Alexza Pharmaceuticals 10Q 2008 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, 2008


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		(IRS Employer
Incorporation or Organization)		Identification No.)

2091 Stierlin Court
Mountain View, California		94043

(Address of principal executive offices)		(Zip Code)

(Registrant’s telephone number, including area code):(650) 944-7000

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

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


Large accelerated filero	Accelerated filerþ	Non-accelerated filero	Smaller reporting companyo
		(Do not check if a smaller reporting company)

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

Total number of shares of common stock outstanding as of November 3, 2008; 32,820,874.

ALEXZA PHARMACEUTICALS, INC.
TABLE OF CONTENTS


	page
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007		3
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2007 and for the period from December 19, 2000 (inception) to September 30, 2008		4
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007 and for the period from December 19, 2000 (inception) to September 30, 2008		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		32

Item 4. Controls and Procedures		32

PART II. OTHER INFORMATION

Item 1A. Risk Factors		33

Item 1. Legal Proceedings		50

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		50

Item 3. Defaults Upon Senior Securities		50

Item 4. Submission of Matters to a Vote of Security Holders		50

Item 5. Other Information		50

Item 6. Exhibits		50

SIGNATURES		51
EX-31.1
EX-31.2
EX-32.1

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements(Unaudited)

ALEXZA PHARMACEUTICALS, INC.
(a development stage company)

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)


	September 30,			December 31,
	2008			2007⁽¹⁾
ASSETS
Current assets:
Cash and cash equivalents	$	17,302		$	31,337
Marketable securities		34,145			38,054
Investments held by Symphony Allegro, Inc.		26,534			39,449
Other receivables		—			12,055
Prepaid expenses and other current assets		1,563			1,377

Total current assets		79,544			122,272

Property and equipment, net		24,837			26,156
Restricted cash		400			604
Other assets		92			93

Total assets	$	104,873		$	149,125


LIABILITIES, NONCONTROLLING INTEREST, AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,263		$	5,206
Accrued clinical trial expenses		2,706			1,301
Other accrued expenses		5,862			5,087
Deferred revenue		1,667			—
Current portion of equipment financing obligations		4,430			4,586

Total current liabilities		19,928			16,180

Deferred rent		17,679			16,685
Deferred revenue		8,264			10,000
Noncurrent portion of equipment financing obligations		3,075			6,317
Other noncurrent liabilities		450			—

Noncontrolling interest in Symphony Allegro, Inc.		8,238			23,952

Stockholders’ equity:
Preferred stock		—			—
Common stock		3			3
Additional paid-in-capital		255,060			240,681
Deferred share-based compensation		(321	)		(739	)
Other comprehensive income		15			141
Deficit accumulated during development stage		(207,518	)		(164,095	)

Total stockholders’ equity		47,239			75,991

Total liabilities, noncontrolling interest and stockholders’ equity	$	104,873		$	149,125


⁽¹⁾		Condensed consolidated balance sheet at December 31, 2007 has been derived from audited consolidated financial statements at that date.

See accompanying notes.

ALEXZA PHARMACEUTICALS, INC.
(a development stage company)

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


													Period from
													December 19,
													2000
	Three Months Ended						Nine Months Ended						(inception) to
	September 30,						September 30,						September 30,
	2008			2007			2008			2007			2008
Revenue	$	69		$	—		$	69		$	—		$	7,014

Operating expenses:
Research and development		16,774			11,570			47,165			31,947			190,283
General and administrative		4,362			3,566			13,626			11,168			58,689
Acquired in-process research and development		—			—			—			—			3,916

Total operating expenses		21,136			15,136			60,791			43,115			252,888

Loss from operations		(21,067	)		(15,136	)		(60,722	)		(43,115	)		(245,874	)

Interest and other income, net		512			1,677			2,321			4,215			13,513
Interest expense		(203	)		(258	)		(736	)		(737	)		(3,382	)

Loss before noncontrolling interest in Symphony Allegro, Inc.		(20,758	)		(13,717	)		(59,137	)		(39,637	)		(235,743	)
Loss attributed to noncontrolling interest in Symphony Allegro, Inc.		6,066			2,965			15,714			7,691			28,225

Net loss	$	(14,692	)	$	(10,752	)	$	(43,423	)	$	(31,946	)	$	(207,518	)


Basic and diluted net loss per share	$	(0.45	)	$	(0.35	)	$	(1.35	)	$	(1.15	)


Shares used to compute basic and diluted net loss per share		32,610			30,975			32,122			27,775

See accompanying notes.

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,
	2008			2007			2008
Cash flows from operating activities:
Net loss	$	(43,423	)	$	(31,946	)	$	(207,518	)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss attributed to noncontrolling interest in Symphony Allegro, Inc.		(15,714	)		(7,691	)		(28,225	)
Share-based compensation		4,039			2,038			10,786
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		38			34			362
Amortization of discount on available-for-sale securities		(751	)		(596	)		(681	)
Depreciation and amortization		3,990			2,884			15,455
Loss on disposal of property and equipment		(12	)		—			54
Changes in operating assets and liabilities:
Other receivables		12,055			—			—
Prepaid expenses and other current assets		(186	)		(4,963	)		(1,557	)
Other assets		(37	)		45			(2,638	)
Accounts payable		57			1,749			5,134
Accrued clinical and other accrued liabilities		2,180			694			4,868
Deferred revenue		(69	)		—			9,931
Other liabilities		994			13,247			21,069

Net cash used in operating activities		(36,839	)		(24,505	)		(166,430	)


Cash flows from investing activities:
Purchases of available-for-sale securities		(47,111	)		(39,973	)		(324,913	)
Maturities of available-for-sale securities		51,645			30,552			291,465
Purchases of investments held by Symphony Allegro, Inc.		—			—			(49,975	)
Maturities of investments held by Symphony Allegro, Inc.		12,915			7,723			23,441
Decrease/(increase) in restricted cash		204			—			(400	)
Purchases of property and equipment		(2,234	)		(14,969	)		(39,659	)
Proceeds from disposal of property and equipment		25			—			28
Cash paid for merger		—			—			(250	)

Net cash provided by (used in) investing activities		15,444			(16,667	)		(100,263	)

See accompanying notes.

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,
	2008			2007			2008
Cash flows from financing activities:
Proceeds from issuance of common stock and warrants, net of offering costs		9,840			65,982			120,732
Proceeds from exercise of stock options and stock purchase rights under the Employee Stock Purchase Plan		918			992			4,338
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			18,932
Payments of equipment financing obligations		(3,398	)		(2,515	)		(11,880	)

Net cash provided by financing activities		7,360			68,912			283,995


Net increase (decrease) in cash and cash equivalents		(14,035	)		27,740			17,302
Cash and cash equivalents at beginning of period		31,337			17,032			—

Cash and cash equivalents at end of period	$	17,302		$	44,772		$	17,302

See accompanying notes.

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 a specialty 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, manufacturing devices for clinical trials and conducting manufacturing scale-up, 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 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, 2008 are not necessarily indicative of the results to be expected for the year ending December 31, 2008 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, 2007 included in the Company’s Annual Report on Form 10-K filed on March 17, 2008.

Basis of Consolidation

The condensed consolidated financial statements include the accounts of Alexza, its two wholly owned direct subsidiaries, Alexza Singapore Pte. Ltd., (“ASPL”) and Alexza UK, Ltd., ASPL’s wholly owned subsidiary, Alexza Manufacturing Pte. Ltd., and Alexza’s variable interest entity, Symphony Allegro, Inc.(“Allegro”). Alexza is considered the primary beneficiary of Allegro 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.

Recently Adopted Accounting Standards

Statement of Financial Accounting Standard No. 157 and Staff Position 157-2

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standard No. 157,Fair Value Measurements(“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and enhances disclosures about fair value measurements. The Company applies the provisions of SFAS 157 prospectively. Fair value is defined under SFAS 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

	•		Level 1 — Quoted prices in active markets for identical assets or liabilities.

	•		Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

	•		Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

In February 2008, the FASB issued FASB Staff Position 157-2Partial Deferral of the Effective Date of Statement 157(“FSP 157-2”). FSP 157-2 delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008.

In accordance with FSP 157-2, the Company deferred the adoption of FAS 157 for one year for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The adoption of SFAS 157 for financial assets and financial liabilities, effective January 1, 2008, did not have a material effect on our consolidated financial position, operating results or cash flows. See Note 3

Emerging Issues Task Force Issue No. 07-3

Effective January 1, 2008, the Company adopted the Emerging Issues Task Force (“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. The Company adopted the provisions of EITF 07-3 prospectively for new contracts entered into on or after January 1, 2008. The adoption of the provisions of EITF 07-3 on January 1, 2008 did not have a material impact on the Company’s financial position, results of operations or cash flows.

2. Common Stock Offerings

Equity Financing Facility

In March 2008, the Company obtained a committed equity financing facility under which the Company may sell up to $50 million of its registered common stock to Azimuth Opportunity, Ltd. (“Azimuth”) over a 24-month period. The Company is not obligated to utilize any of the $50 million facility.

The Company will determine, at its sole discretion, the timing, the dollar amount and the minimum price per share of each draw under this facility, subject to certain conditions. When and if the Company elects to use the facility, the Company will issue shares to Azimuth at a discount of between 4.15% and 6.00% to the volume weighted average price of the Company’s common stock over a preceding period of trading days. Azimuth is not required to purchase any shares below $5.00 per share, and any shares sold under this facility will be sold pursuant to a shelf registration statement declared effective by the Securities and Exchange Commission on April 16, 2007. The agreement will terminate on March 31, 2010. As of September 30, 2008, there have been no sales of common stock under this agreement.

Registered Direct Equity Issuance

In March 2008, the Company completed the sale of 1,250,000 shares of its common stock to Biomedical Sciences Investment Fund Pte. Ltd. (“Bio*One”) at a price of $8.00 per share. Furthermore, unless the average closing price of the Company’s stock over a 45 consecutive day trading period exceeds $8.00 between the closing date and December 31, 2008, Bio*One will receive 135,041 additional shares, which would adjust the effective purchase price to $7.22 per share. If required to do so, the Company will issue the additional shares to Bio*One in January 2009.

In addition, the Company issued a warrant to Bio*One to purchase up to 375,000 of additional shares of Alexza common stock at a purchase price per share of $8.00. Subject to the same price adjustment as the common stock sale, the warrant may be adjusted to purchase 415,522 shares at a purchase price of $7.22 per share. The Company has committed to initiate and maintain manufacturing operations in Singapore, and the warrant will become exercisable only if the Company terminates operations in Singapore or does not achieve certain performance milestones. The warrant has a maximum term of 5 years. Net proceeds from the sale of the stock and warrant were approximately $9.84 million after deducting offering expenses.

Secondary Public Stock Offering

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.

3. Financial Instruments

The following table represents the Company’s fair value hierarchy, as defined by SFAS 157, for its financial assets (cash equivalents and marketable securities and investments held by Symphony Allegro, Inc.) measured at fair value on a recurring basis as of September 30, 2008 (in thousands):


	Level 1		Level 2		Level 3		Total
Money market funds	$	14,265	$	—	$	—	$	14,265
Money market fund held by Symphony Allegro, Inc.		26,534		—		—		26,534
Commercial paper		—		14,717		—		14,717
U.S. government agencies		—		22,423		—		22,423

Total	$	40,799	$	37,140	$	—	$	77,939

Level 2 assets include certain of our marketable securities with quoted market prices that are traded in less active markets or priced using a quoted market price for similar assets.

4. Share-Based Compensation

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

Compensation cost for employee stock options granted prior to January 1, 2006, was accounted for using the option’s intrinsic value. 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, 2008, the Company reversed $34,000 and $83,000, respectively, of deferred stock-based compensation related to unvested options cancelled as a result of employee terminations, and $22,000 and $246,000 in the same periods in 2007, respectively. The expected future amortization expense related to employee options granted prior to January 1, 2006 is as follows (in thousands):


Remainder of 2008	$	101
2009		220

	$	321

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, 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, 2008 the weighted average fair value of the employee stock options granted was $2.63 and $3.06, respectively, and $6.05 and $6.26 in the same periods in 2007, respectively. The weighted average fair value of stock purchase rights granted under the Company’s employee stock purchase plan was $3.71 and $3.46 during the three and nine months ended September 30, 2008, respectively, and $3.60 and $3.44 in the same periods in 2007, respectively. The weighted average fair value of restricted stock units granted was $4.35 during the three and nine months ended September 30, 2008 and $8.89 during the three and nine months ended September 30, 2007.

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,
	2008			2007			2008			2007
Stock Option Plans
Weighted-average expected term	5.0 years			6.1 years			5.0 years			6.1 years
Expected volatility		67	%		73	%		67	%		73	%
Risk-free interest rate		3.25	%		4.82	%		3.16	%		4.78	%
Dividend yield		0	%		0	%		0	%		0	%
Employee Stock Purchase Plan
Weighted-average expected term	1.6 years			1.8 years			1.41 years			1.6 years
Expected volatility		68	%		53	%		66	%		53	%
Risk-free interest rate		3.48	%		4.78	%		3.53	%		4.78	%
Dividend yield		0	%		0	%		0	%		0	%

Weighted-Average Expected LifePrior to January 1, 2008, the expected term of options granted was 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 was presumed to be the average of the vesting term and the contractual term of the option. As detailed information about the employees’ exercise behavior is now available to the Company, beginning on January 1, 2008, the Company no longer uses the above mentioned shortcut method and determines the expected term of the options granted through a combination of the Company’s own historical experience and expected future activity. The change of approach in determining the estimated weighted average expected life resulted in the assumption decreasing from approximately 6.1 years to 5.0 years.

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

VolatilityPrior to January 1, 2008, as the Company considered itself a newly public entity with insufficient historical data on volatility of its stock, the expected volatility used was 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 and size. Due to the availability of historical volatility data of the Company’s own stock, the Company began utilizing its historical volatility to determine future volatility for the purpose of determining share-based payments for all options granted on or after January 1, 2008.

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 of the options or purchase rights on the respective grant dates.

Dividend YieldThe 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 RateThe Company uses historical data to estimate pre-vesting option 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 increased its estimated forfeiture rate during the three months ended March 31, 2008 from approximately 5.9% at December 31, 2007 to approximately 7.0%.

Restricted Stock UnitsThe 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, 2008, there were $8,630,000, $888,000 and $945,000 of total unrecognized compensation costs related to unvested stock option awards, unvested 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 2.7 years, 3.1 years and 0.9 years, respectively.

There was no share-based compensation capitalized at September 30, 2008.

5. 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”). Stock options issued under the 2005 Plan generally vest over 4 years, which 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 commencing on January 1, 2007 and ending on January 1, 2015. The annual reserve increases will be equal to the lesser of (i) 2% of the total number of shares of the Company’s common stock outstanding on December 31st 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, 2008 an additional 622,757 (2% of the total number of shares of the Company’s common stock outstanding on December 31, 2007) shares of the Company’s common stock were reserved for issuance under this provision. In May 2008, the Company’s shareholders approved an amendment to the plan to increase the number of shares of the Company’s stock reserved for issuance under the plan by an additional 1,500,000 shares.

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”). 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, commencing on January 1, 2007 and ending on January 1, 2015. The annual reserve increases will be 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, 2008 an additional 52,083 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 option plans for the nine months ended September 30, 2008:


	Outstanding Options
	Number of			Weighted Average
	Shares			Exercise Price
Balance at December 31, 2007		3,206,864		$	6.56
Options granted		1,431,571			5.30
Options exercised		(102,190	)		1.56
Options canceled		(346,128	)		7.70

Balance at September 30, 2008		4,190,117			6.16

The total intrinsic value of options exercised during the three and nine months ended September 30, 2008 was $161,000 and $460,000, respectively, and $226,000 and $1,424,000 during the same periods in 2007.

Information regarding the stock options outstanding at September 30, 2008 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
$ 1.10 - 1.10		403,920		5.91	$	1,551,000		345,347		5.86	$	1,326,000
1.38 - 3.94		424,538		7.34		993,000		220,448		6.76		658,000
4.21 - 6.24		526,700		9.77		311,000		—		—		—
6.55 - 7.20		485,000		9.60		3,000		3,120		9.65		—
7.30 - 7.90		606,473		8.05		—		330,119		8.02		—
8.00 - 8.00		157,740		8.88		—		53,854		8.94		—
8.01 - 8.76		600,457		5.88		—		515,132		5.65		—
8.89 - 8.89		635,004		8.58		—		196,192		8.65		—
8.91 - 11.70		350,285		8.35		—		148,856		8.30		—

		4,190,117		7.99	$	2,858,000		1,813,068		6.90	$	1,984,000

The intrinsic value is calculated as the difference between the market value as of September 30, 2008 and the exercise price of the shares. The market value as of September 30, 2008, was $4.94 as reported by NASDAQ Global Market.

The following table sets forth the summary of unvested share units (restricted stock units) activity under the Company’s stock option plan for the nine months ended September 30, 2008:


				Weighted
	Number			Average
	of			Grant-Date
	Shares			Fair Value
Outstanding at December 31, 2007		93,125		$	8.42
Granted		112,423			4.35
Released		(23,443	)		8.33
Forfeited		(7,017	)		7.75

Outstanding at September 30, 2008		175,008			5.85

As of September 30, 2008, 1,323,241 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 generally made on the last trading day of each October and April. Employees purchase shares at each purchase date at 85% of the market value of the Company’s common stock at either the employee’s enrollment date or the end of the purchase period, whichever price is lower.

The ESPP provides for annual reserve increases on the first day of each fiscal year commencing on January 1, 2007 and ending on January 1, 2015. The annual reserve increases will be equal to the lesser of (i) 1% of the total number of shares of the Company’s common stock outstanding on December 31st 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, 2008 an additional 250,000 shares of the Company’s common stock were reserved for issuance under this provision. On April 30, 2008 the Company issued 134,772 shares at an average price of $5.64 under the ESPP. As of September 30, 2008, 515,869 shares of common stock were available for issuance under the plan.

6. Net Loss per Share

Historical 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 net loss per share calculation for the three and nine months ended September 30, 2008 and 2007 because the inclusion of such shares would have had an anti-dilutive effect:


	Three Months Ended				Nine months Ended
	September 30,				September 30,
	2008		2007		2008		2007
Stock options		4,190,117		3,321,653		4,190,117		3,321,653
Unvested restricted stock units		175,008		98,193		175,008		98,193
Warrants to purchase common stock		2,390,720		2,015,720		2,390,720		2,015,720

7. 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, 2008 and 2007 is as follows (in thousands):


	Three Months Ended						Nine months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Net loss	$	(14,692	)	$	(10,752	)	$	(43,423	)	$	(31,946	)
Change in unrealized gain (loss) on marketable securities		(3	)		70			(126	)		66

Comprehensive loss	$	(14,695	)	$	(10,682	)	$	(43,549	)	$	(31,880	)

8. Other Accrued Expenses

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


	September 30,		December 31,
	2008		2007
Accrued compensation	$	4,137	$	3,532
Accrued professional fees		580		555
Other		1,145		1,000

Total	$	5,862	$	5,087

9. Equipment Financing Obligations

The Company has outstanding borrowings under financing agreements to finance equipment purchases. Borrowings under the agreements are to be repaid in 36 to 48 installments of principal and interest. The interest rate, which is fixed for each draw, is based on the U.S. Treasury securities of comparable maturities and ranges from 9.2% to 10.5%. The equipment purchased under each of the equipment financing agreements is pledged as security.

Future principal payments under the equipment financing agreements as of September 30, 2008 are as follows (in thousands):


Remainder of 2008 — 3 months	$	1,187
2009		4,048
2010		1,916
2011		354

Total	$	7,505

10. Facility Leases

The Company leases two buildings with an aggregate of 106,894 square feet of manufacturing, office and laboratory facilities in Mountain View, California, which the Company began to occupy in the fourth quarter of 2007. The lease included a provision for the Company to obtain access to the facilities prior to the commencement of rental payments and includes scheduled annual rent increases. The Company recognizes rental expense on the facility on a straight line basis over the initial term of the lease. Differences between the straight line rent expense and rent payments are classified as deferred rent liability on the balance sheet. The lease for both facilities expires on March 31, 2018, and the Company has two options to extend the lease for five years each.

The Mountain View lease, as amended, included $15,964,000 of tenant improvement reimbursements from the landlord. The Company has recorded all tenant improvements as additions to property and equipment and is amortizing the improvements over the shorter of the estimated useful life of the improvement or the remaining life of the lease. The reimbursements received from the landlord are included in deferred rent liability and amortized over the life of the lease as a contra-expense.

In May 2008, the Company entered into an agreement to sublease 19,558 square feet of its Mountain View facility from May 1, 2008 through April 30, 2009. During the term of the lease, the Company will receive a gross rent of $53,758 per month. There are no options to extend the sublease period, however, if the parties agree to extend the lease term, the monthly sublease rent will be $55,740 per month.

In the three and nine months ended September 30, 2008 the Company incurred $869,000 and $3,772,000 of rent expense, net of sublease income, respectively, and $1,440,000 and $3,922,000 in the same periods in 2007, respectively.

11. License Agreements

Symphony Allegro, Inc.

On December 1, 2006 (the “Closing Date”), the Company entered into a series of related agreements with Symphony Capital LLC (“Symphony Capital”), Symphony Allegro Holdings LLC (“Holdings”) and Holdings’ wholly owned subsidiary Symphony Allegro, Inc., (“Allegro”) providing for the financing of the clinical development of its AZ-002,Staccatoalprazolam, and the AZ-004/104,Staccato loxapine, product candidates (the “Programs”). The material agreements included the: (i) Purchase Option Agreement by and among Holdings, Allegro and Alexza (the “Purchase Option Agreement”); (ii) Warrant Purchase Agreement between Holdings and Alexza (the “Warrant Purchase Agreement”); (iii) Warrant to Purchase shares of Common Stock issued to Holdings (the “Warrant”); (iv) Amended and Restated Research and Development Agreement by and among Holdings, Allegro and Alexza (the “R&D Agreement”); and (v) Novated and Restated Technology License Agreement by and among Holdings and Allegro and Alexza (the “License Agreement”). Symphony Capital and other investors (collectively with Symphony Capital, “Symphony”) invested $50 million in Holdings, which then invested the $50 million in Allegro. Pursuant to the agreements, Allegro agreed to invest up to the full $50 million to fund the clinical development of the Programs, and the Company licensed to Allegro certain intellectual property rights related to these Programs.

Pursuant to the agreements, the Company continues to be primarily responsible for all preclinical, clinical and device development efforts, as well as maintenance of the intellectual property portfolio for the Programs. The Company and Allegro have established a Development Committee to oversee the Programs. The Company participates in the Development Committee and has the right to appoint one of the five members of the board of directors of 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 the Company’s involvement with Allegro. The investments held by Allegro are to be used to fund the development of the Programs, and are not available for general corporate expenses.

Pursuant to the Warrant Agreement, 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 Warrant, issued upon closing, was assigned a value of $10.7 million using the Black-Scholes valuation model and has been recorded in additional paid in-capital.

In consideration for the Warrant, 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 from December 1, 2007 to December 1, 2010, at predetermined prices that increase over time and range from $67.5 million starting December 31, 2007 to $122.5 million through November 30, 2010. 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 the Company’s common stock issued and outstanding as of the purchase option closing date.

The Company determined, pursuant to the guidance in FIN 46R, that Allegro is a variable interest entity and the Company is the primary beneficiary. As a result, the Company has included the financial position and results of operations of Allegro in its condensed consolidated financial statements from the date of Allegro’s formation in December 2006. The noncontrolling interest in Symphony Allegro, as presented on the condensed consolidated balance sheets, represents Symphony’s equity investment in Allegro of $50.0 million equity reduced by $10.7 million for the value of the Purchase Option, and by $2.85 million for a structuring fee and related expenses that the Company paid to Symphony Capital in connection with the closing of the Allegro transaction, resulting in the recording of a net noncontrolling interest of $36.5 million on the effective date. The Company has charged the losses incurred by Allegro to the noncontrolling interest in the determination of the Company’s net loss in the condensed consolidated statements of operations and the Company also reduced the noncontrolling interest in the condensed consolidated balance sheets by Allegro’s losses. For the three and nine months ended September 30, 2008, the net losses of Allegro charged to the noncontrolling interest were $6.1 million and $15.7 million, respectively, and $3.0 million and $7.7 million in the same periods in 2007, respectively. The Company will charge losses to the noncontrolling interest up to an aggregate of $36.5 million, the amount classified as noncontrolling interest on the effective date. If the remaining noncontrolling interest is reduced to zero prior to the Company’s adoption of SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51(“SFAS 160”), the Company will be required to absorb the losses of Allegro.

Endo Pharmaceuticals, Inc.

On December 27, 2007, the effective date, the Company entered into a license, development and supply agreement (the “License Agreement”), with Endo Pharmaceuticals, Inc. (“Endo”) for AZ-003 (Staccatofentanyl) and the fentanyl class of molecules for North America. Under the terms of the License Agreement, Endo paid the Company a $10 million upfront fee. Endo will pay potential additional milestone payments of up to $40 million upon achievement of predetermined regulatory and clinical milestones. Endo will also pay royalties to the Company on net sales of the product, from which the Company will pay for the cost of goods for the manufacture of the commercial version of the product.

The Company and Endo have established a Joint Steering Committee and a Joint Development Committee to oversee the development of AZ-003. The Company has the right but not the obligation to participate on each of the committees. The Company has primary responsibility for the development and costs of theStaccatoElectronic Multiple Dose device and the exclusive right to manufacture the product for clinical development and commercial supply. Endo has responsibility for future pre-clinical, clinical and regulatory development, and, if AZ-003 is approved for marketing, for commercializing the product in North America. Each party will be responsible for all internal costs and expenses incurred related to the respective area of responsibility. Each party will also be responsible for external development costs incurred related to their respective area of responsibility. However, the Company agreed to pay certain external development costs incurred by Endo in excess of an agreed upon threshold, with a maximum expense to the Company of $20 million. The Company will recognize expenses related to the agreement when incurred.

The Company retains all rights to AZ-003 outside of North America. Endo has the right to terminate the License Agreement upon 90 days written notice. Upon such termination, all rights to the product, including regulatory filings, data and clinical and non-clinical data for use with the product will revert to Alexza. The Company recorded the $10 million upfront fee as deferred revenue and began to recognize this revenue in the third quarter of 2008. The revenue will be amortized over the estimated performance period of the Endo license agreement of six years.

12. Manufacturing and Supply Agreement

On November 2, 2007, the Company entered into a Manufacturing and Supply Agreement, (“Supply Agreement”), with Autoliv ASP, Inc.(“Autoliv”) relating to the commercial supply of heat packages that can be incorporated into itsStaccatodevice (the “Chemical Heat Packages”). Under the terms of the Supply Agreement, Autoliv will develop a manufacturing line capable of producing 10 million Chemical Heat packages a year. The Company will pay Autoliv $12 million upon the earlier of December 31, 2011, 60 days after the approval by the Food and Drug Administration of a new drug application filed by the Company, or 60 days after termination, as defined, by the Company or Autoliv, herein called the “Purchase Date.” If the Supply Agreement is terminated by either party, prior to the purchase date, the Company will be required to reimburse Autoliv up to $12 million for certain expenses related to the equipment and tooling used in the production and testing of the Chemical Heat Packages. Upon payment by the Company Autoliv will be required to transfer possession and ownership of such equipment and tooling to the Company. Each quarter, with assistance from Autoliv, the Company estimates the amount of work performed on the development of the manufacturing line and recognizes a portion of the total payment related to the manufacturing line as a capital asset and a corresponding non-current liability. As of September 30, 2008, the Company has recorded a fixed asset and a non-current liability of $450,000 related to its commitment to Autoliv for the development of the manufacturing line.

Autoliv has agreed to manufacture, assemble and test the Chemical Heat Packages solely for the Company in conformance with the Company’s specifications. The Company will pay Autoliv a specified purchase price, which varies based on annual quantities ordered by the Company, per Chemical Heat Package delivered. The initial term of the Supply Agreement expires on December 31, 2012 and may be extended by mutual written consent. The Supply Agreement provides that during the term of the Supply Agreement, Autoliv will be the Company’s exclusive supplier of the Chemical Heat Packages. In addition, the Supply Agreement grants Autoliv the right to negotiate for the right to supply commercially any second generation chemical heat package (a “Second Generation Product”) and provides that the Company will pay Autoliv certain royalty payments if the Company manufactures Second Generation Products itself or if the Company obtains Second Generation Products from a third party manufacturer. Upon the expiration or termination of the Supply Agreement the Company will be required, on an ongoing basis, to pay Autoliv certain royalty payments related to the manufacture of the Chemical Heat Packages by the Company or third party manufacturers. No Chemical Heat Packages have been purchased under this agreement as of September 30, 2008.

13. Recent Accounting Pronouncements

Statement of Financial Accounting Standard No. 160

In December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51(“SFAS 160”). SFAS 160 will require that noncontrolling interests in subsidiaries be reported as a component of stockholders’ equity in the consolidated balance sheet. SFAS 160 also requires that earnings or losses attributed to the noncontrolling interests be reported as part of consolidated earnings and not as a separate component of income or expense, as well as requires disclosure of the attribution of consolidated earnings to the controlling and noncontrolling interests on the face of the consolidated statement of operations. SFAS 160 is effective for fiscal years beginning after December 15, 2008 and must be applied on a prospective basis. The Company is currently evaluating the impact of SFAS 160 on its financial position, results of operations and cash flows.

Statement of Financial Accounting Standard No. 141R

In December 2007, the FASB issued SFAS No. 141 (revised 2007),Business Combinations(“SFAS 141(R)”). This standard establishes principles and requirements for how an acquirer in a business combination recognizes and measures the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree in its financial statements. SFAS 141(R) also establishes principles and requirements for how an acquirer recognizes and measures the goodwill acquired in a business combination and it establishes disclosure requirements to facilitate an evaluation of the nature and financial effects of a business combination. SFAS 141(R) is effective for business combinations which occur during the first annual reporting period beginning on or after December 15, 2008. The Company expects the effect of adoption of this standard will be limited to any acquisitions made by the Company which close subsequent to December 31, 2008.

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: estimated timelines for regulatory filings, 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 Securities and Exchange Commission, or 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 a specialty pharmaceutical company focused on the development and commercialization of novel, proprietary products for the treatment of acute and intermittent conditions, all based upon ourStaccatosystem technology. We currently have five product candidates in various stages of clinical development. Our technology, theStaccatosystem, vaporizes an excipient-free drug to form a condensation aerosol that, when inhaled, allows for rapid systemic drug delivery. Because of the particle size of the aerosol, the drug is quickly absorbed through the deep lung into the bloodstream, providing speed of therapeutic onset that is comparable to intravenous, or IV, administration but with greater ease, patient comfort and convenience.

We have identified approximately 200 drug compounds that have demonstrated initial vaporization feasibility for delivery with our technology. We believe that a number of these drug compounds, when delivered by theStaccatosystem, will have a desirable therapeutic profile for the treatment of acute and intermittent conditions. We are initially focusing on developing proprietary products by combining ourStaccatosystem with small molecule drugs that have been in use for many years and are well characterized to create aerosolized forms of these drugs. We believe that we will be able to reduce the development time and risks associated with our product candidates, compared to the development of new chemical entities.

Our clinical-stage product candidates are:

•		AZ-004 (Staccatoloxapine).We are developing AZ-004 for the treatment of acute agitation in patients with schizophrenia or bipolar disorder. AZ-004 is currently in Phase 3 clinical testing and, if the results of the second Phase 3 clinical trial are positive we project a New Drug Application, or NDA, filing in early 2010.

		In October 2008, we completed enrollment in the second of our two Phase 3 clinical trials. This trial enrolled 314 patients with bipolar disorder and acute agitation at 17 U.S. clinical centers. The trial was an in-clinic, multicenter, randomized, double-blind, placebo-controlled study, testing AZ-004 at two dose levels, 5 and 10 mg. Patients received up to 3 doses of study drug in a 24-hour period, depending on their clinical status. Patients eligible for the study include those who are admitted through an emergency department and those who were already in-patients in a hospital setting, as long as they had acute agitation at the time of patient randomization. This study was the first AZ-004 study enrolling bipolar disorder patients. We expect to release initial results of this trial by the end of 2008.

		The primary endpoint for this study is a reduction of agitation, measured as the change from baseline in the PANSS (Positive and Negative Symptom Scale) Excited Component (PEC) score at 2 hours after the first dose. Various assessments of a patient’s agitation state were conducted at serial time points using standard agitation scales over the first 4-hour post-dose time period, with follow-up assessments at the end of the 24-hour study period. Side effects were recorded throughout the 24-hour period.

		In September 2008, we announced positive results from our first Phase 3 clinical trial of AZ-004 in schizophrenic patients with acute agitation. The trial enrolled 344 schizophrenic patients with acute agitation at 24 U.S. clinical centers. The trial was designed as an in-clinic, multi-center, randomized, double-blind, placebo-controlled study and tested AZ-004 at two dose levels, 5 mg and 10 mg. Patients were eligible to receive up to 3 doses of study drug in a 24-hour period, depending on their clinical status. Only one dose of study drug was allowed during the first 2 hours of the study period. The primary endpoint for the study was the change from baseline in the PEC score, measured at 2 hours after the first dose. The key secondary endpoint was the Clinical Global Impression-Improvement, or CGI-I, score, measured at 2 hours after the first dose. Both the 5 mg and 10 mg doses of AZ-004 met the primary and secondary endpoints. All results were considered statistically significant at the p < 0.05 level, as compared to placebo, and all analyses were made on an intent-to-treat basis. The 10 mg dose of AZ-004 exhibited a rapid onset of effect, with statistically significant reductions in agitation at 10 minutes post-dose. The reductions of agitation were generally sustained through the 24-hour study period. Various additional assessments of a patient’s agitation state were conducted at serial time points using the PEC scale over the first 4-hour post-dose time period, with follow-up assessments at the end of the 24-hour study period. Side effects were recorded throughout the clinical trial period. The administration of AZ-004 was generally safe and well tolerated. The most common side effects, reported by at least 10% of the patients in any treatment group, including placebo, were taste (dysgeusia), dizziness, sedation and headache. These side effects were generally mild to moderate in severity, and occurred in both drug and placebo dose groups.

		We have completed five clinical trials with AZ-004, enrolling more than 800 patients, and have announced positive results from the first four of these studies. These four studies include a 50 subject Phase 1 study in healthy volunteers, a 129 patient Phase 2 study in agitated schizophrenic patients, a 32 patient multiple-dose tolerability and pharmacokinetic study in non-agitated schizophrenic patients, and a 344 patient Phase 3 study in schizophrenic patients with acute agitation. We completed and end-of-Phase 2 meeting with the Food and Drug Administration, or FDA, for AZ-004 in September 2007, and we believe we have a clear understanding of the development requirements for filing an NDA for AZ-004.

		AZ-004 has been licensed to Symphony Allegro, Inc., or Symphony Allegro, and we have the right to repurchase all rights to this product candidate.

•		AZ-001 (Staccatoprochlorperazine).We are developing AZ-001 to treat patients suffering from acute migraine headaches. During the third quarter of 2008, we conducted an end-of-Phase 2 meeting with the FDA. We believe we have a clear understanding of the NDA requirements for this product candidate. Consistent with previous guidance, we are not planning on conducting any AZ-001 Phase 3 studies without a partner, and we are continuing to seek partners for ourStaccato migraine product candidates, AZ-001 and AZ-104.

		In December 2007, we completed enrollment of a thorough QT clinical trial, in which two doses of AZ-001 (5 and 10 mg) were compared to active control and to placebo. The purpose of a thorough QT study is to determine a drug’s effect on cardiac rhythms. With approximately 40 subjects per treatment condition, we found that the active control, moxyfloxacin, produced a positive QT/QTc signal that verified the sensitivity of the clinical study. Neither of the doses of AZ-001 produced a QT/QTc prolongation that would suggest an increased risk of cardiac arrhythmia. During the second quarter of 2008, we completed a 28-day repeat dose inhalation study in dogs. Consistent with previous findings in shorter-term and higher dose studies, we observed dose-related minimal to slight metaplasia in the upper respiratory tract, primarily in the nasal epithelium, in all treated groups. These changes were partially reversible by the end of a 28-day post-treatment period. No lower respiratory tract or lung findings were reported.

In March 2007, we announced positive 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 (5, 7.5 and 10 mg) met the primary endpoint of statistically significant pain relief 2-hours post-dose using the IHS (International Headache Society) 4-point headache pain rating scale, 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, where a patient has a pain score of 0, or “no” headache, 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. Side effects were recorded throughout the clinical trial study period and a safety evaluation was made at each patient’s closeout visit. There were no serious adverse events reported during the trial. The most common drug-related side effects reported across all three active dose groups in the clinical trial were taste (25%-33%), throat irritation (18%-30%), cough (16%-30%), somnolence (6%-10%), breathlessness (2%-9%), and dizziness (0%-9%). These side effects appeared to be dose related, with a lower incidence and severity of the side effects generally seen at the lower doses of AZ-001. These side effects were generally mild to moderate in severity, and occurred in both drug and placebo dose groups.

•		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. AZ-104 has completed a Phase 2a in-clinic study, and we plan to initiate an out-patient Phase 2b clinical trial early in 2009.

		We submitted an updated investigational new drug application, or IND, in October 2008. The original IND forStaccatoloxapine was filed with the Division of Neuropharmacological Drug Products of the FDA. In July 2005 the FDA reorganized this division into two new divisions, the Division of Psychiatry Products, or DPP, and the Division of Neurology Products, or DNP. TheStaccatoloxapine IND was transferred to the DPP, as the AZ-004 development program is for a psychiatric indication. Under that IND, we were allowed to conduct the Phase 2a proof-of-concept trial, the first patient study in migraine patients. With the positive initial results from that clinical trial and the decision to move forward to a Phase 2b outpatient clinical trial in migraine patients, we were required to file a new IND with the DNP.

		In March 2008, we announced initial results of an in-clinic, multi-center randomized, double-blind, single administration, placebo controlled Phase 2a proof-of-concept clinical trial in 168 migraine patients with or without aura. Three doses of AZ-104 (1.25, 2.5 and 5 mg) were evaluated against placebo in the clinical trial. Using the IHS 4-point rating scale, the primary efficacy endpoint was pain-relief response at 2 hours post-administration. AZ-104 met the primary efficacy endpoint of the clinical trial for the two highest doses of the drug compared to placebo. Statistically significant improvements in pain response were observed in 76.7% of patients at the 5 mg dose (p= 0.02), 79.1% of patients at the 2.5 mg dose (p = 0.01) and 67.4% of patients at the 1.25 mg dose (p = 0.18), compared to 51.3% of patients receiving placebo. Using survival analysis for pain relief response, all three dose groups were statistically superior (p < 0.05) to placebo during the 4-hour post-treatment time period that the patients remained in the clinic. We project that we will file this new IND in the fourth quarter of 2008 and initiate our Phase 2b outpatient study in the first quarter of 2009. Side effects were recorded throughout the clinical trial study period. There were no serious adverse events reported during the trial. The most common drug-related side effects, incidence greater than 10% in at lease one drug dose group, reported across the three drug dose groups and placebo were taste, or dysgeusia, somnolence and fatigue. These side effects were generally mild to moderate in severity, and occurred in both drug and placebo dose groups. We are continuing to seek partners for ourStaccatomigraine product candidates, AZ-001 and AZ-104.

		AZ-104 has been licensed to Symphony Allegro, and we have the right to repurchase all rights to this product candidate

•		AZ-003 or EN3294 (Staccatofentanyl). We are jointly developing EN3294 with Endo Pharmaceuticals, Inc., or Endo, for the treatment of breakthrough pain. Endo is responsible for regulatory, pre-clinical and clinical development, and for commercializing the product in North America. We are responsible for the development of theStaccatoElectric Multiple Dose device and we have the exclusive right to manufacture the product for clinical development and commercial supply.

		During the third quarter of 2008, we completed testing and released our first batch of EN3294 clinical trial material, or CTM, and shipped the CTM to Endo for use in the first EN3294 Phase 2 clinical trial. In connection with this shipment of CTM, we began to recognize revenue from the $10 million upfront fee in the third quarter of 2008. The revenue will be amortized over the estimated performance period of six years.

•		AZ-007 (Staccatozaleplon). We are developing AZ-007 for the treatment of insomnia in patients who have difficulty falling asleep, including patients who awake in the middle of the night and have difficulty falling back asleep. AZ-007 has completed Phase 1 testing.

		We filed an IND in December 2007. In April 2008, we announced positive results from our Phase 1 clinical trial in 40 healthy volunteers. This study was conducted at a single site and was designed to assess the safety, tolerability and pharmacokinetic parameters of a single dose of AZ-007. Using a double-blind, randomized, dose-escalation trial design, 4 doses of AZ-007 (ranging from 0.5 to 4.0 mg) were compared to placebo. AZ-007 delivered an IV-like pharmacokinetic profile with a median time to peak venous concentration, or Tmax, of 1.6 minutes. Zaleplon exposure was dose proportional across the 4 doses studied, as calculated by power analysis. Pharmacodynamics, measured as sedation assessed on a 100 mm visual-analog scale, showed onset of effect as early as 2 minutes after dosing with AZ-007. There were no serious adverse events. The most frequently reported adverse events in subjects receiving AZ-007 were dizziness and somnolence. These data indicate a rapid onset of effect, apparently directly related to the IV-like pharmacokinetics, and showed that AZ-007 was generally safe and well tolerated in this population of healthy volunteers.

•		AZ-002 (Staccatoalprazolam). AZ-002 has completed a Phase 2a proof-of-concept clinical trial for the treatment of panic attacks, an indication the Company is not planning to pursue. However, given the demonstrated safety profile, the successful and reproducible delivery of alprazolam, and the IV-like pharmacological effect demonstrated to date, we and Symphony Allegro are assessing AZ-002 for other possible indications and renewed clinical development. AZ-002 has been licensed to Symphony Allegro, and we have the right to repurchase all rights to this product candidate.

We were incorporated December 19, 2000. We have funded our operations primarily through the sale of equity securities, capital lease and equipment financings and government grants. We have generated $7.0 million in revenue from inception through September 30, 2008, substantially all of which was earned through United States Small Business Innovation Research grants. We did not have any revenues in 2007 or the first half of 2008, and we do not expect any material product revenue until at least 2011. We began to recognize revenues related to a $10 million upfront fee received in connection with the Endo development agreement in the third quarter of 2008 and will amortize the amount over a six year period.

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. In 2008, we have conducted several clinical trials, including our two Phase 3 clinical trials for AZ-004, the second of which completed enrollment in October 2008. With our partner Endo, we intend to continue device development and manufacturing of AZ-003. These clinical trials and development efforts resulted in higher expenditures in 2008 than in previous years. If our product candidates continue to progress, expenses for future clinical trials and development will be higher than those incurred in 2008. We also anticipate increased expenses as we expand our commercial manufacturing, and related commercial scale-up and pre-launch activities in anticipation of the NDA filing and, if approved, the commercial launch of AZ-004.

In 2007, we completed a current good manufacturing practice, or GMP, pilot manufacturing facility in Mountain View, California and received a California manufacturing license. We completed the move of our operations to the new facility in the first quarter of 2008. We intend for the pilot manufacturing facility to be capable of manufacturing materials for toxicology studies, clinical trial materials for future clinical trials and commercial product for any future product launch. Facility lease payments decreased in the third quarter of 2008 as the remaining lease on our Palo Alto, California facilities expired at the end of the second quarter of 2008.

In March 2008, we obtained a committed equity financing facility under which we may sell up to $50 million of our registered common stock to Azimuth Opportunity, Ltd., or Azimuth, over a 24-month period. We are not obligated to utilize any of the $50 million facility. We will determine, at our sole discretion, the timing, the dollar amount and the price per share of each draw under this facility, subject to certain conditions. When and if we elect to use the facility, we will issue shares to Azimuth at a discount between 4.15% and 6.00% to the volume weighted average price of our common stock over a preceding period of trading days. Azimuth is not required to purchase any shares at a price below $5.00 per share. Any shares sold under this facility will be sold pursuant to a shelf registration statement declared effective by the Securities and Exchange Commission on April 16, 2007. We have not sold any shares under this agreement as of September 30, 2008. As of November 5, 2008 our stock price was $2.00.

In March 2008, we sold 1,250,000 shares of our common stock to Biomedical Sciences Investment Fund Pte. Ltd, or Bio*One, at a price of $8.00 per share. Subject to certain conditions, Bio*One may receive 135,041 additional shares, which would adjust the effective purchase price to $7.22 per share. In addition, Alexza has committed to initiate and maintain manufacturing operations in Singapore and issued a warrant to Bio*One to purchase up to $3 million of additional shares of Alexza common stock at a purchase price per share of $8.00, subject to the same price adjustment as the common stock sale. The warrant is exercisable only if we terminate operations in Singapore or do not achieve certain performance milestones.

In December 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 to fund additional clinical and nonclinical development ofStaccato alprazolam andStaccatoloxapine. We have exclusively licensed to Symphony Allegro certain intellectual property rights related toStaccatoalprazolam andStaccatoloxapine. We have retained manufacturing rights to these product candidates. We continue to be primarily responsible for the development of these 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 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.

In December 2007, we entered into a license, development and supply agreement, or the license agreement, with Endo for AZ-003,Staccatofentanyl, and the fentanyl class of molecules for North America. Under the terms of the license agreement, Endo paid us an upfront fee of $10 million, and will pay potential additional milestone payments of up to $40 million upon achievement of predetermined regulatory and clinical milestones. Endo will also pay undisclosed royalties to us on net sales of the product, from which we will pay for the cost of goods for the manufacture of the commercial version of the product. We have primary responsibility for the development and costs of theStaccatoElectronic Multiple Dose device and the exclusive right to manufacture the product for clinical development and commercial supply. Endo has responsibility for pre-clinical, clinical and regulatory development, and, if AZ-003 is approved for marketing, for commercializing the product in North America. Each party will be responsible for all internal costs and expenses incurred related to the respective area of responsibility. Generally speaking, each party will also be responsible for external development costs incurred related to the respective area of responsibility, but we agreed to pay certain external development costs incurred by Endo in excess of an agreed upon threshold, with a maximum expense to us of $20 million. We and Endo have established a joint steering committee and a joint development committee to oversee the development of AZ-003. We have the right, but not the obligation to participate on each of the committees. We retain all rights outside of North America. Endo has the right to terminate the license agreement on 90 days written notice. Upon such termination, all rights to the product, including regulatory filings, data and clinical and non-clinical data for use with the product will revert to us. We will recognize expense related to the agreement when incurred. The Company recorded the $10 million upfront fee as deferred revenue and began to recognize this revenue in the third quarter of 2008. The revenue will be amortized over the estimated performance period of the Endo license agreement of six years.

As our activities have expanded, we have consistently increased the number of our employees. We expect that we will add employees during the remainder of 2008 to support our expanded operations.

We have incurred significant losses since our inception. As of September 30, 2008, our deficit accumulated during development stage was $207.5 million and total stockholders’ equity was $47.2 million. We recognized a net loss of $43.4 million during the nine months ended September 30, 2008 and $45.1 million, $41.8 million, and $32.4 million, in the years ended December 31, 2007, 2006 and 2005, 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, continue our manufacturing development, begin commercialization development, and add infrastructure to support these expanded operations.

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 and Endo relationships. Endo has control over preclinical and clinical development of AZ-003. If in the future we enter into additional partnerships, third parties could have control over preclinical development or clinical trials for some of our product candidates. Accordingly, the progress of such product candidate would 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 our product candidates, we anticipate that we and our partners 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 believe that with current cash, cash equivalents and marketable securities along with interest earned thereon, the funding available from Symphony Allegro, Inc., the funds available under our equity financing agreement with Azimuth, the proceeds from option exercises, and purchases of common stock pursuant to our Employee Stock Purchase Plan, we will be able to maintain our currently planned operations through the second quarter of 2010. The equity financing agreement with Azimuth provides that Azimuth is not required to purchase any shares at prices less than $5.00 per share. If we do not sell any shares to Azimuth, we believe that we will be able to maintain our currently planned operations through the third quarter of 2009.

Results of Operations

Comparison of Three and Nine months Ended September 30, 2008 and 2007

Revenue

We had $69,000 of revenues in the three and nine months ended September 30, 2008. We had no revenues in the three or nine months ended September 30, 2007. In the third quarter of 2008, we began to recognize revenues related to our Endo development agreement. We will amortize the $10 million upfront fee paid by Endo ratably over a period of 6 years. In prior years we have recognized governmental grant revenue and drug compound feasibility revenue, however, we expect no grant revenue or drug compound feasibility screening revenue in 2008 or 2009.

Operating Expenses

Our operating expenses were affected by our prospective method of adoption of SFAS 123R. As a result, we believe reviewing our operating expenses both inclusive and exclusive of 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,
	2008		2007		2008		2007
Operating expenses without share-based compensation expenses:
Research and development	$	16,112	$	11,207	$	45,096	$	30,873
General and administrative		3,841		3,167		11,874		10,204

Total operating expenses without share-based compensation expenses		19,953		14,374		56,970		41,077
Share-based compensation expenses:
Research and development		662		363		2,069		1,074
General and administrative		521		399		1,752		964

Total share-based compensation expenses		1,183		762		3,821		2,038

Total operating expenses	$	21,136	$	15,136	$	60,791	$	43,115

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 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 the allocation is 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
	Three Months Ended				Nine months Ended				(inception) to
	September 30,				September 30,				September 30,
	2008		2007		2008		2007		2008
Preclinical and clinical development
AZ-004/104	$	8,575	$	4,711	$	19,580	$	9,899	$	44,483
AZ-001		186		1,845		1,110		4,398		39,331
AZ-002		314		716		1,606		3,336		14,718
AZ-003		5,094		180		12,416		858		25,240
AZ-007		194		2,100		1,714		6,712		12,312
Other preclinical programs		—		—		—		—		3,243

Total preclinical and clinical development		14,363		9,552		36,426		25,203		139,327
Research		2,411		2,018		10,739		6,744		50,956

Total research and development	$	16,774	$	11,570	$	47,165	$	31,947	$	190,283

Research and development expenses were $16.8 million and $47.2 million during the three and nine months ended September 30, 2008, respectively and $11.6 million and $31.9 million during the three and nine months ended September 30, 2007, respectively. The increases were due primarily to:

•		increased spending on our AZ-004/104 product candidates as we continued development of these product candidates under the Symphony Allegro agreement, including our first Phase 3 clinical trial of AZ-004 which began enrollment in February 2008 and completed enrollment in June 2008 and our second Phase 3 clinical trial of AZ-004 which began enrollment in July 2008 and completed enrollment in October 2008,

•		increased spending on our AZ-003 product candidate as we continued development of this product candidate under the Endo agreement, and

•

increased research expenses as we increase our commercial device development and manufacturing process scale-up efforts.

These increases were partially offset by decreased spending on:

•		our AZ-001 product candidate due to Phase 2b clinical trial efforts and ongoing non clinical efforts occurring in 2007,

•		our AZ-002 product candidate due to higher development and manufacturing efforts to modify the AZ-002 device and manufacture clinical trial materials for the Phase 2a trial in 2007, and

•		our AZ-007 product candidate due to the preclinical and regulatory efforts in 2007 to support and prepare the IND filing that occurred in the fourth quarter of 2007.

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, including our second AZ-004 Phase 3 clinical trial which began enrollment in July 2008, for our product candidates. In addition, we expect to incur increasing amounts of non-cash share-based compensation expense in 2008 as future employee share-based awards are expensed and existing grants continue to be expensed.

General and Administrative Expenses

General and administrative expenses were $4.4 million and $13.6 million during the three and nine months ended September 30, 2008, respectively, and $3.6 million and $11.2 million during the three and nine months ended September 30, 2007, respectively. Share-based compensation increased to $521,000 and $1,752,000 during the three and nine months ended September 30, 2008, respectively, as compared to $399,000 and $964,000 in the same periods in 2007, respectively. We expect share-based compensation expense to continue to increase as future employee share-based awards will continue to be recorded at fair value and existing grants continue to be expensed.

Without the impact of share-based compensation expenses, general and administrative expenses increased to $3.8 million and $11.9 million in the three and nine months ended September 30, 2008, respectively from $3.2 million and $10.2 million in the comparable periods in 2007, respectively. The increases were primarily due to increased staffing to manage and support our growth resulting in increased payroll and related expenses, increased third party intellectual property expenses as we continue to increase and maintain our intellectual property portfolio, and higher facilities expenses to support our growth.

We expect that our general and administrative expenses will increase as we continue to add infrastructure to support the expected increase in operations as we continue the development of our product candidates and expand our operations to international locations. In addition, we expect to incur increasing amounts of non-cash stock-based compensation expense in 2008 and 2009 as future employee share-based awards are expensed and existing grants continue to be expensed.

Interest and Other Income, Net and Interest Expense

Interest and other income, net was $0.5 million and $2.3 million for the three and nine months ended September 30, 2008, respectively, and $1.7 million and $4.2 million in the comparable periods in 2007, respectively. Interest and other income primarily represents income earned on our cash and cash equivalents, marketable securities and on investments held by Symphony Allegro. The decrease was primarily due to lower cash, cash equivalent, and marketable securities balances and lower interest rates earned on such balances due to the interest rate environment in 2008. We expect interest income to decrease in future periods as we expect decreases in our cash, cash equivalent and marketable securities balances as well as decreases in investments held by Symphony Allegro.

Interest expense was $203,000 and $736,000 for the three and nine months ended September 30, 2008, respectively, and $258,000 and $737,000 in the comparable periods in 2007, respectively. Interest expense represents interest on our equipment financing obligations. Interest expense decreased during the three month period due to lower average balances on our equipment financing obligations.

Liquidity and Capital Resources

Since inception through September 30, 2008, we have financed our operations primarily through private placements and public sales of equity securities, totaling aggregate net proceeds of $225.4 million, revenues primarily from government grants totaling $7.0 million and funding from Symphony Allegro. We have received additional funding from equipment financing obligations, 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, 2008, we had $51.4 million in cash, cash equivalents and marketable securities, and $26.5 million of marketable securities held by Symphony Allegro. 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 investment 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 consist of investments in a money market 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 ActivitiesNet cash used in operating activities was $36.8 million and $24.5 million during the nine months ended September 30, 2008 and 2007, respectively. The net cash used in the nine months ended September 30, 2008 primarily reflects the net loss of $43.4 million, and the loss attributed to noncontrolling interest in Symphony Allegro, Inc. of $15.7 million, net of depreciation of $4.0 million and non-cash share-based compensation expense of $4.0 million. These decreases were, partially offset by the decrease in other receivables of $12.1 million which primarily reflected the receipt of $10.0 million from Endo in the first quarter of 2008 and receipt of the receivable for tenant improvement reimbursements for the Mountain View facility.

The net cash used in the nine months ended September 30, 2007 primarily reflects the net loss of $31.9 million, net of losses attributed to noncontrolling interests in Symphony Allegro, Inc. of $7.7 million, deprecation of $2.9 million and non-cash share-based compensation expense of $2.0 million. Cash flows from operations in 2007 were also impacted by the increase in prepaid expenses and other current assets of $5.0 million, increases in deferred rent of $13.3 million, primarily as a result of tenant improvement reimbursements from our landlord, an increase in accounts payable of $1.7 million and accrued clinical and other accrued liabilities of $0.7 million resulted in reducing cash use from operations.

Cash Flows from Investing ActivitiesNet cash provided by (used in) investing activities was $15.4 million and ($16.7) million during the nine months ended September 30, 2008 and 2007, respectively. Investing activities consist primarily of purchases and sales of marketable securities and capital purchases. During the nine months ended September 30, 2008, we had purchases of marketable securities, net of maturities of $4.5 million, and purchases of property and equipment of $2.2 million, consisting primarily of tenant improvements for our Mountain View facility, and maturities of available-for-sale securities held by Symphony Allegro of $12.9 million.

During the nine months ended September 30, 2007, we had maturities of marketable securities, net of purchases, of $9.4 million, and purchases of property and equipment of $15.0 million, consisting primarily of tenant improvements of our Mountain View facility, and maturities of available for-sale securities held by Symphony Allegro of $7.7 million.

Cash Flows from Financing ActivitiesNet cash provided by financing activities was $7.4 million and $68.9 million during the nine months ended September 30, 2008 and 2007, respectively. Cash flows from financing activities have generally consisted of proceeds from the issuance of our common stock and net proceeds from our equipment financing agreements. In March 2008 we issued 1,250,000 shares of common stock and a warrant to purchase 375,000 shares of common stock in a private offering resulting in net proceeds of $9.8 million. In 2008, payments on our equipment financing obligations were $3.4 million. In the nine months ended September 30, 2007, we received net proceeds of $66.0 million, from the issuance of 6,900,000 shares of common stock from the public offerings of our common stock and we had proceeds from equipment financing arrangements, net of payments, were $1.9 million.

We believe that with current cash, cash equivalents and marketable securities along with interest earned thereon, the funding available from Symphony Allegro, the funds available under our equity financing agreement with Azimuth, the proceeds from option exercises, and purchases of common stock pursuant to our Employee Stock Purchase Plan, we will be able to maintain our currently planned operations through the second quarter of 2010. The equity financing agreement with Azimuth provides that Azimuth is not required to purchase any shares at prices less than $5.00 per share. If we do not sell any shares to Azimuth, we believe that we will be able to maintain our currently planned operations through the third quarter of 2009. Changing circumstances may cause us to consume capital

significantly faster or slower 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;

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

•		the availability of funds, if any, under our equity financing agreement with Azimuth, which provides that Azimuth is not required to purchase shares at prices less than $5.00 per share.

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;

•		our ability to draw on our equity financing facility with Azimuth;

•		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 106,894 square feet of manufacturing, office and laboratory facilities in Mountain View, California, which we began to occupy in the fourth quarter of 2007. We currently occupy 87,560 square feet of these facilities and sublease the remaining 19,334 square feet. The lease for both facilities expires on March 31, 2018, and we have two options to extend the lease for five years each. Our sublease agreement expires on April 30, 2009.

We have financed 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.

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


	Operating		Equipment
	Lease		Financing
	Agreements		Obligations		Total
2008 — remaining 3 months	$	912	$	1,362	$	2,274
2009		4,558		4,472		9,030
2010		5,016		2,037		7,053
2011		5,138		366		5,504
2012		5,263		—		5,263
Thereafter		25,711		—		25,711

Total	$	46,598	$	8,237	$	54,835

On November 2, 2007, we entered into a supply agreement, with Autoliv, relating to the commercial supply of chemical heat packages that can be incorporated into ourStaccatodevice. Autoliv had developed these chemical heat packages for us pursuant to a development agreement between Autoliv and us executed in October 2005. Under the terms of the supply agreement, Autoliv will develop a manufacturing line capable of producing 10 million chemical heat packages a year. We will pay Autoliv $12 million upon the earlier of December 31, 2011 or 60 days after the approval by the FDA of a NDA filed by us. If the agreement is terminated by either party, we will be required to reimburse Autoliv up to $12 million for certain expenses related to the equipment and tooling used in the production and testing of the chemical heat packages. Upon payment by us, Autoliv will be required to transfer possession and ownership of such equipment and tooling to us. Each quarter, with assistance from Autoliv, we estimate the amount of work performed on the development of the manufacturing line and recognizes a portion of the total payment related to the manufacturing line as a capital asset and a corresponding non-current liability. As of September 30, 2008, we recorded a fixed asset and a non-current liability of $450,000 related to our commitment to Autoliv for the development of the manufacturing line. Autoliv has also agreed to manufacture, assemble and test the chemical heat packages solely for us in conformance with our specifications. We will pay Autoliv a specified purchase price, which varies based on annual quantities ordered by us, per chemical heat package delivered. The initial term of the supply agreement expires on December 31, 2012 and may be extended by written mutual consent.

On December 27, 2007, we entered into a license agreement with Endo. Pursuant to the license agreement, Endo obtained a license to develop and commercialize AZ-003 (Staccatofentanyl) in North America and to obtain a supply of AZ-003 from us. Endo is responsible for regulatory, pre-clinical and clinical development, and for commercializing the product. We are responsible for the development of theStaccatoElectric Multiple Dose commercial device and we have the exclusive right to manufacture the product for clinical development and commercial supply. Both Alexza and Endo will be responsible for all internal costs and expenses incurred related to their area of responsibility. We have agreed to pay certain external development costs incurred by Endo in excess of an agreed upon threshold, with a maximum expense to us of $20 million.

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 U.S. generally accepted accounting principles. 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 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.

While our significant accounting policies are more fully described in Note 2 of the notes to consolidated financial statements on our annual report on Form 10-K as filed with the SEC on March 17, 2008, we believe the following accounting policies are critical to the process of making significant estimates and judgments in preparation of our financial statements.

Preclinical Study and Clinical Trial Accruals

We estimate our preclinical study and clinical trial expenses based on our estimates of the services received pursuant to contracts with multiple research institutions and clinical research organizations that conduct and manage preclinical studies and clinical trials on our behalf. The financial terms of these agreements vary from contract to contract and may result in uneven payment flows. Preclinical study and clinical trial expenses include the following:

•		fees paid to contract research organizations in connection with preclinical studies;

•		fees paid to contract research organizations and other clinical sites in connection with clinical trials; and

•		fees paid to contract manufacturers in connection with the production of components and drug materials for preclinical studies and clinical trials.

We record accruals for these preclinical study and clinical trial costs based upon the estimated amount of work completed. All such costs are charged to research and development expenses based on these estimates. Costs related to patient enrollment in clinical trials are accrued as patients are entered in the trial. We monitor patient enrollment levels and related activities to the extent possible through internal reviews, correspondence and discussions with research institutions and organizations. However, if we have incomplete or inaccurate information, we may underestimate or overestimate activity levels associated with various preclinical studies and clinical trials at a given point in time. In this event, we could record significant research and development expenses in future periods when the actual activity level becomes known. To date, we have not made any material adjustments to our estimates of preclinical study and clinical trial costs. We make good faith estimates which we believe to be accurate, but the actual costs and timing of clinical trials are highly uncertain, subject to risk and may change depending upon a number of factors, including our clinical development plan. With the our ongoing Phase 3 clinical trial and future Phase 3 clinical trials, the process of estimating clinical trial costs will become more difficult as the trials will involve larger numbers of patients and clinical sites.

Effective January 1, 2008, we adopted Emerging Issues Task Force ratified EITF Issue No. 07-3,Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities, or EITF 07-3.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. The adoption of provisions of EITF 07-3 did not have a material impact on our financial position, results of operations or cash flows.

Share-Based Compensation

On January 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standard No. 123R,Share-Based Payment, or SFAS 123R. As required, 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 share-based payments granted prior to, but not yet vested as of December 31, 2005 related to (i) employees, based on the intrinsic value in accordance with the provisions of Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees, or APB 25, and (ii) non-employees based on the options fair value in accordance with the provisions of SFAS 123, 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.

We currently use the Black-Scholes option pricing model to determine the fair value of stock options and purchase rights issued under the employee stock purchase plan. The determination of the fair value of share-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.

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

Through 2007, we estimated the expected term of options using the “simplified” method, as illustrated in SAB 107. Beginning in 2008, we estimate the expected term of options based on the historical term periods of options that have been granted but are no longer outstanding and the estimated terms of outstanding options.

As we had been operating as a public company for a period of time that was significantly shorter than our estimated expected option term, we were unable to use actual price volatility data. Therefore, we estimated the volatility of our common stock based on volatility of similar entities through 2007. In 2008 we estimated the volatility of our stock based on our actual historical volatility since our initial public offering.

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 share-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 share-based compensation expense in future periods or if we decide to use a different valuation model, the expenses in 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 4 to the consolidated financial statements in this Quarterly Report on Form 10-Q for further information regarding the SFAS 123R disclosures.

Symphony Allegro, Inc.

On December 1, 2006 we entered into a transaction involving a series of related agreements with Symphony Capital LLC, or Symphony Capital, Symphony Allegro Holdings LLC, or Holdings, and Holdings’ wholly owned subsidiary Symphony Allegro, Inc., or Allegro, to fund the clinical development of AZ-002,Staccatoalprazolam, and AZ-004/104,Staccatoloxapine, or the programs. Symphony Capital and other investors, together referred to as Symphony, invested $50 million in Holdings, which then invested the $50 million in Allegro. Pursuant to the agreements, Allegro agreed to invest up to the full $50 million to fund the clinical development of the programs, and we licensed to Allegro certain intellectual property rights related to these programs. We have retained manufacturing rights to these product candidates. Pursuant to the agreements, we continue to be primarily responsible for all preclinical, clinical and device development efforts as well as maintenance of the intellectual property portfolio for the programs. We and Allegro have established a development committee to oversee the programs. We participate in the development committee and have the right to appoint one of the five board of director seats of Allegro. We have incurred and may continue to incur expenses related to the programs that are not funded by Allegro. Pursuant to the agreements, we have received an exclusive purchase option, or the purchase option, that gives us the right, but not the obligation, to acquire all, but not less than all, of the equity of Allegro, and reacquire the intellectual property rights that we licensed to Allegro. The purchase option is exercisable at predetermined prices that increase over time and range from $67.5 million starting December 31, 2007 to $122.5 million through November 30, 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 the purchase option by December 1, 2010, then Allegro will retain its exclusive license to develop and commercializeStaccatoalprazolam andStaccato loxapine for all indications, and, if they are ultimately commercialized, we will manufacture and sellStaccatoalprazolam andStaccatoloxapine to Allegro or its sublicensee for those purposes. In consideration for the purchase option, we issued to Holdings a five-year warrant to purchase 2,000,000 shares of our common stock at $9.91 per share and paid $2.85 million for structuring fees and related expenses to Symphony Capital.

Under FASB Interpretation No. 46,Consolidation of Variable Interest Entities,or FIN 46R, a variable interest entity, or VIE, is (1) an entity that has equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support, or (2) an entity that has equity investors that cannot make significant decisions about the entity’s operations or that do not absorb their proportionate share of the expected losses or do not receive the expected residual returns of the entity. FIN 46R requires a VIE to be consolidated by the party that is deemed to be the primary beneficiary, which is the party that has exposure to a majority of the potential variability in the VIE’s outcomes. The application of FIN 46R to a given arrangement requires significant management judgment.

We have consolidated the financial position and results of operations of Allegro in accordance with FIN 46R. We believe Allegro is by design a VIE because we have a purchase option to acquire its outstanding voting stock at prices that are fixed based upon the date the option is exercised. The fixed nature of the purchase option price limits Symphony’s returns, as the investor in Allegro.

FIN 46R deems parties to be de facto agents if they cannot sell, transfer, or encumber their interests without the prior approval of an enterprise. Symphony Capital is considered to be a de facto agent of the Company pursuant to this provision, and because we and Symphony, as a related party group, absorb a majority of Allegro’s variability, we evaluated whether, pursuant to FIN 46R’s requirements, we are most closely associated with Allegro. We concluded that we are most closely associated with Allegro and should consolidate Allegro because (1) we originally developed the technology that was assigned to Allegro, (2) we will continue to oversee and monitor the development program, (3) our employees will continue to perform substantially all of the development work, (4) we significantly influenced the design of the responsibilities and corporate structure of Allegro, (5) Allegro’s operations are substantially similar to our activities, and (6) through the purchase option, we have the ability to meaningfully participate in the benefits of a successful development effort.

Symphony Capital will be required to absorb the development risk for its equity investment in Allegro. Pursuant to FIN 46R’s requirements, Symphony Capital’s equity investment in Allegro is classified as noncontrolling interest in our consolidated balance sheets. The noncontrolling interest held by Symphony Capital has been reduced by the $10.7 million fair value of the warrant it received in consideration for the purchase option and $2.85 million of fees we immediately paid to Symphony Capital upon the transaction’s closing because the total consideration provided by us to Symphony Capital effectively reduces Symphony Capital’s at-risk equity investment in Allegro. While we perform the research and development on behalf of Allegro, our development risk is limited to the consideration we provided to Symphony Capital (the warrant and fees).

Losses incurred by Allegro are charged to the noncontrolling interest until that balance has been reduced to zero, at which point our net loss will be increased for the research and development expenses incurred subsequent to that date. Net losses incurred by Allegro and charged to the noncontrolling interest were $15.7 million and $7.7 million for the nine months ended September 30, 2008 and 2007, respectively. At September 30, 2008, the noncontrolling interest balance was $8.2 million. As of September 30, 2008, the investments held by Allegro were $26.5 million, which we expect to spend through the term of the collaboration in 2011.

In December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB No. 5, or SFAS 160. SFAS 160 will require that noncontrolling interests in subsidiaries be reported as a component of stockholders’ equity in the consolidated balance sheet. SFAS 160 also requires that earnings or losses attributed to the noncontrolling interests be reported as part of consolidated earnings and not as a separate component of income or expense, as well as requires disclosure of the attribution of consolidated earnings to the controlling and noncontrolling interests on the face of the consolidated statement of operations. SFAS 160 is effective for fiscal years beginning after December 15, 2008. We are currently evaluating the impact of SFAS 160 on our financial position, results of operations and cash flows.

If the remaining noncontrolling interest is reduced to zero prior to the Company’s adoption of SFAS No. 160, the Company will be required to absorb the losses of Allegro. Furthermore, if the purchase option expires unexercised, we would then be required to deconsolidate Allegro. That potential deconsolidation would not be expected to impact our earnings because the carrying value of the net assets of Allegro would be expected to be zero.

In contrast, if we exercise the purchase option, we will retain control of Allegro. As such, we would expect to record the exercise of the purchase option as a return to the noncontrolling interest. We do not expect to recognize an asset for the purchase option payment to be made to Symphony. Instead, the payment is expected to be accounted for as a capital transaction (that is, a return to the noncontrolling interest) that would not affect our net income or loss. However, because the exercise of the purchase option will be accounted for as a capital transaction, it will be treated as a deemed dividend for purposes of reporting earnings per share, increasing loss per share or decreasing income per share, as the case may be, in the period we exercise the purchase option. If the programs are successful and the resources are available, we expect to exercise the purchase option.

Autoliv ASP, Inc.

On November 2, 2007, we entered into a supply agreement, with Autoliv, relating to the commercial supply of chemical heat packages that can be incorporated into ourStaccatodevice. Autoliv had developed these chemical heat packages for us pursuant to a development agreement between Autoliv and us executed in October 2005. Under the terms of the supply agreement, Autoliv will develop a manufacturing line capable of producing 10 million chemical heat packages a year. We will pay Autoliv $12 million upon the date that is the earlier of December 31, 2011, 60 days after the approval by the FDA of a NDA filed by us, or 60 days after termination of the supply agreement by us or Autoliv, such date herein called the purchase date. If the supply agreement is terminated by either party, prior to December 31, 2011 or 60 days after the approval by the FED of a NDA filed by us, we will be required to reimburse Autoliv up to $12 million for certain expenses related to the equipment and tooling used in the production and testing of the chemical heat packages. Upon payment by us, Autoliv will be required to transfer possession and ownership of such equipment and tooling to the Company. Each quarter, with assistance from Autoliv, we estimate the amount of work performed on the development of the manufacturing line and recognize a portion of the total payment related to the manufacturing line as a capital asset and a corresponding liability.

Revenue Recognition

We recognize revenue in accordance with the SEC Staff Accounting Bulletin (SAB) No. 101,Revenue Recognition in FinancialStatements, or SAB 101, as amended by Staff Accounting Bulletin No. 104,Revision of Topic 13.or SAB 104.

In determining the accounting for collaboration agreements, we follow the provisions of Emerging Issues Task Force (EITF) Issue 00-21,Revenue Arrangements with Multiple Deliverables, or EITF 00-21. EITF 00-21 provides guidance on whether an arrangement involves multiple revenue-generating deliverables that should be accounted for as a single unit of accounting or divided into separate units of accounting for revenue recognition purposes and, if this division is required, how the arrangement consideration should be allocated among the separate units of accounting. If the arrangement represents a single unit of accounting, the revenue recognition policy and the performance obligation period must be determined (if not already contractually defined) for the entire arrangement. If the arrangement represents separate units of accounting according to the EITF’s separation criteria, a revenue recognition policy must be determined for each unit.

Revenues for non-refundable upfront license fee payments will be recognized on a straight line basis as collaboration revenue over the estimated performance period. The Company recorded the $10 million upfront fee paid by Endo as deferred revenue and began to recognize this revenue in the third quarter of 2008. The revenue will be amortized over the estimated performance period of six years. To date, we have recognized $69,000 in revenue in connection with the Endo upfront fee.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk is confined to our cash, cash equivalents, marketable securities and investments held by Symphony Allegro. 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, 2008, we had cash, cash equivalents and marketable securities of $51.4 million and investments held by Symphony Allegro of $26.5 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. In each of the last four quarters, we performed a review of our investment portfolio and believe we have minimal exposure related to mortgage and other asset backed securities and no exposure to auction rate securities.

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, 2008 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.

PART II. OTHER INFORMATION

Item 1A. RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below, together with all of the other information included in this Quarterly Report, before deciding whether to invest in shares of our common stock. 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 or results of operations. In such case, the trading price of our common stock could decline, 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 $43.4 million for the nine months ended September 30, 2008 and $45.1 million, $41.8 million, and $32.4 million for the years ended December 31, 2007, 2006 and 2005, respectively. As of September 30, 2008, we had a deficit accumulated during development stage of $207.5 million. We expect our expenses to increase as we expand our product candidate and manufacturing development programs and add sales and marketing personnel and the necessary infrastructure to support operating 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 (deficit) 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, capital lease and 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 strategic partnerships are uncertain because we may not enter into any additional strategic partnerships. We began to recognize revenues from our partnership with Endo in the third quarter of 2008, however we do not expect to recognize any product or grant revenues in 2008 or 2009. 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 completed clinical development 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

•		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 amount and timing of any milestone and royalty payments from Endo related to the development and commercialization ofStaccatofentanyl;

•		our ability to draw on our equity financing facility with Azimuth;

•		the cost, timing and outcomes of regulatory proceedings;

•		the cost and timing of developing sales and marketing capabilities prior to receipt of any regulatory approval of our product candidates;

•		the cost and timing of developing manufacturing capacity;

•		revenues received from any future products;

•		payments received under any future strategic partnerships;

•		the filing, prosecution and enforcement of patent claims; and

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

•		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;

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

•		the availability of funds, if any, under our equity financing agreement with Azimuth, which provides that Azimuth is not required to purchase shares at prices less than $5.00 per share.

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.

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. OurStaccatosystem 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 results of operations.

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;

•		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.

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 results of operations. 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 results of operations.

Continuing development of our single dose version device may delay regulatory submissions and marketing approval for AZ-004

Our clinical studies to date for our AZ-004, AZ-001, AZ-104, AZ-002 and AZ-007 product candidates have been completed using a version of our single doseStaccatodevice we refer to as the chemical single dose, or CSD, device. We are developing a version of the CSD which is intended to cost less to manufacture and is more scalable than the current version of CSD. We refer to the newer version of this single dose device as the commercial production device, or CPD, version. The CPD incorporates the same basic chemical heat package and electronics as the CSD. We are conducting a bioequivalence study in normal volunteers using the CSD and the CPD versions of the device to determine if the drug dose dispensed by the two devices is bioequivalent. If the results of the planned bioequivalence study and the available analytical data do not support the bioequivalency, or if the FDA or foreign regulatory authorities determine the CPD is unacceptable for any other reason, we may be required to conduct an additional Phase 3 clinical trial for AZ-004 with the CPD version of the device. Conducting an additional Phase 3 clinical trial could delay the filing of an NDA which could also delay any potential marketing approval in the United States.

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 we 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. In June 2008, we announced that on our Phase 2a proof-of-concept clinical trial of AZ-002 (StaccatoAlprazolam) did not meet either of its two primarily endpoints.

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.

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. 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. OurStaccatosystem 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;

•		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 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 effect on our ability to continue clinical development of our product candidates or commercialize any future products.

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, and we will outsource the manufacturing of the chemical heat packages to be used in our commercial single dose device. We have no experience in the manufacturing of components (other than our current chemical heat packages), 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.

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 supply agreement with Autoliv 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 supply our heat packages 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, and in December 2007, we entered into a license and development agreement with Endo related to AZ-003 (Staccatofentanyl). 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. To date, other than Symphony Allegro and Endo, 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 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 Endo we are, and for any additional strategic partnerships with pharmaceutical or biotechnology companies we will be, 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 $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 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 payment estimated to be $102.5 million in the fourth quarter of 2009, 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 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 theStaccatosystem 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 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 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 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 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-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.

We anticipate that, if approved, AZ-001 and AZ-104 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 in development for the treatment of migraines, including triptan products.

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 three fentanyl products under review by Regulatory agencies either in the United States or abroad, and at least 15 products in Phase 3 clinical trial development for acute pain, four of which are fentanyl products. There are two inhaled forms of fentanyl products that are in Phase 2 development. 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.

We anticipate that, if approved, AZ-007 would compete with non-benzodiazepine GABA-A receptor agonists, which include Ambien^® (immediate release and controlled-release tablets), Sonata^®, and Lunesta^®. We are also aware of more than 10 generic versions of zolpidem (brand Ambien) oral tablets and one zaleplon (brand Sonata) that have been tentatively approved by the FDA, as well as three insomnia products that are under review by the FDA. Additionally, we are aware of 5 products in Phase 3 development for the treatment of insomnia, two of which are sublingual forms of zolpidem.

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 or the profitability of these 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 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 results of operations.

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 results of operations. 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 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 necessary that we will be able to do so in a timely fashion.

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 results of operations.

Risks Relating to Owning Our Common Stock

Our stock price has been and may continue to be extremely volatile.

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;

•		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;

•		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 (or other securities) by us, including sales under our equity financing facility arrangement with Azimuth; 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.

If we sell shares of our common stock under our equity financing facility or in other future financings, existing common stock holders will experience immediate dilution and, as a result, our stock price may go down.

We will need to raise additional capital to fund our operations, to develop our product candidates, and to develop our manufacturing capabilities. We may obtain such financing through the sale of our equity securities from time to time. As a result, our existing common stockholders will experience immediate dilution upon any such issuance. For example, in March 2008, we entered into a common stock purchase agreement with Azimuth, or the purchase agreement, which provides that, upon the terms and subject to the conditions set forth in the purchase agreement, Azimuth is committed to purchase up to $50 million of our common stock at times and in amounts determined by us. Our existing common stockholders will experience immediate dilution upon the purchase of any shares of our common stock by Azimuth pursuant to the purchase agreement.

Item 1. Legal Proceedings

None.

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

None

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)

10.2		Form of Director/Officer Indemnity Agreement entered into between the Company and each of its directors and officers. (3)

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 the 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 the exhibit to our Annual Report on Form 10-K/A filed on April 10, 2007.

(3)		Incorporated by reference to the exhibit to our Current Report on Form 8-K filed on July 14, 2008.

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 6, 2008	/s/ Thomas B. King
	Thomas B. King
	President and Chief Executive Officer


November 6, 2008	/s/ August J. Moretti
	August J. Moretti
	Senior Vice President, Chief Financial Officer and Secretary (principal financial and accounting officer)

Exhibit Index

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)

10.2		Form of Director/Officer Indemnity Agreement entered into between the Company and each of its directors and officers. (3)

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 the 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 the exhibit to our Annual Report on Form 10-K/A filed on April 10, 2007.

(3)		Incorporated by reference to the exhibit to our Current report on Form 8-K filed on July 14, 2008.

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

Alexza Pharmaceuticals (ALXA) Inactive 10-Q2008 Q3 Quarterly report

Content analysis