, double-blind, placebo-controlled, Phase 2a proof-of-concept clinical trial in patients with panic disorder. As a result of observing greater than expected levels of sedation in the first two patients enrolled in the trial, we reduced the dose of AZ-002, modified the AZ-002 device, manufactured and released new clinical trial materials for the trial, and added two additional study sites to the study group. In April 2007, we re-initiated dosing in the 42 patient clinical trial with a lower dose of AZ-002 and expect to complete enrollment of this trial in the first half of 2008. AZ-002 has been licensed to Symphony Allegro, and we have the right to repurchase all rights to this product candidate, as discussed below.

• AZ-003 (Staccatofentanyl).We are developing AZ-003 for the treatment of patients with acute pain, including patients with breakthrough cancer pain and postoperative patients with acute pain episodes. In December 2006, we completed enrollment and announced initial results of a Phase 1 clinical trial of AZ-003 in opioid naïve healthy subjects. We plan no additional clinical development of AZ-003 unless we are able to secure a corporate partner to support continued clinical and device development.

• AZ-007 (Staccatozaleplon). We are developing AZ-007 for the treatment of sleep disorder in patients who have difficulty falling asleep, including those patients with middle of the night awakening who have difficulty falling back asleep. To date, we have completed a pre-IND meeting and have initiated several pre-clinical studies and expect to initiate a Phase 1 clinical trial in the first quarter of 2008.

We were incorporated on December 19, 2000. We have funded our operations primarily through the sale of equity securities, capital lease and equipment financings, government grants and financing from Symphony Allegro. We have generated $6.9 million in revenue from inception through September 30, 2007, substantially all of which was earned through United States Small Business Innovation Research grants. We do not expect any grant revenues in 2007 or material product revenue until at least 2011.

In May 2007, we completed a public offering of 6,900,000 shares of common stock, which resulted in net cash proceeds to us of approximately $66.0 million.

18

From inception through 2003, we focused on the development of our technology, the selection and preclinical testing of product candidates and the manufacture of clinical trial supplies. In 2004, we expanded our activities to include the clinical development of our product candidates. The continued development of our product candidates will require significant additional expenditures, including expenses for preclinical studies, clinical trials, research and development, manufacturing development and seeking regulatory approvals. We rely on third parties to conduct a portion of our preclinical studies and all of our clinical trials, and we expect these expenditures to increase in future years as we continue development of our product candidates. During the fourth quarter of 2007, we intend to continue our clinical trials for AZ-002 and AZ-104, conduct clinical and preclinical studies to support our AZ-001, AZ-004 and AZ-007 programs, and file an IND for AZ-007. These clinical trials will result in higher expenditures than in previous years. If each product candidate continues to progress, expenses for future Phase 3 clinical trials, the first of which for AZ-004 are expected to start late in the first quarter of 2008, will be significantly higher than those incurred in Phase 2 clinical trials for each respective product candidate.

In August 2006 we executed a lease for a new facility in Mountain View, California. We are building a current good manufacturing practice pilot manufacturing facility in this new location and plan to move our research and development and manufacturing operations to this location by the end of 2007 or early 2008. We intend the pilot manufacturing facility to be capable of manufacturing materials for toxicology studies and clinical trial materials for future clinical trials. In August 2007, we amended our lease agreement for the Mountain View, California facility. The amendment provides us with up to an additional $6.6 million of reimbursements for tenant improvements made by us. As of September 30, 2007 we had an outstanding receivable from the landlord of $4.7 million related to tenant improvement reimbursements due to us, which was included in prepaid and other current assets, and reimbursed to us by our landlord in October 2007. At September 30, 2007, in addition to the $4.7 million included in prepaid and other current assets, we had approximately $2.3 million of tenant improvement reimbursements available. Under the terms of the amendment, minimum monthly payments will be increased for any reimbursements received by the Company. The increased lease payment periods will cover a period of 5 years for $2 million of the reimbursement, seven years for $2 million of the reimbursement and the remaining term of the lease agreement for $2.6 million of the reimbursement. In May 2007, we executed a lease for an additional facility in Mountain View, California. We intend to move our administrative operations to this facility in 2007 and 2008. Facility lease expenses will increase in the fourth quarter of 2007 and the first half of 2008, as we incur lease expense on the new Mountain View facilities while we continue to make tenant improvements in 2007 and 2008 and continue to lease our current facilities in Palo Alto, California. In addition, we will incur significant expense in moving our operations, including our laboratories and manufacturing operations, from our existing premises to the new facilities.

On December 1, 2006 we entered into a transaction involving a series of related agreements providing for the financing of additional clinical and nonclinical development of AZ-002,Staccato alprazolam, and AZ-004/104,Staccatoloxapine. Pursuant to the agreements, Symphony Capital LLC, a wholly owned subsidiary of Symphony Holdings LLC, and its investors have invested $50 million to form Symphony Allegro, Inc., or Symphony Allegro, to fund additional clinical and nonclinical development ofStaccatoalprazolam andStaccatoloxapine. We have exclusively licensed to Symphony Allegro certain intellectual property rights related toStaccatoalprazolam andStaccatoloxapine. We have retained manufacturing rights to these two product candidates. We continue to be primarily responsible for the development of these two product candidates in accordance with a development plan and related development budgets and we have incurred and may continue to incur expenses that are not funded by Symphony Allegro. Pursuant to the agreements, we have received an exclusive purchase option that gives us the right, but not the obligation, to acquire all, but not less than all, of the equity of Symphony Allegro, and reacquire the intellectual property rights that we licensed to Symphony Allegro. This purchase option is exercisable at predetermined prices between December 1, 2007 and December 1, 2010. The purchase option exercise price may be paid for in cash or in a combination of cash and our common stock, in our sole discretion, provided that the common stock portion may not exceed 40% of the purchase option exercise price or 10% of our common stock issued and outstanding as of the purchase option closing date. If we pay a portion of the purchase option exercise price in shares of our common stock, then we will be required to register such shares for resale under a resale registration statement pursuant to the terms of a registration rights agreement. If we do not exercise our purchase option by December 1, 2010, then Symphony Allegro will retain its exclusive license to develop and commercializeStaccatoalprazolam andStaccatoloxapine for all indications, and we will manufacture and sellStaccatoalprazolam andStaccatoloxapine to Symphony Allegro or its sublicensee for those purposes.

19

As our activities have expanded, we have consistently increased the number of our employees. We expect that we will add a significant number of employees during the remainder of 2007 to support our expanded operations.

We have incurred significant losses since our inception. As of September 30, 2007, our deficit accumulated during development stage was $150.9 million. We recognized net losses of $31.9 million for the nine months ended September 30, 2007 and $41.8 million, $32.4 million, and $16.6 million for the years ended December 31, 2006, 2005 and 2004, respectively. We expect our net losses to increase as we continue our existing and planned preclinical studies and clinical trials, expand our research and development efforts and our manufacturing development, move to our new facilities, and continue to support the infrastructure necessary to operate as a public company.

The process of conducting preclinical studies and clinical trials necessary to obtain FDA approval is costly and time consuming. We consider the development of our product candidates to be crucial to our long term success. If we do not complete development of our product candidates and obtain regulatory approval to market one or more of these product candidates, we may be forced to cease operations. The probability of success for each product candidate may be impacted by numerous factors, including preclinical data, clinical data, competition, device development, manufacturing capability, regulatory approval and commercial viability. Our strategy includes entering into strategic partnerships with third parties to participate in the development and commercialization of some of our product candidates, such as our Symphony Allegro relationship. If third parties have control over preclinical development or clinical trials for some of our product candidates, the progress of such product candidate will not be under our control. We cannot forecast with any degree of certainty which of our product candidates, if any, will be subject to any future partnerships or how such arrangements would affect our development plans or capital requirements.

As a result of the uncertainties discussed above, the uncertainty associated with clinical trial enrollments, and the risks inherent in the development process, we are unable to determine the duration and completion costs of the current or future clinical stages of our product candidates or when, or to what extent, we will generate revenues from the commercialization and sale of any of our product candidates. Development timelines, probability of success, and development costs vary widely. While we are currently focused on developing AZ-004, AZ-001, AZ-104, AZ-002 and AZ-007, we anticipate that we will make determinations as to which programs to pursue and how much funding to direct to each program on an ongoing basis in response to the scientific and clinical success of each product candidate, as well as an ongoing assessment as to the product candidate’s commercial potential. We anticipate developing additional product candidates, which will also increase our research and development expenses in future periods. We do not expect any of our current product candidates to be commercially available before 2011, if at all. We expect our existing cash, cash equivalents and marketable securities, interest earned thereon, borrowings available under our equipment financing obligations, our tenant improvement allowance, funding available from Symphony Allegro and funds received from option exercises and purchases of common stock pursuant to our Employee Stock Purchase Plan, will enable us to maintain our currently planned operations through at least the middle of 2009. We will need to raise additional capital to support continued development of our product candidates thereafter.

Results of Operations

Comparison of Three and Nine Months Ended September 30, 2007 and 2006

Revenue

We had no revenues during the three or nine months ended September 30, 2007. Revenue for the three and nine months ended September 30, 2006 was $329,000 and $1,028,000, respectively, including government grant revenue of $329,000 and $998,000, respectively. We recognized no revenue from drug compound feasibility screening agreements for the three months ended September 30, 2006, and $30,000 of revenue from drug compound feasibility screening agreements for the nine months ended September 30, 2006. We expect no grant revenue or drug compound feasibility screening revenue in 2007.

Operating Expenses

Our operating expenses were affected by our prospective method of adoption of SFAS 123R as well as the reversal of share-based compensation expense resulting from variable accounting in the three months ended March 31, 2006. As a result, we believe reviewing our operating expenses both inclusive and exclusive of

20

share-based compensation provides a better understanding of the growth of our operations. The impact of share-based compensation on operating expenses is outlined as follows (in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2007		2006		2007		2006
Operating expenses without share-based compensation expenses:
Research and development	$	11,207	$	8,836	$	30,873	$	24,732
General and administrative		3,167		2,375		10,204		6,471
Total operating expenses without share-based compensation expenses		14,374		11,211		41,077		31,203
Share-based compensation expenses:
Research and development		363		564		1,074		1,248
General and administrative		399		292		964		159
Total share-based compensation expenses		762		856		2,038		1,407
Total operating expenses	$	15,136	$	12,067	$	43,115	$	32,610

Research and Development Expenses

Research and development costs are identified as either directly attributed to one of our lead product candidates or as general research. Direct costs consist of personnel costs directly associated with a product candidate, preclinical study costs, clinical trial costs, related clinical drug and device development and manufacturing costs, contract services and other research expenditures. Overhead, facility costs and other support service expenses are allocated to each candidate or to general research and are based on employee time spent on each program. The following table summarizes our expenditures on each candidate based on our internal records and estimated allocations of employee time and related expenses (in thousands):

									From
									December
									19, 2000
									(inception
	Three Months Ended				Nine Months Ended				to
	September 30,				September 30,				September 30,
	2007		2006		2007		2006		2007
Preclinical and clinical development
AZ-004/104	$	4,711	$	1,877	$	9,899	$	3,865	$	19,278
AZ-001		1,845		2,508		4,398		7,381		34,456
AZ-002		716		725		3,336		1,897		12,653
AZ-003		180		635		858		2,956		12,208
AZ-007		2,100		981		6,712		1,062		9,096
Other preclinical programs		—		722		—		2,785		3,243
Total preclinical and clinical development		9,552		7,448		25,203		19,946		90,934
Research		2,018		1,952		6,744		6,034		38,486
Total research and development	$	11,570	$	9,400	$	31,947	$	25,980	$	129,420

Research and development expenses were $11,570,000 and $31,947,000 during the three and nine months ended September 30, 2007, respectively and $9,400,000 and $25,980,000 during the three and nine months ended September 30, 2006, respectively. The increases were due primarily to:

• increased spending on our AZ-004/104 and AZ-002 product candidates as we continued development of these product candidates under the Symphony Allegro agreement, including the launch of a Phase 2a clinical trial of AZ-104 at the end of the second quarter of 2007,

• the initiation of AZ-007 pre-clinical product development, and

• increased spending onStaccatodevice development and manufacturing scale up.

21

These increased efforts were partially offset by decreased spending on:

• our AZ-001 product candidate due to the completion of the Phase 2b trial in the first quarter of 2007,

• our AZ-003 product candidate, as we have significantly reduced further development on this program until we obtain a partner to assist in the development of the product candidate, and

• our other preclinical development as we focused our efforts on our AZ-007 product candidate.

We expect to continue to devote substantial resources to research and development to support the continued development of our product candidates and core technology, to expand our research and development efforts and to expand our manufacturing development. We expect that research and development expenses for clinical trials will continue to increase as we conduct additional and later-stage clinical trials for our product candidates. In addition, we expect to incur additional non-cash stock-based compensation expense as future employee stock options granted are recorded at fair value and existing grants continue to be expensed.

General and Administrative Expenses

General and administrative expenses were $3,566,000 and $11,168,000 during the three and nine months ended September 30, 2007, respectively, and $2,667,000 and $6,630,000 during the three and nine months ended September 30, 2006, respectively.

General and administrative expenses included share-based compensation expenses of $399,000 and $964,000 during the three and nine months ended September 30, 2007, respectively, compared to $292,000 and $159,000 during the comparable periods in 2006, respectively. During the nine months ended September 30, 2006, share-based compensation was impacted by a $442,000 reduction in compensation expense related to officer stock option grants that were treated as variable awards during. The contingency which had caused these awards to be variable in nature was resolved during the three months ended March 31, 2006 and thus variable accounting ceased. We expect share-based compensation expense to continue to increase as we do not anticipate any additional expense reversals resulting from variable accounting and as future stock option grants will continue to be recorded at fair value.

Without the impact of share-based compensation expenses, general and administrative expenses increased to $3,167,000 and $10,204,000 in the three and nine months ended September 30, 2007, respectively, from $2,375,000 and $6,471,000 in the comparable periods in 2006, respectively. The increases during the three and nine month periods were primarily due to increased staffing to manage and support our growth resulting in payroll and related expenses increasing $389,000 and $1,336,000, respectively, and the additional administrative costs related to Symphony Allegro resulting in an additional $168,000 and $545,000 of expenses, respectively. Additional regulatory requirements as a publicly traded company resulted in increases in accounting and legal fees of $495,000 during the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. We also incurred higher facilities expenses to support our overall growth.

We expect that our general and administrative expenses will increase as we continue to add infrastructure to support the expected increase in operations and as we continue to meet our obligations as a public company. In addition, we expect to incur additional non-cash stock-based compensation expense in 2007 as future employee stock options granted are recorded at fair value and existing grants continue to be expensed.

Interest and Other Income and Interest Expense, Net

Interest and other income primarily consists of interest earned on our cash, cash equivalents, marketable securities, and investments held by Symphony Allegro, Inc. and was $1,677,000 and $4,215,000 for the three and nine months ended September 30, 2007, respectively, as compared to $850,000 and $2,029,000 in the comparable periods in 2006, respectively. The increase was primarily due to higher average cash, cash equivalent and marketable securities balances due to our public stock offering in May 2007, and the addition of investments held by Symphony Allegro, Inc in December 2006. We expect interest income to gradually decrease in future quarters as we expect our cash, cash equivalent and marketable securities balances to decrease as we continue to incur net losses.

Interest expense represents interest on our equipment loans and was $258,000 and $737,000 for the three and nine months ended September 30, 2007, respectively, compared to $302,000 and $646,000 in the

22

comparable periods in 2006, respectively. The increases were due to increases in our equipment loan borrowings. We expect interest expense to continue to increase as we anticipate additional borrowings under our equipment financing agreements.

Liquidity and Capital Resources

Since inception through September 30, 2007, we have financed our operations primarily through private placements and public offerings of equity securities, receiving aggregate net proceeds from such sales totaling$215.6 million, revenues primarily from government grants totaling $6.9 million and funding from Symphony Allegro. We have received additional funding from equipment financing obligations, tenant improvement allowances, interest earned on investments, as described below, and funds received upon exercises of stock options and exercises of purchase rights under our Employee Stock Purchase Plan. As of September 30, 2007, we had $80.4 million in cash, cash equivalents and marketable securities, $42.2 million of marketable securities held by Symphony Allegro, and $7.3 million available under an equipment financing line of credit. The marketable securities held by Symphony Allegro are used to fund the development of AZ-002, AZ-004 and AZ-104 and are not available for general corporate expenses. Our cash and marketable security balances are held in a variety of interest bearing instruments, including obligations of United States government agencies, high credit rating corporate borrowers and money market accounts. Investments held by Symphony Allegro, Inc. consist of investments in a mutual fund that invests primarily in domestic commercial paper, securities issued or guaranteed by the U.S. government or its agencies, U.S. and Yankee bank obligations and fully collateralized repurchase agreements. Cash in excess of immediate requirements is invested with regard to liquidity and capital preservation.

Cash Flows from Operating Activities.Net cash used in operating activities was $24,505,000 and $26,289,000 during the nine months ended September 30, 2007 and 2006, respectively. The net cash used in the nine months ended September 30, 2007 primarily reflects the net loss of $31,946,000, net of losses attributed to noncontrolling interests in Symphony Allegro, Inc. of $7,691,000, deprecation of $2,884,000 and non-cash share based compensation expense of $2,038,000. Cash flows from operations in 2007 were also impacted by the increase in prepaid expenses and other current assets of $4,963,000. Increases in deferred rent of $13,247,000, primarily as a result of tenant improvement reimbursements from our landlord, an increase in accounts payable of $1,749,000 and accrued clinical and other accrued liabilities of $694,000 resulted in reducing cash use from operations.The net cash used in the nine months ended September 30, 2006 primarily reflects net loss of $30,199,000, net of depreciation of $2,623,000 and non-cash share based compensation expense of $1,407,000. Cash flows from operations were also impacted by the reduction in other accrued expenses of $819,000 and accounts payable of $461,000 partially offset by the increase in accrued clinical trial expense of $1,306,000 and the decrease in prepaid and other current assets of $688,000. We expect to utilize the remaining tenant improvement reimbursements, approximately $3.3 million for both Mountain View facilities, in the fourth quarter of 2007, which will result in increases in net cash used in operating activities in first quarter of 2008.

Cash Flows from Investing Activities.Net cash used in investing activities was $16,667,000 and $17,426,000 during the nine months ended September 30, 2007 and 2006, respectively. Investing activities consist primarily of purchases and maturities of marketable securities and capital purchases. During the nine months ended September 30, 2007, we had maturities of marketable securities, net of purchases, of $9,431,000, and purchases of property and equipment of $14,969,000, consisting primarily of tenant improvements of our Mountain View facility, and maturities of available for-sale securities held by Symphony Allegro of $7,723,000. During the nine months ended September 30, 2006 we had purchases, net of maturities of $12,208,000 of marketable securities and purchases of equipment of $4,819,000.

Cash Flows from Financing Activities. Net cash provided by financing activities was $68,912,000 and $47,137,000 during the nine months ended September 30, 2007 and 2006, respectively. Financing activities consist primarily of proceeds from the sale of our stock and equipment financing arrangements. In the nine months ended September 30, 2007 and 2006, we received net proceeds of $65,982,000 and $44,902,000, respectively, from the issuance of 6,900,000 and 6,325,000 shares of common stock from the public offerings of our common stock, respectively. Proceeds from equipment financing arrangements, net of payments, were $1,938,000 and $2,094,000 during the nine months ended September 30, 2007 and 2006, respectively.

We believe that our current cash, cash equivalents and marketable securities along with interest earned thereon, the funding available from Symphony Allegro, Inc., the funds available under our equipment

23

financing agreement, our tenant improvement allowance and the proceeds from option exercises and purchases of common stock pursuant to our Employee Stock Purchase Plan, will enable us to maintain our currently planned operations through the middle of 2009. Changing circumstances may cause us to consume capital significantly faster than we currently anticipate. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available financial resources sooner than we currently expect. The key assumptions underlying this estimate include:

• expenditures related to continued preclinical and clinical development of our lead product candidates during this period within budgeted levels;

• the timing and amount of payments from Symphony Allegro;

• no unexpected costs related to the development of our manufacturing capability; and

• the hiring of a number of new employees at salary levels consistent with our estimates to support our continued growth during this period.

Our forecast of the period of time that our financial resources will be adequate to support operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed in “Risk Factors.” In light of the numerous risks and uncertainties associated with the development and commercialization of our product candidates and the extent to which we enter into strategic partnerships with third parties to participate in their development and commercialization, we are unable to estimate the amounts of increased capital outlays and operating expenditures associated with our current and anticipated clinical trials. Our future funding requirements will depend on many factors, including:

• the scope, rate of progress, results and costs of our preclinical studies, clinical trials and other research and development activities;

• the terms and timing of any distribution, strategic partnerships or licensing agreements that we may establish;

• the cost, timing and outcomes of regulatory approvals;

• the number and characteristics of product candidates that we pursue;

• the cost and timing of establishing manufacturing, marketing and sales capabilities;

• the cost of establishing clinical and commercial supplies of our product candidates;

• the cost of preparing, filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and

• the extent to which we acquire or invest in businesses, products or technologies, although we currently have no commitments or agreements relating to any of these types of transactions.

We will need to raise additional funds to support our operations, and such funding may not be available to us on acceptable terms, or at all. If we are unable to raise additional funds when needed, we may not be able to continue development of our product candidates or we could be required to delay, scale back or eliminate some or all of our development programs and other operations. We may seek to raise additional funds through public or private financing, strategic partnerships or other arrangements. Any additional equity financing may be dilutive to stockholders and debt financing, if available, may involve restrictive covenants. If we raise funds through collaborative or licensing arrangements, we may be required to relinquish, on terms that are not favorable to us, rights to some of our technologies or product candidates that we would otherwise seek to develop or commercialize ourselves. Our failure to raise capital when needed may harm our business, financial condition and prospects.

Contractual Obligations

We lease two buildings with an aggregate of 65,143 square feet of office and laboratory facilities in Palo Alto, California. The lease on one facility expires on March 31, 2008 and the lease on the second facility expires on June 30, 2008.

In August 2006, we entered into an agreement to lease 65,604 square feet for office, laboratory and manufacturing facilities in Mountain View, California. The lease agreement included provisions to reimburse us for up to $8.3 million of tenant improvements made by us. In May 2007, we amended the

24

Mountain View lease agreement to lease an additional facility with a total of 41,290 square feet, which the Company will occupy in two stages, 21,956 square feet immediately, and the remaining 19,334 square feet on or about June 1, 2008. The lease amendment included provisions to reimburse us for up to $1.0 million of tenant improvements made by us. Lease payments on the additional Mountain View space will commence on January 1, 2008. In August 2007, we amended the lease to provide us with up to an additional $6.6 million of reimbursements for tenant improvements made by us. Under the terms of the amendment, minimum monthly payments will be increased for any reimbursements received by the Company. The increased lease payment periods will cover a period of 5 years for $2 million of the reimbursement, seven years for $2 million of the reimbursement and the remaining term of the lease agreement for $2.6 million of the reimbursement The agreement for the two buildings has an initial termination date of March 31, 2018 and includes two options to extend the lease, each for a period of five years.

We finance a portion of our equipment purchases through various equipment financing agreements. Under the agreements, equipment advances are to be repaid in 36 to 48 monthly installments of principal and interest. The interest rate, which is fixed for each draw, is based on the U.S. Treasuries of comparable maturities and ranges from 9.2% to 10.6%. The equipment purchased under the equipment financing agreement is pledged as security.

In October 2005, we entered into a development agreement with Autoliv ASP, Inc. for the development of heat packages that can be incorporated into our proprietary single dose drug delivery device. Under the terms of the development agreement, both we and Autoliv have agreed to contribute $2,500,000 each toward the development efforts. Our contribution will have totaled approximately $1,750,000 for the purchases of equipment and $750,000 for co-development efforts. All equipment purchased by us under this agreement is owned by us and included on our balance sheet. As of September 30, 2007, we have purchased all of the equipment required under the agreement.

The Company’s future contractual payments, including interest, are as follows (in thousands):

	Operating		Equipment
	Lease		Financing		Autoliv
	Agreements		Obligations		Agreement		Total
2007 - Remaining 3 Months	$	1,099	$	1,241	$	83	$	2,423
2008		3,940		4,964		83		8,987
2009		4,157		3,989		—		8,146
2010		4,414		1,583		—		5,997
2011		4,536		255		—		4,791
Thereafter		30,166		—		—		30,166
Total	$	48,312	$	12,032	$	166	$	60,510

Related Party Transactions

On March 7, 2006 (“the Settlement Date”), in settlement for the extinguishment of officer housing loans, we increased the exercise price on certain stock option awards held by three executive officers from $1.10 per share to $8.00 per share, which reduced the aggregate intrinsic value of these options by $3.4 million.

Also on the Settlement Date, the Company entered into amended loan extinguishment agreements with the above mentioned officers, whereby we were given the right to increase the exercise price of selected options to $8.00 per share, which resulted in an additional reduction in aggregate intrinsic value of these options of $0.6 million. This modification was accounted for under SFAS 123R, and resulted in no additional share-based compensation expense.

Critical Accounting Estimates and Judgments

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent

25

assets and liabilities at the date of the financial statements, as well as reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments related to development costs. 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 assumptions about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting estimates and judgments have not changed since our Annual Report on Form 10-K/A which was filed with the Securities and Exchange Commission on April 10, 2007.

Stock-Based Compensation

On January 1, 2006, we adopted the fair value recognition provisions of SFAS 123R. We adopted SFAS 123R using the prospective transition method. Under this transition method, beginning January 1, 2006, compensation cost recognized includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of December 31, 2005, based on the intrinsic value in accordance with the provisions of Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees(“APB 25”) , and (b) compensation cost for all share-based payments granted or modified subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of Statement 123R.

We currently use the Black-Scholes option pricing model to determine the fair value of stock options and employee stock purchase plan shares. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rates and expected dividends.

We estimate the expected term of options using the “simplified” method, as illustrated in SAB 107. As we have been operating as a public company for a period of time that is shorter than our estimated expected option term, we are unable to use actual price volatility data. Therefore, we estimate the volatility of our common stock based on volatility of similar entities. We base the risk-free interest rate that we use in the option pricing model on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option pricing model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. All share based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.

If factors change and we employ different assumptions for estimating stock-based compensation expense in future periods or if we decide to use a different valuation model, the future periods may differ significantly from what we have recorded in the current period and could materially affect our operating loss, net loss and net loss per share.

See Note 2 to the Condensed Consolidated Financial Statements for further information regarding the SFAS 123R disclosures.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk is confined to our cash, cash equivalents, and marketable securities. The primary objective of our investment activities is to preserve our capital to fund operations. We also seek to maximize income from our investments without assuming significant risk. To achieve our objectives, we maintain a portfolio of cash equivalents and marketable securities in a variety of securities of high credit quality. As of September 30, 2007, we had cash, cash equivalents and marketable securities of $80.4 million and investments held by Symphony Allegro of $42.2 million. The securities in our investment portfolio are not leveraged, are classified as available for sale and are, due to their very short-term nature, subject to minimal interest rate risk. We currently do not hedge interest rate exposure. Because of the short-term maturities of our investments, we do not believe that an increase in market rates would have a material negative impact on the realized value of our investment portfolio. We actively monitor changes in interest rates.

26

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

Based on our management’s evaluation (with the participation of our chief executive officer and chief financial officer), our chief executive officer and chief financial officer have concluded that, subject to limitations described below, our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended), were effective as of September 30, 2007 to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. 

Changes in Internal Controls over Financial Reporting

None

Limitations on the Effectiveness of Controls.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met and, as set forth above, our chief executive officer and chief financial officer have concluded, based on their evaluation as of the end of the period covered by this report, that our disclosure controls and procedures were sufficiently effective to provide reasonable assurance that the objectives of our disclosure control system were met.

27

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors.

The following risks and uncertainties may have a material adverse effect on our business, financial condition and prospects. You should carefully consider the risks described below, together with all of the other information included in this report, in considering our business prospects. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. The occurrence of any of the following risks could harm our business, financial condition and prospects. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment.

Risks Relating to Our Business

We have a history of net losses. We expect to continue to incur substantial and increasing net losses for the foreseeable future, and we may never achieve or maintain profitability.

We are not profitable and have incurred significant net losses in each year since our inception, including net losses of $31.9 million for the nine months ended September 30, 2007 and $41.8 million, $32.4 million and $16.6 million for the years ended December 31, 2006, 2005 and 2004, respectively. As of September 30, 2007, we had a deficit accumulated during development stage of $150.9 million. We expect our expenses to increase as we continue our existing and planned preclinical studies and clinical trials, expand research and development efforts, expand our manufacturing development efforts, relocate our main operations, complete construction on a current good manufacturing practice compliant pilot facility, and continue to add the necessary infrastructure to support our operations as a public company. As a result, we expect to incur substantial and increasing net losses and negative cash flow for the foreseeable future. These losses and negative cash flows have had, and will continue to have, an adverse effect on our stockholders’ equity and working capital.

Because of the numerous risks and uncertainties associated with pharmaceutical product development, we are unable to accurately predict the timing or amount of increased expenses or when, or if, we will be able to achieve or maintain profitability. Currently, we have no products approved for commercial sale, and to date we have not generated any product revenue. We have financed our operations primarily through the sale of equity securities, equipment financing and government grants. The size of our future net losses will depend, in part, on the rate of growth of our expenses and the rate of growth, if any, of our revenues. Revenues from potential strategic partnerships are uncertain because we may not enter into any strategic partnerships, and we do not expect any government grant revenue in 2007. If we are unable to develop and commercialize one or more of our product candidates or if sales revenue from any product candidate that receives marketing approval is insufficient, we will not achieve profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability.

We are a development stage company. Our success depends substantially on our lead product candidates. If we do not develop commercially successful products, we may be forced to cease operations.

You must evaluate us in light of the uncertainties and complexities affecting a development stage pharmaceutical company. We have not yet commenced Phase 3 clinical trials for any of our product candidates. Each of our product candidates is at an early stage of development and will be unsuccessful if it:

• does not demonstrate acceptable safety and efficacy in preclinical studies and clinical trials or otherwise does not meet applicable regulatory standards for approval;

• does not offer therapeutic or other improvements over existing or future drugs used to treat the same or similar conditions;

• is not capable of being produced in commercial quantities at an acceptable cost, or at all; or

28

• is not accepted by patients, the medical community or third party payors.

Our ability to generate product revenue in the future is dependent on the successful development and commercialization of our product candidates. We have not proven our ability to develop and commercialize products. Problems frequently encountered in connection with the development and utilization of new and unproven technologies and the competitive environment in which we operate might limit our ability to develop commercially successful products. We do not expect any of our current product candidates to be commercially available before 2011, if at all. If we are unable to make our product candidates commercially available, we will not generate product revenues, and we will not be successful.

We will need substantial additional capital in the future. If additional capital is not available, we will have to delay, reduce or cease operations.

We will need to raise additional capital to fund our operations, to develop our product candidates and to develop our manufacturing capabilities. Our future capital requirements will be substantial and will depend on many factors including:

• the scope, rate of progress, results and costs of our preclinical studies, clinical trials and other research and development activities, and our manufacturing development and commercial manufacturing activities;

• the amount and timing of payments from Symphony Allegro related to the development ofStaccatoalprazolam andStaccatoloxapine;

• the amount and timing of any payments to Symphony Allegro related to the repurchase of rights toStaccatoalprazolam andStaccatoloxapine;

• the cost, timing and outcomes of regulatory proceedings;

• the cost and timing of developing sales and marketing capabilities;

• the cost and timing of developing manufacturing capacity;

• revenues received from any future products;

• payments received under any strategic partnerships;

• the filing, prosecution and enforcement of patent claims;

• the costs associated with building out and moving to our new facilities in 2007 and 2008; and

• the costs associated with commercializing our product candidates, if they receive regulatory approval.

We anticipate that existing cash, cash equivalents and marketable securities, along with interest earned thereon, funding available under our equipment financing arrangements, our tenant improvement allowance, expected payments from Symphony Allegro, expected proceeds from stock option exercises and purchases under our Employee Stock Purchase Plan, will enable us to maintain our currently planned operations through the middle of 2009. Changing circumstances may cause us to consume capital significantly faster than we currently anticipate. We may be unable to raise sufficient additional capital on terms favorable to us, or at all. If we fail to raise sufficient funds, we will have to delay development programs or reduce or cease operations, or we may be required to enter into a strategic partnership at an earlier stage of development than currently anticipated. Our estimates of future capital use are uncertain, and changes in our development plans, payments received from Symphony Allegro, partnering activities, regulatory requirements and other developments may increase our rate of spending and decrease the amount of time our available resources will fund our operations.

We may never be able to generate a sufficient amount of product revenue to cover our expenses. Until we do, we expect to finance our future cash needs through public or private equity offerings, debt financings, strategic partnerships or licensing arrangements, as well as interest income earned on cash and marketable securities balances and proceeds from stock option exercises and purchases under our Employee Stock Purchase Plan. Any financing transaction may contain unfavorable terms. If we raise additional funds by issuing equity securities, our stockholders’ equity will be diluted. If we raise additional funds through strategic partnerships, we may be required to relinquish rights to our product candidates or technologies, or to grant licenses on terms that are not favorable to us.

29

Unless our preclinical studies demonstrate the safety of our product candidates, we will not be able to commercialize our product candidates.

To obtain regulatory approval to market and sell any of our product candidates, we must satisfy the FDA and other regulatory authorities abroad, through extensive preclinical studies, that our product candidates are safe. OurStaccatotechnology creates condensation aerosols from drug compounds, and there currently are no approved products that use a similar method of drug delivery. Companies developing other inhalation products have not defined or successfully completed the types of preclinical studies we believe will be required for submission to regulatory authorities as we seek approval to conduct our clinical trials. We may not conduct the types of preclinical testing eventually required by regulatory authorities, or the preclinical tests may indicate that our product candidates are not safe for use in humans. Preclinical testing is expensive, can take many years and have an uncertain outcome. In addition, success in initial preclinical testing does not ensure that later preclinical testing will be successful. We may experience numerous unforeseen events during, or as a result of, the preclinical testing process, which could delay or prevent our ability to develop or commercialize our product candidates, including:

• our preclinical testing may produce inconclusive or negative safety results, which may require us to conduct additional preclinical testing or to abandon product candidates that we believed to be promising;

• our product candidates may have unfavorable pharmacology, toxicology or carcinogenicity; and

• our product candidates may cause undesirable side effects.

Any such events would increase our costs and could delay or prevent our ability to commercialize our product candidates, which could adversely impact our business, financial condition and prospects.

Preclinical studies indicated possible adverse impact of pulmonary delivery of AZ-001.

In our daily dosing animal toxicology studies of prochlorperazine, the active pharmaceutical ingredient, or API, in AZ-001, we detected changes to, and increases of, the cells in the upper airway of the test animals. The terms for these changes and increases are “squamous metaplasia” and “hyperplasia,” respectively. We also observed lung inflammation in some animals. These findings occurred in daily dosing studies at doses that were proportionately substantially greater than any dose we expect to continue to develop or commercialize. In subsequent toxicology studies of AZ-001 involving intermittent dosing consistent with its intended use, we detected lower incidence and severity of the changes to, and increases of, the cells in the upper airway of the test animals compared to the daily dosing results. We did not observe any lung inflammation with intermittent dosing. These findings suggest that the delivery of the pure drug compound of AZ-001 at the proportionately higher doses used in daily dosing toxicology studies may cause adverse consequences if we were to administer prochlorperazine chronically for prolonged periods of time. If we observe these findings in our clinical trials of AZ-001, it could prevent further development or commercialization of AZ-001.

Failure or delay in commencing or completing clinical trials for our product candidates could harm our business.

To date, we have not completed all the clinical trials necessary to support an application with the FDA for approval to market any of our product candidates. Current and planned clinical trials may be delayed or terminated as a result of many factors, including:

• delays or failure in reaching agreement on acceptable clinical trial contracts or clinical trial protocols with prospective sites;

• regulators or institutional review boards may not authorize us to commence a clinical trial;

• regulators or institutional review boards may suspend or terminate clinical research for various reasons, including noncompliance with regulatory requirements or concerns about patient safety;

• we may suspend or terminate our clinical trials if we believe that they expose the participating patients to unacceptable health risks;

• we may experience slower than expected patient enrollment or lack of a sufficient number of patients that meet the enrollment criteria for our clinical trials;

30

• patients may not complete clinical trials due to safety issues, side effects, dissatisfaction with the product candidate, or other reasons;

• we may have difficulty in maintaining contact with patients after treatment, preventing us from collecting the data required by our study protocol;

• product candidates may demonstrate a lack of efficacy during clinical trials;

• we may experience governmental or regulatory delays, failure to obtain regulatory approval or changes in regulatory requirements, policy and guidelines; and

• we may experience delays in our ability to manufacture clinical trial materials in a timely manner as a result of ongoing process and design enhancements to ourStaccatosystem and the planned move to a new facility in 2007 and 2008.

Any delay in commencing or completing clinical trials for our product candidates would delay commercialization of our product candidates and harm our business, financial condition and prospects. It is possible that none of our product candidates will successfully complete clinical trials or receive regulatory approval, which would severely harm our business, financial condition and prospects.

If our product candidates do not meet safety and efficacy endpoints in clinical trials, they will not receive regulatory approval, and we will be unable to market them.

Our product candidates are in preclinical and clinical development and have not received regulatory approval from the FDA or any foreign regulatory authority. The clinical development and regulatory approval process is extremely expensive and takes many years. The timing of any approval cannot be accurately predicted. If we fail to obtain regulatory approval for our current or future product candidates, we will be unable to market and sell them and therefore may never be profitable.

As part of the regulatory process, we must conduct clinical trials for each product candidate to demonstrate safety and efficacy to the satisfaction of the FDA and other regulatory authorities abroad. The number and design of clinical trials that will be required varies depending on the product candidate, the condition being evaluated, the trial results and regulations applicable to any particular product candidate.

Prior clinical trial program designs and results are not necessarily predictive of future clinical trial designs or results. Initial results may not be confirmed upon full analysis of the detailed results of a trial. Product candidates in later stage clinical trials may fail to show the desired safety and efficacy despite having progressed through initial clinical trials with acceptable endpoints. Prior clinical trial program designs and results are not necessarily predictive of future clinical trial designs or results.

If our product candidates fail to show a clinically significant benefit compared to placebo, they will not be approved for marketing.

Device failure rates higher than we anticipate may result in clinical trials that do not meet their specific efficacy endpoints. We experienced a 3% device failure rate in our Phase 2a clinical trial of AZ-001, which caused some of the results to be not statistically significant. We experienced a device failure rate in our Phase 2b clinical trial of AZ-001 of less than 1%. Device failures or improper device use by patients may impact the results of future trials. The design of our clinical trials is based on many assumptions about the expected effect of our product candidates, and if those assumptions prove incorrect, the clinical trials may not produce statistically significant results. In addition, because we are developing AZ-002 for a novel indication, and may develop future product candidates for other novel indications, and because ourStaccatotechnology is not similar to other approved drug delivery methods, there is no clear precedent for the application of detailed regulatory requirements to our product candidates. We cannot assure you that the design of, or data collected from, the clinical trials of our product candidates will be sufficient to support the FDA and foreign regulatory approvals.

Regulatory authorities may not approve our product candidates even if they meet safety and efficacy endpoints in clinical trials.

The FDA and other foreign regulatory agencies can delay, limit or deny marketing approval for many reasons, including:

• a product candidate may not be considered safe or effective;

31

• the manufacturing processes or facilities we have selected may not meet the applicable requirements; and

• changes in their approval policies or adoption of new regulations may require additional work on our part.

Any delay in, or failure to receive or maintain, approval for any of our product candidates could prevent us from ever generating meaningful revenues or achieving profitability.

Our product candidates may not be approved even if they achieve their endpoints in clinical trials. Regulatory agencies, including the FDA, or their advisors may disagree with our trial design and our interpretations of data from preclinical studies and clinical trials. Regulatory agencies may change requirements for approval even after a clinical trial design has been approved. Regulatory agencies also may approve a product candidate for fewer or more limited indications than requested or may grant approval subject to the performance of post-marketing studies. In addition, regulatory agencies may not approve the labeling claims that are necessary or desirable for the successful commercialization of our product candidates.

Our product candidates will remain subject to ongoing regulatory review even if they receive marketing approval. If we fail to comply with continuing regulations, we could lose these approvals, and the sale of any future products could be suspended.

Even if we receive regulatory approval to market a particular product candidate, the FDA or a foreign regulatory authority could condition approval on conducting additional costly post-approval studies or could limit the scope of our approved labeling. Moreover, the product may later cause adverse effects that limit or prevent its widespread use, force us to withdraw it from the market or impede or delay our ability to obtain regulatory approvals in additional countries. In addition, we will continue to be subject to FDA review and periodic inspections to ensure adherence to applicable regulations. After receiving marketing approval, the FDA imposes extensive regulatory requirements on the manufacturing, labeling, packaging, adverse event reporting, storage, advertising, promotion and record keeping related to the product.

If we fail to comply with the regulatory requirements of the FDA and other applicable U.S. and foreign regulatory authorities or previously unknown problems with any future products, suppliers or manufacturing processes are discovered, we could be subject to administrative or judicially imposed sanctions, including:

• restrictions on the products, suppliers or manufacturing processes;

• warning letters or untitled letters;

• civil or criminal penalties or fines;

• injunctions;

• product seizures, detentions or import bans;

• voluntary or mandatory product recalls and publicity requirements;

• suspension or withdrawal of regulatory approvals;

• total or partial suspension of production; and

• refusal to approve pending applications for marketing approval of new drugs or supplements to approved applications.

If we do not produce our devices cost effectively, we will never be profitable.

OurStaccatosystem based product candidates contain electronic and other components in addition to the active pharmaceutical ingredients. As a result of the cost of developing and producing these components, the cost to produce our product candidates, and any approved products, will likely be higher per dose than the cost to produce intravenous or oral tablet products. This increased cost of goods may prevent us from ever selling any products at a profit. In addition, we are developing single dose and multiple dose versions of ourStaccatosystem. Developing multiple versions of ourStaccatosystem may reduce or eliminate our ability to achieve manufacturing economies of scale. In addition, developing multiple versions of ourStaccatosystem reduces our ability to focus development resources on each version, potentially reducing

32

our ability to effectively develop any particular version. We expect to continue to modify each of our product candidates throughout their clinical development to improve their performance, dependability, manufacturability and quality. Some of these modifications may require additional regulatory review and approval, which may delay or prevent us from conducting clinical trials. The development and production of our technology entail a number of technical challenges, including achieving adequate dependability, that may be expensive or time consuming to solve. Any delay in or failure to develop and manufacture any future products in a cost effective way could prevent us from generating any meaningful revenues and prevent us from becoming profitable.

We rely on third parties to conduct our preclinical studies and our clinical trials. If these third parties do not perform as contractually required or expected, we may not be able to obtain regulatory approval for our product candidates, or we may be delayed in doing so.

We do not have the ability to conduct preclinical studies or clinical trials independently for our product candidates. We must rely on third parties, such as contract research organizations, medical institutions, academic institutions, clinical investigators and contract laboratories, to conduct our preclinical studies and clinical trials. We are responsible for confirming that our preclinical studies are conducted in accordance with applicable regulations and that each of our clinical trials is conducted in accordance with its general investigational plan and protocol. The FDA requires us to comply with regulations and standards, commonly referred to as good laboratory practices, or GLP, for conducting and recording the results of our preclinical studies and good clinical practices for conducting, monitoring, recording and reporting the results of clinical trials, to assure that data and reported results are accurate and that the clinical trial participants are adequately protected. Our reliance on third parties does not relieve us of these responsibilities. If the third parties conducting our clinical trials do not perform their contractual duties or obligations, do not meet expected deadlines, fail to comply with the FDA’s good clinical practice regulations, do not adhere to our clinical trial protocols or otherwise fail to generate reliable clinical data, we may need to enter into new arrangements with alternative third parties and our clinical trials may be extended, delayed or terminated or may need to be repeated, and we may not be able to obtain regulatory approval for or commercialize the product candidate being tested in such trials.

Problems with the third parties that manufacture the active pharmaceutical ingredients in our product candidates may delay our clinical trials or subject us to liability.

We do not currently own or operate manufacturing facilities for clinical or commercial production of the API used in any of our product candidates. We have no experience in drug manufacturing, and we lack the resources and the capability to manufacture any of the APIs used in our product candidates, on either a clinical or commercial scale. As a result, we rely on third parties to supply the API used in each of our product candidates. We expect to continue to depend on third parties to supply the API for our lead product candidates and any additional product candidates we develop in the foreseeable future.

An API manufacturer must meet high precision and quality standards for that API to meet regulatory specifications and comply with regulatory requirements. A contract manufacturer is subject to ongoing periodic unannounced inspection by the FDA and corresponding state and foreign authorities to ensure strict compliance with current good manufacturing practice, or cGMP, and other applicable government regulations and corresponding foreign standards. Additionally, a contract manufacturer must pass a pre-approval inspection by the FDA to ensure strict compliance with cGMP prior to the FDA’s approval of any product candidate for marketing. A contract manufacturer’s failure to conform with cGMP could result in the FDA’s refusal to approve or a delay in the FDA’s approval of a product candidate for marketing. We are ultimately responsible for confirming that the APIs used in our product candidates are manufactured in accordance with applicable regulations.

Our third party suppliers may not carry out their contractual obligations or meet our deadlines. In addition, the API they supply to us may not meet our specifications and quality policies and procedures. If we need to find alternative suppliers of the API used in any of our product candidates, we may not be able to contract for such supplies on acceptable terms, if at all. Any such failure to supply or delay caused by such contract manufacturers would have an adverse affect on our ability to continue clinical development of our product candidates or commercialize any future products.

33

If our third party drug suppliers fail to achieve and maintain high manufacturing standards in compliance with cGMP regulations, we could be subject to certain product liability claims in the event such failure to comply resulted in defective products that caused injury or harm.

If we experience problems with the manufacturers of components of our product candidates, our development programs may be delayed or we may be subject to liability.

We outsource the manufacturing of some of the components of ourStaccatosystem, including the printed circuit boards and the plastic airways. We have no experience in the manufacturing of these components, and we currently lack the resources and the capability to manufacture them, on either a clinical or commercial scale. As a result, we rely on third parties to supply these components. We expect to continue to depend on third parties to supply these components for our current product candidates and any devices based on theStaccatosystem we develop in the foreseeable future. In the future, we may outsource the manufacture of additional components, including the heat packages in our single dose design.

The third party suppliers of the components of ourStaccatosystem must meet high precision and quality standards for those components to comply with regulatory requirements. A contract manufacturer is subject to ongoing periodic unannounced inspection by the FDA and corresponding state and foreign authorities to ensure strict compliance with the FDA’s Quality System Regulation, or QSR, which sets forth the FDA’s current good manufacturing practice requirements for medical devices and their components, and other applicable government regulations and corresponding foreign standards. We are ultimately responsible for confirming that the components used in theStaccato system are manufactured in accordance with the QSR or other applicable regulations.

Our third party suppliers may not comply with their contractual obligations or meet our deadlines, or the components they supply to us may not meet our specifications and quality policies and procedures. If we need to find alternative suppliers of the components used in theStaccatosystem, we may not be able to contract for such components on acceptable terms, if at all. Any such failure to supply or delay caused by such contract manufacturers would have an adverse affect on our ability to continue clinical development of our product candidates or commercialize any future products.

In addition, the heat packages used in the single dose version of ourStaccatosystem are manufactured using certain energetic, or highly combustible, materials that are used to generate the rapid heating necessary for vaporizing the drug compound while avoiding degradation. Manufacture of products containing these types of materials is regulated by the U.S. government. We currently manufacture the heat packages that are being used in the devices used in our clinical trials. We have entered into a joint development agreement with Autoliv ASP, Inc. for the manufacture of the heat packages in the commercial design of our single dose version of ourStaccatosystem. If we are unable to manufacture the heat packages used in our ongoing clinical trials or if in the future Autoliv is unable to manufacture the heat packages to our specifications, or does not carry out its contractual obligations to develop our heat packages or to supply them to us, our clinical trials may be delayed, suspended or terminated while we seek additional suitable manufacturers of our heat packages, which may prevent us from commercializing our product candidates that utilize the single dose version of theStaccatosystem.

If we do not establish additional strategic partnerships, we will have to undertake development and commercialization efforts on our own, which would be costly and delay our ability to commercialize any future products.

A key element of our business strategy is our intent to selectively partner with pharmaceutical, biotechnology and other companies to obtain assistance for the development and potential commercialization of our product candidates. In December 2006, we entered into such a development relationship with Symphony Allegro. We intend to enter into additional strategic partnerships with third parties to develop and commercialize our product candidates that are intended for larger markets, and we may enter into strategic partnerships for product candidates that are targeted toward specialty markets. We believe the effective commercialization of AZ-001 and AZ-003 will require a large, sophisticated sales and marketing organization. We have completed a Phase 1 clinical trial of AZ-003, and we plan no additional development of AZ-003 unless and until we secure a partner to support continued drug and device development. To date, other than Symphony Allegro, we have not entered into any strategic partnerships for any of our product candidates. We face significant competition in seeking appropriate strategic partners, and these strategic partnerships can be intricate and time consuming to negotiate and document. We may

34

not be able to negotiate strategic partnerships on acceptable terms, or at all. We are unable to predict when, if ever, we will enter into any additional strategic partnerships because of the numerous risks and uncertainties associated with establishing strategic partnerships. If we are unable to negotiate additional strategic partnerships for our product candidates we may be forced to curtail the development of a particular candidate, reduce or delay its development program or one or more of our other development programs, delay its potential commercialization, reduce the scope of our sales or marketing activities or undertake development or commercialization activities at our own expense. In addition, we will bear all the risk related to the development of that product candidate. If we elect to increase our expenditures to fund development or commercialization activities on our own, we may need to obtain additional capital, which may not be available to us on acceptable terms, or at all. If we do not have sufficient funds, we will not be able to bring our product candidates to market and generate product revenue.

If we enter into additional strategic partnerships, we may be required to relinquish important rights to and control over the development of our product candidates or otherwise be subject to terms unfavorable to us.

Due to our relationship with Symphony Allegro, and for any additional strategic partnerships with pharmaceutical or biotechnology companies, we are subject to a number of risks, including:

• we may not be able to control the amount and timing of resources that our strategic partners devote to the development or commercialization of product candidates;

• strategic partners may delay clinical trials, provide insufficient funding, terminate a clinical trial or abandon a product candidate, repeat or conduct new clinical trials or require a new version of a product candidate for clinical testing;

• strategic partners may not pursue further development and commercialization of products resulting from the strategic partnering arrangement or may elect to discontinue research and development programs;

• strategic partners may not commit adequate resources to the marketing and distribution of any future products, limiting our potential revenues from these products;

• disputes may arise between us and our strategic partners that result in the delay or termination of the research, development or commercialization of our product candidates or that result in costly litigation or arbitration that diverts management’s attention and consumes resources;

• strategic partners may experience financial difficulties;

• strategic partners may not properly maintain or defend our intellectual property rights or may use our proprietary information in a manner that could jeopardize or invalidate our proprietary information or expose us to potential litigation;

• business combinations or significant changes in a strategic partner’s business strategy may also adversely affect a strategic partner’s willingness or ability to complete its obligations under any arrangement;

• strategic partners could independently move forward with a competing product candidate developed either independently or in collaboration with others, including our competitors; and

• strategic partners could terminate the arrangement or allow it to expire, which would delay the development and may increase the cost of developing our product candidates.

We have exclusively licensed certain intellectual property rights to Staccato alprazolam and Staccato loxapine in connection with our Symphony Allegro arrangement and will not receive material future royalties or revenues with respect to this intellectual property unless we exercise an option to repurchase the rights to the programs in the future through the acquisition of Symphony Allegro. We may not obtain sufficient clinical data in order to determine whether we should exercise this option prior to the expiration of the development period, and even if we decide to exercise the option, we may not have the financial resources to exercise it in a timely manner.

In December 2006, we entered into a transaction providing for the financing of additional clinical and nonclinical development ofStaccatoalprazolam, our AZ-002 program andStaccatoloxapine, our AZ-004 and AZ-104 programs. Pursuant to the agreements, Symphony Capital LLC and its investors have invested

35

$50 million to form Symphony Allegro, to fund additional clinical and nonclinical development ofStaccatoalprazolam andStaccatoloxapine. We have exclusively licensed to Symphony Allegro certain intellectual property rights related toStaccatoalprazolam andStaccatoloxapine. We have retained manufacturing rights to these two product candidates. As part of the arrangement, we received an option granting us the exclusive right, but not the obligation, to acquire the licensed programs at specified points in time at specified prices during the term of the development period through the acquisition of Symphony Allegro. The development programs under the arrangement are jointly managed by Symphony Allegro and us, and there can be no assurance that we will agree on various decisions that will enable us to successfully develop the potential products, or even if we are in agreement on the development plans, that the development efforts will result in sufficient clinical data to make a fully informed decision with respect to the exercise of our option. If we do not exercise our purchase option by December 1, 2010, then Symphony Allegro will retain its exclusive license to develop and commercializeStaccatoalprazolam andStaccatoloxapine for all indications, and we will manufacture and sellStaccatoalprazolam andStaccatoloxapine to Symphony Allegro or its sublicensee for those purposes.

If we elect to exercise the purchase option, we will be required to make a substantial payment, which at our election may be paid partially in shares of our common stock. As a result, in order to exercise the option, we will be required to make a substantial payment of cash and possibly issue a substantial number of shares of our common stock. We do not currently have the resources to exercise the option, and we may be required to enter into a financing arrangement or license arrangement with one or more third parties, or some combination of these, in order to exercise the option, even if we paid a portion of the purchase price with our common stock. There can be no assurance that any financing or licensing arrangement will be available or even if available, that the terms would be favorable to us and our stockholders. In addition, the exercise of the purchase option may require us to record a significant charge to earnings and may adversely impact future operating results.

If we fail to gain market acceptance among physicians, patients, third-party payors and the medical community, we will not become profitable.

TheStaccatosystem is a fundamentally new method of drug delivery. Any future product based on ourStaccatosystem may not gain market acceptance among physicians, patients, third-party payors and the medical community. If these products do not achieve an adequate level of acceptance, we will not generate sufficient product revenues to become profitable. The degree of market acceptance of any of our product candidates, if approved for commercial sale, will depend on a number of factors, including:

• demonstration of efficacy and safety in clinical trials;

• the existence, prevalence and severity of any side effects;

• potential or perceived advantages or disadvantages compared to alternative treatments;

• perceptions about the relationship or similarity between our product candidates and the parent drug compound upon which each product candidate is based;

• the timing of market entry relative to competitive treatments;

• the ability to offer any future products for sale at competitive prices;

• relative convenience, product dependability and ease of administration;

• the strength of marketing and distribution support;

• the sufficiency of coverage and reimbursement of our product candidates by governmental and other third-party payors; and

• the product labeling or product insert required by the FDA or regulatory authorities in other countries.

Our pipeline may be limited by the number of drug compounds suitable for use with the Staccato system.

The current versions of theStaccatosystem cannot deliver large molecule drugs, such as peptides and proteins. In addition, the physical size of the metal substrates in the single dose and multiple dose versions of theStaccatosystem limits their use to drugs that require dose amounts less than 10 to 15 milligrams and 100 to 200 micrograms, respectively. Further, approximately 200 of the 400 small molecule compounds we have screened for initial vaporization feasibility did not form drug aerosols with the 97% purity we use as

36

an internal standard for further development. There are also many drug compounds that are covered by composition of matter patents that prevent us from developing the compound in theStaccato system without a license from the patent owner, which may not be available on acceptable terms, if at all. If we are not able to identify additional drug compounds that can be developed with theStaccatosystem, we will not be able to implement our strategy of filing one IND in 2007 and one to two INDs per year thereafter, and we may not develop enough products to develop a sustainable business.

AZ-001 and other product candidates that we may develop may require expensive carcinogenicity tests.

The API in AZ-001, prochlorperazine, was approved by the FDA in 1956 for the treatment of severe nausea and vomiting. At that time, the FDA did not require the carcinogenicity testing that is now generally required for marketing approval. It is unclear whether we will be required to perform such testing prior to filing our application for marketing approval of AZ-001 or whether we will be allowed to perform such testing after we file an application. Such carcinogenicity testing will be expensive and require significant additional resources to complete and may delay approval to market AZ-001. We may encounter similar requirements with other product candidates incorporating drugs that have not undergone carcinogenicity testing. Any carcinogenicity testing we are required to complete will increase the costs to develop a particular product candidate and may delay or halt the development of such product candidate.

If some or all of our patents expire, are invalidated or are unenforceable, or if some or all of our patent applications do not yield issued patents or yield patents with narrow claims, competitors may develop competing products using our or similar intellectual property and our business will suffer.

Our success will depend in part on our ability to obtain and maintain patent and trade secret protection for our technologies and product candidates both in the United States and other countries. We do not know whether any patents will issue from any of our pending or future patent applications. In addition, a third party may successfully circumvent our patents. Our rights under any issued patents may not provide us with sufficient protection against competitive products or otherwise cover commercially valuable products or processes.

The degree of protection for our proprietary technologies and product candidates is uncertain because legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep our competitive advantage. For example:

• we might not have been the first to make the inventions covered by each of our pending patent applications and issued patents;

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

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

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

• the claims of our issued patents may be narrower than as filed and not sufficiently broad to prevent third parties from circumventing them;

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

• our patent applications or patents may be subject to interference, opposition or similar administrative proceedings;

• any patents issued to us or our potential strategic partners may not provide a basis for commercially viable products or may be challenged by third parties in the course of litigation or administrative proceedings such as reexaminations or interferences; and

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

Even if valid and enforceable patents cover our product candidates and technologies, the patents will provide protection only for a limited amount of time.

Our and our potential strategic partners’ ability to obtain patents is uncertain because, to date, some legal principles remain unresolved, there has not been a consistent policy regarding the breadth or interpretation of claims allowed in patents in the United States, and the specific content of patents and patent applications that are necessary to support and interpret patent claims is highly uncertain due to the complex nature of the

37

relevant legal, scientific and factual issues. Furthermore, the policies governing pharmaceutical and medical device patents outside the United States may be even more uncertain. Changes in either patent laws or interpretations of patent laws in the United States and other countries may diminish the value of our intellectual property or narrow the scope of our patent protection.

Even if patents are issued regarding our product candidates or methods of using them, those patents can be challenged by our competitors who can argue that our patents are invalid and/or unenforceable. Third parties may challenge our rights to, or the scope or validity of, our patents. Patents also may not protect our product candidates if competitors devise ways of making these or similar product candidates without legally infringing our patents. The Federal Food, Drug and Cosmetic Act and the FDA regulations and policies provide incentives to manufacturers to challenge patent validity or create modified, non-infringing versions of a drug or device in order to facilitate the approval of generic substitutes. These same types of incentives encourage manufacturers to submit new drug applications that rely on literature and clinical data not prepared for or by the drug sponsor.

We also rely on trade secrets to protect our technology, especially where we do not believe that patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. The employees, consultants, contractors, outside scientific collaborators and other advisors of our company and our strategic partners, if any, may unintentionally or willfully disclose our confidential information to competitors. Enforcing a claim that a third party illegally obtained and is using our trade secrets is expensive and time consuming and the outcome is unpredictable. Failure to protect or maintain trade secret protection could adversely affect our competitive business position.

Our research and development collaborators may have rights to publish data and other information in which we have rights. In addition, we sometimes engage individuals or entities to conduct research that may be relevant to our business. The ability of these individuals or entities to publish or otherwise publicly disclose data and other information generated during the course of their research is subject to certain contractual limitations. These contractual provisions may be insufficient or inadequate to protect our trade secrets and may impair our patent rights. If we do not apply for patent protection prior to such publication or if we cannot otherwise maintain the confidentiality of our technology and other confidential information, then our ability to receive patent protection or protect our proprietary information may be jeopardized.

Litigation or other proceedings or third party claims of intellectual property infringement could require us to spend time and money and could shut down some of our operations.

Our commercial success depends in part on not infringing patents and proprietary rights of third parties. Others have filed, and in the future are likely to file, patent applications covering products that are similar to our product candidates, as well as methods of making or using similar or identical products. If these patent applications result in issued patents and we wish to use the claimed technology, we would need to obtain a license from the third party. We may not be able to obtain these licenses at a reasonable cost, if at all.

In particular, we are aware of at least one pending U.S. patent application and foreign counterparts filed by a biopharmaceutical company relating to the use of drugs, including alprazolam which is the API in AZ-002, for treating disorders of the central nervous system by pulmonary delivery. In addition, we are aware of another pending U.S. patent application and foreign counterparts, filed by another biopharmaceutical company, that claims a method of making a vapor medicament under specific manufacturing conditions. We do not currently have a license to these patent applications. If these patent applications were to result in issued patents as originally filed, the relevant patent holders at that time may assert that we require licenses.

If these patent applications issue as originally filed, we believe we have valid defenses against any assertions that our product candidates are infringing. We do not know whether a court would determine that our defenses are valid. If we decide to pursue a license to one or more of these patent applications, or patents issued therefrom, we do not know that we will be able to obtain such a license on commercially reasonable terms, or at all.

In addition, administrative proceedings, such as interferences and reexaminations before the U.S. Patent and Trademark Office, could limit the scope of our patent rights. We may incur substantial costs and diversion of management and technical personnel as a result of our involvement in such proceedings. In particular, our patents and patent applications may be subject to interferences in which the priority of

38

invention may be awarded to a third party. We do not know whether our patents and patent applications will be entitled to priority over patents or patent applications held by such a third party. Our issued patents may also be subject to reexamination proceedings. We do not know whether our patents would survive reexamination in light of new questions of patentability that may be raised following their issuance.

Third parties may assert that we are employing their proprietary technology or their proprietary products without authorization. In addition, third parties may already have or may obtain patents in the future and claim that use of our technologies or our products infringes these patents. We could incur substantial costs and diversion of management and technical personnel in defending our self against any of these claims. Furthermore, parties making claims against us may be able to obtain injunctive or other equitable relief, which could effectively block our ability to further develop, commercialize and sell any future products and could result in the award of substantial damages against us. In the event of a successful claim of infringement against us, we may be required to pay damages and obtain one or more licenses from third parties. We may not be able to obtain these licenses at a reasonable cost, if at all. In that event, we could encounter delays in product introductions while we attempt to develop alternative methods or products. In the event we cannot develop alternative methods or products, we may be effectively blocked from developing, commercializing or selling any future products. Defense of any lawsuit or failure to obtain any of these licenses would be expensive and could prevent us from commercializing any future products.

We review from time to time publicly available information concerning the technological development efforts of other companies in our industry. If we determine that these efforts violate our intellectual property or other rights, we intend to take appropriate action, which could include litigation. Any action we take could result in substantial costs and diversion of management and technical personnel in enforcing our patents or other intellectual property rights against others. Furthermore, the outcome of any action we take to protect our rights may not be resolved in our favor.

Competition in the pharmaceutical industry is intense. If our competitors are able to develop and market products that are more effective, safer or less costly than any future products that we may develop, our commercial opportunity will be reduced or eliminated.

We face competition from established as well as emerging pharmaceutical and biotechnology companies, as well as from academic institutions, government agencies and private and public research institutions. Our commercial opportunity will be reduced or eliminated if our competitors develop and commercialize products that are safer, more effective, have fewer side effects or are less expensive than any future products that we may develop and commercialize. In addition, significant delays in the development of our product candidates could allow our competitors to bring products to market before us and impair our ability to commercialize our product candidates.

We anticipate that, if approved, AZ-001 would compete with currently marketed triptan drugs and with other migraine headache treatments, including intravenous, or IV, delivery of prochlorperazine, the API in AZ-001. In addition, we are aware of at least 14 product candidates for the treatment of migraines, including triptan products and a sumatriptan/naproxen combination product.

We anticipate that, if approved, AZ-004 would compete with the available intramuscular, or IM, injectable form and oral forms of loxapine for the treatment of agitation, and other forms of available antipsychotic drugs. In addition, we are aware of a post marketing study of Seroquel^® quetiapine for reducing agitation in elderly patients with Alzheimer’s disease.

We anticipate that, if approved, AZ-002 would compete with the oral tablet form of alprazolam and several other approved anti-depressant drugs. In addition, we are aware of two product candidates in early stage clinical development for the treatment of acute panic attacks.

We anticipate that, if approved, AZ-003 would compete with some of the available forms of fentanyl, including injectable fentanyl, oral transmucosal fentanyl formulations and ionophoretic transdermal delivery of fentanyl. We are also aware of at least 20 products in Phase 2 and Phase 3 development for acute pain, five of which are fentanyl products. Two of these fentanyl products are inhaled versions. In addition, if approved, AZ-003 would compete with various generic opioid drugs, such as oxycodone, hydrocodone and morphine, or combination products including one or more of such drugs.

39

Many of our competitors have significantly greater financial resources and expertise in research and development, manufacturing, preclinical testing, conducting clinical trials, obtaining regulatory approvals and marketing approved products than we do. Established pharmaceutical companies may invest heavily to discover quickly and develop novel compounds or drug delivery technology that could make our product candidates obsolete. Smaller or early stage companies may also prove to be significant competitors, particularly through strategic partnerships with large and established companies. In addition, these third parties compete with us in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient registration for clinical trials, as well as in acquiring technologies and technology licenses complementary to our programs or advantageous to our business. Accordingly, our competitors may succeed in obtaining patent protection, receiving FDA approval or discovering, developing and commercializing products before we do. If we are not able to compete effectively against our current and future competitors, our business will not grow and our financial condition will suffer.

If we are unable to establish sales and marketing capabilities or enter into agreements with third parties to market and sell our product candidates, we may be unable to generate significant product revenue.

We do not have a sales and marketing organization and have no experience in the sales, marketing and distribution of pharmaceutical products. There are risks involved with establishing our own sales and marketing capabilities, as well as entering into arrangements with third parties to perform these services. Developing an internal sales force is expensive and time consuming and could delay any product launch. On the other hand, if we enter into arrangements with third parties to perform sales, marketing and distribution services, our product revenues are likely to be lower than if we market and sell any products that we develop ourselves.

We may establish our own specialty sales force and/or engage pharmaceutical or other healthcare companies with existing sales and marketing organization and distribution systems to sell, market and distribute any future products. We may not be able to establish a specialty sales force or establish sales and distribution relationships on acceptable terms. Factors that may inhibit our efforts to commercialize any future products without strategic partners or licensees include:

• our inability to recruit and retain adequate numbers of effective sales and marketing personnel;

• the inability of sales personnel to obtain access to or persuade adequate numbers of physicians to prescribe any future products;

• the lack of complementary products to be offered by sales personnel, which may put us at a competitive disadvantage relative to companies with more extensive product lines; and

• unforeseen costs and expenses associated with creating an independent sales and marketing organization.

Because the establishment of sales and marketing capabilities depends on the progress towards commercialization of our product candidates and because of the numerous risks and uncertainties involved with establishing our own sales and marketing capabilities, we are unable to predict when, if ever, we will establish our own sales and marketing capabilities. However, we do not anticipate establishing sales and marketing capabilities until at least 2010. If we are not able to partner with a third party and are unsuccessful in recruiting sales and marketing personnel or in building a sales and marketing infrastructure, we will have difficulty commercializing our product candidates, which would adversely affect our business and financial condition.

If we lose our key personnel or are unable to attract and retain additional personnel, we may be unable to develop or commercialize our product candidates.

We are highly dependent on our President and Chief Executive Officer, Thomas B. King, the loss of whose services might adversely impact the achievement of our objectives. In addition, recruiting and retaining qualified clinical, scientific and engineering personnel to manage clinical trials of our product candidates and to perform future research and development work will be critical to our success. There is currently a shortage of skilled executives in our industry, which is likely to continue. As a result, competition for skilled personnel is intense and the turnover rate can be high. Although we believe we will be successful in attracting and retaining qualified personnel, competition for experienced management and clinical, scientific and engineering personnel from numerous companies and academic and other research institutions may limit our ability to do so on acceptable terms. In addition, we do not have employment

40

agreements with any of our employees, and they could leave our employment at will. We have change of control agreements with our executive officers and vice presidents that provide for certain benefits upon termination or a change in role or responsibility in connection with a change of control of our company. We do not maintain life insurance policies on any employees. Failure to attract and retain personnel would prevent us from developing and commercializing our product candidates.

We may encounter difficulties in managing our growth, which could increase our losses.

We expect to experience substantial growth in our business over the next few years. We expect to substantially increase our number of employees to service our internal programs and planned strategic partnering arrangements. This growth will place a strain on our human and capital resources. If we are unable to manage this growth effectively, our losses could increase. Our need to manage our operations and growth effectively requires us to continue to expend funds to improve our operational, financial and management controls, reporting systems and procedures, to attract and retain sufficient numbers of talented employees and to manage our facility requirements. If we are unable to implement improvements to our management information and control systems successfully in an efficient or timely manner, or if we encounter deficiencies in existing systems and controls, then management may receive inadequate information to manage our day to day operations.

If plaintiffs bring product liability lawsuits against us, we may incur substantial liabilities and may be required to limit commercialization of the product candidates that we may develop.

We face an inherent risk of product liability as a result of the clinical testing of our product candidates in clinical trials and will face an even greater risk if we commercialize any products. We may be held liable if any product we develop causes injury or is found otherwise unsuitable during product testing, manufacturing, marketing or sale. Regardless of merit or eventual outcome, liability claims may result in decreased demand for any product candidates or products that we may develop, injury to our reputation, withdrawal of clinical trials, costs to defend litigation, substantial monetary awards to clinical trial participants or patients, loss of revenue and the inability to commercialize any products that we develop. We have product liability insurance that covers our clinical trials up to a $10 million aggregate annual limit. We intend to expand product liability insurance coverage to include the sale of commercial products if we obtain marketing approval for any products that we may develop. However, this insurance may be prohibitively expensive, or may not fully cover our potential liabilities. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or delay the commercialization of our product candidates. If we are sued for any injury caused by any future products, our liability could exceed our total assets.

Our product candidates AZ-002, AZ-003 and AZ-007 contain drug substances which are regulated by the U.S. Drug Enforcement Administration. Failure to comply with applicable regulations could harm our business.

The Controlled Substances Act imposes various registration, recordkeeping and reporting requirements, procurement and manufacturing quotas, labeling and packaging requirements, security controls and a restriction on prescription refills on certain pharmaceutical products. A principal factor in determining the particular requirements, if any, applicable to a product is its actual or potential abuse profile. The U.S. Drug Enforcement Administration, or DEA, regulates chemical compounds as Schedule I, II, III, IV or V substances, with Schedule I substances considered to present the highest risk of substance abuse and Schedule V substances the lowest risk. Alprazolam, the API in AZ-002, is regulated as a Schedule IV substance, fentanyl, the API in AZ-003, is regulated as a Schedule II substance, and zaleplon, the API in AZ-007, is regulated as a Schedule IV substance. Each of these product candidates is subject to DEA regulations relating to manufacture, storage, distribution and physician prescription procedures, and the DEA regulates the amount of the scheduled substance that would be available for clinical trials and commercial distribution. As a Schedule II substance, fentanyl is subject to more stringent controls, including quotas on the amount of product that can be manufactured as well as a prohibition on the refilling of prescriptions without a new prescription from the physician. The DEA periodically inspects facilities for compliance with its rules and regulations. Failure to comply with current and future regulations of the DEA could lead to a variety of sanctions, including revocation, or denial of renewal, or of DEA registrations, injunctions, or civil or criminal penalties and could harm our business, financial condition and prospects.

41

The single dose version of our Staccato system contains materials that are regulated by the U.S. government, and failure to comply with applicable regulations could harm our business.

The single dose version of ourStaccatosystem uses energetic materials to generate the rapid heating necessary for vaporizing the drug, while avoiding degradation. Manufacture of products containing energetic materials is controlled by the U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives, or ATF. Technically, the energetic materials used in ourStaccatosystem are classified as “low explosives,” and the ATF has granted us a license/permit for the manufacture of such low explosives. Additionally, due to inclusion of the energetic materials in ourStaccatosystem, the Department of Transportation, or DOT, regulates shipments of the single dose version of ourStaccatosystem. The DOT has granted the single dose version of ourStaccatosystem “Not Regulated as an Explosive” status. Failure to comply with the current and future regulations of the ATF or DOT could subject us to future liabilities and could harm our business, financial condition and prospects. Furthermore, these regulations could restrict our ability to expand our facilities or construct new facilities or could require us to incur other significant expenses in order to maintain compliance.

We use hazardous chemicals and highly combustible materials in our business. Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.

Our research and development processes involve the controlled use of hazardous materials, including chemicals. We also use energetic materials in the manufacture of the chemical heat packages that are used in our single dose devices. Our operations produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge or injury from these materials. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these materials. We could be subject to civil damages in the event of an improper or unauthorized release of, or exposure of individuals to, hazardous materials. In addition, claimants may sue us for injury or contamination that results from our use or the use by third parties of these materials and our liability may exceed our total assets. We maintain insurance for the use of hazardous materials in the aggregate amount of $1 million, which may not be adequate to cover any claims. Compliance with environmental and other laws and regulations may be expensive, and current or future regulations may impair our research, development or production efforts.

Certain of our suppliers are working with these types of hazardous and highly combustible materials in connection with our component manufacturing agreements. In the event of a lawsuit or investigation, we could be held responsible for any injury caused to persons or property by exposure to, or release of, these hazardous and highly combustible materials. Further, under certain circumstances, we have agreed to indemnify our suppliers against damages and other liabilities arising out of development activities or products produced in connection with these agreements.

We will need to implement additional finance and accounting systems, procedures and controls in the future as we grow and to satisfy new reporting requirements.

The laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, and rules enacted and proposed by the U.S. Securities and Exchange Commission, or SEC, and by the Nasdaq Global Market, will result in increased costs to us as we continue to undertake efforts to comply with rules and respond to the requirements applicable to public companies. The rules make it more difficult and costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage as compared to the polices previously available to public companies. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or our board committees or as executive officers.

As a public company, we need to comply with Sarbanes-Oxley and the related rules and regulations of the SEC, including expanded disclosure, accelerated reporting requirements and more complex accounting rules. Compliance with Section 404 of Sarbanes-Oxley and other requirements will continue to increase our costs and require additional management resources. We have been upgrading our finance and accounting systems, procedures and controls and will need to continue to implement additional finance and accounting systems, procedures and controls as we grow to satisfy new reporting requirements. We currently do not have an internal audit group. In addition, we may need to hire additional legal and accounting staff with appropriate experience and technical knowledge, and we cannot assure you that if additional staffing is

42

necessary that we will be able to do so in a timely fashion. If we are unable to complete the required assessment as to the adequacy of our internal reporting or if our independent registered public accounting firm is unable to provide us with an unqualified report as to the effectiveness of our internal controls over financial reporting as of December 31, 2007, investors could lose confidence in the reliability of our internal controls over financial reporting, which could adversely affect our stock price.

Our facilities are located near known earthquake fault zones, and the occurrence of an earthquake or other catastrophic disaster could damage our facilities and equipment, which could cause us to curtail or cease operations.

Our facilities are located in the San Francisco Bay Area near known earthquake fault zones and, therefore, are vulnerable to damage from earthquakes. We are also vulnerable to damage from other types of disasters, such as power loss, fire, floods and similar events. If any disaster were to occur, our ability to operate our business could be seriously impaired. We currently may not have adequate insurance to cover our losses resulting from disasters or other similar significant business interruptions, and we do not plan to purchase additional insurance to cover such losses due to the cost of obtaining such coverage. Any significant losses that are not recoverable under our insurance policies could seriously impair our business, financial condition and prospects.

Risks Relating to Owning Our Common Stock

Our stock price may be extremely volatile, and you may not be able to resell your shares at or above the price you paid for the stock.

Our common stock price has experienced large fluctuations since our initial public offering in March 2006. In addition, the trading prices of life science and biotechnology company stocks in general have experienced extreme price fluctuations in recent years. The valuations of many life science companies without consistent product revenues and earnings are extraordinarily high based on conventional valuation standards, such as price to revenue ratios. These trading prices and valuations may not be sustained. Any negative change in the public’s perception of the prospects of life science or biotechnology companies could depress our stock price regardless of our results of operations. Other broad market and industry factors may decrease the trading price of our common stock, regardless of our performance. Market fluctuations, as well as general political and economic conditions such as terrorism, military conflict, recession or interest rate or currency rate fluctuations, also may decrease the trading price of our common stock. In addition, our stock price could be subject to wide fluctuations in response to various factors, including:

• actual or anticipated results and timing of our clinical trials;

• actual or anticipated regulatory approvals of our product candidates or competing products;

• changes in laws or regulations applicable to our product candidates;

• changes in the expected or actual timing of our development programs, including delays or cancellations of clinical trials for our product candidates;

• period to period fluctuations in our operating results;

• announcements of new technological innovations or new products by us or our competitors;

• costs or delays related to our planned facility relocation in 2007 and 2008;

• changes in financial estimates or recommendations by securities analysts;

• conditions or trends in the life science and biotechnology industries;

• changes in the market valuations of other life science or biotechnology companies;

• developments in domestic and international governmental policy or regulations;

• announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;

• additions or departures of key personnel;

43

• disputes or other developments relating to proprietary rights, including patents, litigation matters and our ability to obtain patent protection for our technologies;

• sales of our common stock by us; and

• sales and distributions of our common stock by our stockholders.

In the past, stockholders have often instituted securities class action litigation after periods of volatility in the market price of a company’s securities. If a stockholder files a securities class action suit against us, we would incur substantial legal fees and our management’s attention and resources would be diverted from operating our business in order to respond to the litigation.

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

Recent Sales of Unregistered Equity Securities

None

Use of Proceeds from the Sale of Registered Securities

March 2006 Initial Public Offering

Our initial public offering of common stock was effected through a Registration Statement on Form S-1 (File No. 333-130644), that was declared effective by the SEC on March 8, 2006. We registered 6,325,000 shares of our common stock, including the full underwriters’ over-allocation, with a proposed maximum aggregate offering price of $50.6 million, of which we sold 6,325,000 shares at $8.00 per share and an aggregate offering price of $50.6 million. The offering was completed after the sale of 6,325,000 shares. Piper Jaffray & Co. and Pacific Growth Equities, LLC were the joint book-running managing underwriters of our initial public offering and RBC Capital Markets and JMP Securities, acted as co-managers.

Of this amount, $3.5 million was paid in underwriting discounts and commissions, and an additional $2.2 million of expenses were incurred, of which $1.1 million and $1.1 million were incurred during the fiscal years ended December 31, 2006 and 2005, respectively. None of the expenses were paid, directly or indirectly, to directors, officers or persons owning 10% or more of our common stock, or to our affiliates. As of September 30, 2007, we had applied the aggregate net proceeds of $44.9 million from our initial public offering as follows:

• approximately $30.5 million was used for working capital; and

• the remainder of the net proceeds from the offering, approximately $14.4 million, remain invested in cash, cash equivalents and marketable securities.

The foregoing amounts represent our best estimate of our use of proceeds for the period indicated. No payments were made to directors, officers or persons owning ten percent or more of our common stock or to their associates, or to our affiliates, other than payments in the ordinary course of business to officers for salaries and to non-employee directors as compensation for board or board committee service.

May 2007 Public Offering

Our public offering of common stock was effected through a Registration Statement on Form S-3 (File No. 333-141739), that was declared effective by the SEC on April 16, 2007. We registered to sell common stock, preferred stock, debt securities and/or warrants, either individually or in units, with a total value of up to $150,000,000. We may also offer common stock or preferred stock upon conversion of debt securities, common stock upon conversion of preferred stock or common stock, preferred stock or debt securities upon the exercise of warrants. We sold 6,900,000 shares at $10.25 per share and an aggregate offering price of $70.7 million. The offering was completed after the sale of 6,900,000 shares. Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley & Co. Incorporated were the joint book-running managing underwriters of our public offering and Pacific Growth Equities and RBC Capital Markets, acted as co-managers.

Of this amount, $4.2 million was paid in underwriting discounts and commissions, and an additional $0.5 million of expenses were incurred. None of the expenses were paid, directly or indirectly, to directors, officers or persons owning 10% or more of our common stock, or to our affiliates. As of September 30,

44

2007, the aggregate net proceeds of $66.0 million from our public offering remained invested in cash, cash equivalents and marketable securities.

The foregoing amounts represent our best estimate of our use of proceeds for the period indicated. No payments were made to directors, officers or persons owning ten percent or more of our common stock or to their associates, or to our affiliates, other than payments in the ordinary course of business to officers for salaries and to non-employee directors as compensation for board or board committee service.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information

None.

Item 6. Exhibits

3.5	Amended and Restated Certificate of Incorporation. (1)
3.6	Amended and Restated Bylaws. (1)
3.7	Amendment to Amended and Restated Bylaws. (2)
4.1	Specimen Common Stock Certificate. (1)
4.2	Second Amended and Restated Investors’ Right Agreement dated November 5, 2004, by and between Alexza and certain holders of Preferred Stock. (1)
10.35	Second Amendment to Lease Agreement between Britannia Hacienda VIII, LLC and the Registrant dated August 28, 2007.
31.1	Certification required by Rule 13a-14(a) or Rule 15d-14(a).
31.2	Certification required by Rule 13a-14(a) or Rule 15d-14(a).
32.1	Certifications required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).

(1)	Incorporated by reference to exhibits to our Registration Statement on Form S-1 filed on December 22, 2005, as amended (File No. 333-130644).
(2)	Incorporated by reference to exhibit to our Annual Report on Form 10-K/A filed on April 10, 2007.

45

SIGNATURES

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

	Alexza Pharmaceuticals, Inc.
	(Registrant)
November 1, 2007	/s/ Thomas B. King
	Thomas B. King
	President and Chief Executive Officer
November 1, 2007	/s/ August J. Moretti
	August J. Moretti
	Senior Vice President, Chief Financial Officer and Secretary (principal financial and accounting officer)

46