Edgar Filing: ARYx Therapeutics, Inc.

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

		For the quarterly period ended June 30, 2009.

or

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

		For the Transition Period From to .

Commission file number 001-33782

ARYx THERAPEUTICS, INC.

(Exact name of registrant as specified in its charter)

Delaware		77-0456039
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

6300 Dumbarton Circle, Fremont, California 94555

(Address of Principal Executive Offices including zip code)

(510) 585-2200

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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.

Large accelerated filer o		Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company x

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

As of July 31, 2009, the registrant had 27,448,530 shares of common stock outstanding.

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ARYx THERAPEUTICS, INC.

FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2009

INDEX

		Page
PART I — FINANCIAL INFORMATION

Item 1.	Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2009 and December 31, 2008		2
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2009 and 2008		3
Condensed Consolidated Statements of Cash Flow for the six months ended June 30, 2009 and 2008		4
Notes to Condensed Consolidated Financial Statements		5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	20
Item 4T.	Controls and Procedures	20

PART II — OTHER INFORMATION
Item 1.	Legal Proceedings	21
Item 1A.	Risk Factors	21
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 3.	Defaults Upon Senior Securities	42
Item 4.	Submission of Matters to a Vote of Security Holders	42
Item 5.	Other Information	42
Item 6.	Exhibits	42

SIGNATURE		43

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ARYx THERAPEUTICS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

	June 30,			December 31,
	2009			2008
	(unaudited)			(Note 1)
ASSETS
Current assets:
Cash and cash equivalents	$	11,933		$	35,999
Marketable securities	10,306			8,588
Restricted cash - current	150			150
Prepaid research and development expenses	270			381
Other prepaid, receivable, and current assets	503			732
Total current assets	23,162			45,850
Restricted cash	1,203			1,203
Property and equipment, net	2,726			3,198
Other assets	773			897
Total assets	$	27,864		$	51,148

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	314		$	2,454
Accrued compensation	640			494
Accrued research and development expenses	1,014			3,832
Current portion of notes payable	7,459			3,404
Other accrued liabilities	703			835
Total current liabilities	10,130			11,019
Deferred lease credit	1,247			1,436
Notes payable	7,127			11,278
Commitments and contingencies
Stockholders’ equity:
Common stock	27			27
Additional paid-in capital	182,498			181,285
Accumulated other comprehensive income	7			45
Accumulated deficit	(173,172		)	(153,942		)
Total stockholders’ equity	9,360			27,415
Total liabilities and stockholders’ equity	$	27,864		$	51,148

The accompanying notes are an integral part of these financial statements.

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ARYx THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

	For the three months ended						For the six months ended
	June 30,			June 30,			June 30,			June 30,
	2009			2008			2009			2008
Revenue:
Collaboration services	$	—		$	164		$	—		$	232
Technology license fees	—			974			—			1,948
Total revenue	—			1,138			—			2,180

Costs and expenses:
Cost of collaboration services	—			164			—			232
Research and development	6,271			10,045			13,060			17,645
Selling, general and administrative	2,622			2,664			5,225			5,596
Total costs and expenses	8,893			12,873			18,285			23,473
Loss from operations	(8,893		)	(11,735		)	(18,285		)	(21,293		)

Interest and other income, net	11			308			65			857
Interest expense	(496		)	(469		)	(996		)	(963		)
Other-than-temporary loss on investments	(14		)	—			(14		)	—
Net loss	(9,392		)	(11,896		)	(19,230		)	(21,399		)

Basic and diluted net loss per share	$	(0.34	)	$	(0.67	)	$	(0.70	)	$	(1.21	)
Weighted average shares used to compute basic and diluted net loss per share	27,374			17,641			27,359			17,636

The accompanying notes are an integral part of these financial statements.

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ARYx THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(In thousands)

(Unaudited)

	For the six months ended
	June 30,			June 30,
	2009			2008
Cash flows from operating activities:
Net loss	$	(19,230	)	$	(21,399	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation	549			545
Amortization of premium on marketable securities	87			20
Amortization of warrants	109			214
Impairment losses	26			—
Stock-based compensation	1,161			1,137
Change in assets and liabilities:
Prepaid research and development expenses	111			(739		)
Other prepaid, receivable, and assets	229			136
Accounts payable and other accrued liabilities	(2,461		)	(1,309		)
Accrued compensation	146			(325		)
Accrued research and development expenses	(2,818		)	1,423
Deferred revenue	—			(1,953		)
Net cash used in operating activities	(22,091		)	(22,250		)

Cash flows from investing activities:
Purchases of marketable securities	(9,842		)	(13,232		)
Proceeds from sales of marketable securities	—			3,475
Proceeds from maturities of marketable securities	8,000			4,390
Increase in restricted cash	—			(300		)
Purchases of fixed assets	(89		)	(556		)
Net cash used in investing activities	(1,931		)	(6,223		)

Cash flows from financing activities:
Proceeds from exercise of stock options and issuance of common stock	144			44
Offering cost in connection with placement of equity	(92		)	—
Proceeds from issuance of notes payable	—			9,000
Principal payments on notes payable	(96		)	(1,511		)
Net cash (used in) provided by financing activities	(44		)	7,533

Net decrease in cash and cash equivalents	(24,066		)	(20,940		)
Cash and cash equivalents at beginning of period	35,999			55,476
Cash and cash equivalents at end of period	$	11,933		$	34,536

The accompanying notes are an integral part of these financial statements.

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ARYx THERAPEUTICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

In this report, “ARYx,” “we,” “us” and “our” refer to ARYx Therapeutics, Inc. “Common Stock” refers to ARYx’s common stock, par value $0.001 per share.

1. Organization and Summary of Significant Accounting Policies

The Company

ARYx is a biopharmaceutical company focused on developing a portfolio of internally discovered product candidates designed to eliminate known safety issues associated with well-established, commercially successful drugs. We use our RetroMetabolic Drug Design technology to design structurally unique molecules that retain the efficacy of these original drugs but are metabolized through a potentially safer pathway to avoid specific adverse side effects associated with these compounds. Our product candidate portfolio includes: an oral antiarrhythmic agent, budiodarone (ATI-2042), designed to have the efficacy of amiodarone, in Phase 2b clinical development for the treatment of atrial fibrillation, a form of irregular heartbeat; an oral anticoagulant, tecarfarin (ATI-5923), designed to have the same therapeutic benefits as warfarin, in Phase 2/3 clinical development for the treatment of patients who are at risk for the formation of dangerous blood clots; an oral prokinetic agent, ATI-7505, designed to have the same therapeutic benefits as cisapride, in Phase 2b clinical development for the treatment of chronic constipation, gastroparesis, functional dyspepsia, irritable bowel syndrome with constipation, and gastroesophageal reflux disease; and, a novel, next-generation atypical antipsychotic agent, ATI-9242, currently in Phase 1 clinical testing for the treatment of schizophrenia and other psychiatric disorders. Additionally, we have several product candidates in preclinical development.

We were incorporated in the State of California on February 28, 1997 and reincorporated in the State of Delaware on August 29, 2007. We maintain a wholly-owned subsidiary, ARYx Therapeutics Limited, with registered offices in the United Kingdom, which has had no operations since its inception in September 2004 and was established to serve as a legal entity in support of our clinical trial activities conducted in Europe. We operate in a single business segment with regard to the development of human pharmaceutical products.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of our wholly-owned subsidiary, ARYx Therapeutics, Ltd. All intercompany accounts and transactions have been eliminated. These unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, for interim financial information on the same basis as the annual financial statements and with instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These interim financial statements include all adjustments (consisting only of normal recurring adjustments) that management believes are necessary for the fair presentation of the balances and results for the periods presented. Interim financial results are not necessarily indicative of results to be expected for the full fiscal year or any future interim period.

The balance sheet data at December 31, 2008 has been derived from our audited consolidated financial statements for the year ended December 31, 2008, contained in our Annual Report on Form 10-K. The unaudited condensed consolidated financial statements and related disclosures contained in this report have been prepared with the presumption that users of the interim financial statements have read or have access to our audited financial statements for the preceding year. Accordingly, these interim financial statements should be read in conjunction with our audited financial statements and notes thereto for the year ended December 31, 2008, contained in our Annual Report on Form 10-K.

We have evaluated subsequent events for recognition or disclosure through August 13, 2009, the date on which the accompanying unaudited condensed consolidated financial statements being presented were issued as part of this Quarterly Report on Form 10-Q, and not beyond that date.

Need to Raise Additional Capital

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Our level of capital resources as of June 30, 2009 could raise doubt about our ability to continue to fund our operations at current levels and meet our obligations as they become due. Our ability to continue operations is dependent upon our ability to obtain substantial additional capital to continue our research and development programs and to bring any potential future products to market. In order to satisfy our projected cash needs for at least the next 12 months, we are considering various options that may be available to us, including entering into collaborative arrangements for one or more of our product candidates, public or private equity financings, debt financing or a combination of the aforementioned. However, there is no assurance that we will be able to raise additional capital on terms acceptable to us or at all. Furthermore, any additional equity financings may be dilutive to our stockholders and debt financing, if available to us on acceptable terms or at all, may involve covenants that place substantial restrictions on our business. If we fail to raise sufficient capital as and when needed, we have developed contingency plans that may require us to delay, reduce the scope of, or eliminate one or more of our research and development programs, partner one or more of our product candidates at an earlier stage of development than we might otherwise choose, or to reduce personnel and related costs and other discretionary expenditures that are within our control. Even assuming we successfully raise additional capital, there can be no assurance that we will achieve positive cash flow in the foreseeable future, or at all.

The accompanying condensed consolidated financial statements have been prepared assuming we will continue to operate as a business, which contemplates the realization of assets and the settlement of liabilities in the normal course of business for the foreseeable future. Our condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from uncertainty related to our ability to continue to operate as a business, which may be necessary should we reach a point when we are unable to continue with our operations.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make judgments, assumptions and estimates that affect the reported amounts in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate our critical accounting policies and estimates, including those related to clinical trial accruals and stock-based compensation. Management bases its estimates on historical experience and on assumptions believed to be reasonable under the circumstances. Actual results could differ from those estimates.

Fair Value of Financial Instruments

Our financial instruments consist principally of cash and cash equivalents, marketable securities, restricted cash, and certain other assets such as our long-term marketable securities holding of a single auction rate instrument, accounts payable, accrued liabilities, and current and non-current notes payable. The fair value of our financial instruments reflects the estimated amounts that would be received upon the sale of an asset or the transfer of a liability in an orderly transaction between market participants at the measurement date. The fair value estimates presented throughout this report reflect the information available to us or estimates we used as of June 30, 2009 and December 31, 2008.

Cash, cash equivalents and restricted cash are stated at cost, which approximates fair value. We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

Marketable securities are classified as available-for-sale and are carried at their fair value at the balance sheet date (See Note 2—Fair Value Measurement). Our marketable securities portfolio may include U.S. government obligations, government agency securities, corporate bonds, certificates of deposit, commercial paper, and auction rate securities with original maturities beyond three months.

Accounts payable, accrued liabilities and the current portion of notes payable are carried at cost and amortized cost, respectively, that approximate fair value due to their expected short maturities. Based on the borrowing rates available to us for loans with similar terms and average maturities, we employ a discounted cash flow model using our estimate of risk premiums and corresponding yields to maturity to determine the fair value of our non-current portion of notes payable. The fair value was estimated to be $6.0 million and $9.3 million as of June 30, 2009 and December 31, 2008, respectively, assuming transfer in an orderly market transaction. The carrying amount of our non-current portion of notes payable was stated on the face of our consolidated balance sheet at amortized cost for all periods presented.

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Comprehensive Loss

Comprehensive loss is comprised of net loss and other comprehensive income (loss). The only component of our other comprehensive income (loss) is the unrealized gains and losses on our marketable securities. Comprehensive loss for the three months ended June 30, 2009 and 2008 was $9.4 million and $12.0 million, respectively, and for the six months ended June 30, 2009 and 2008 was $19.3 million and $21.5 million, respectively.

Net Loss Per Share

Basic net loss per share is computed by dividing net loss by the weighted average number of fully vested common shares outstanding during the period. Diluted net loss per share is computed by giving effect to all potential dilutive common shares, including stock options and warrants. For all periods presented in this report, stock options and warrants were not included in the computation of diluted net loss per share because the inclusion would provide an antidilutive effect.

The following table presents the calculation of basic and diluted net loss per share:

	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
	(in thousands, except per share amount)
Numerator:
Net loss	$	(9,392	)	$	(11,896	)	$	(19,230	)	$	(21,399	)
Denominator:
Weighted average common shares outstanding	27,386			17,668			27,372			17,664
Less: Weighted average unvested restricted common shares	(12		)	(27		)	(13		)	(28		)
Weighted average shares used in computing basic and diluted net loss per share	27,374			17,641			27,359			17,636
Basic and diluted net loss per share	$	(0.34	)	$	(0.67	)	$	(0.70	)	$	(1.21	)

Income Taxes

We utilize the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting bases and the tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Based on known factors, our management cannot currently conclude that it will be more likely than not that deferred tax assets will be utilized. Accordingly, deferred tax assets have been fully offset by a valuation allowance.

We elect to classify interest and penalties related to unrecognized tax benefits as part of our income tax provision, although there have been no such interest or penalties recognized to-date.

Recent Accounting Pronouncements

In April 2009, the Financial Accounting Standard Board, or FASB, issued three final Staff Positions, or FSPs, intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities. FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, provides guidelines for making fair value measurements more consistent with the principles presented in FASB Statement No. 157, Fair Value Measurements, or SFAS 157. It reaffirms the objective of fair value measurement, which is to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. FSP FAS 107-1 and APB 28-1, Interim Disclosures About Fair Value of Financial Instruments, relates to fair value disclosures for any financial instruments that are not currently reflected on the balance sheet at fair value. Prior to issuing this FSP, fair values for these assets and liabilities were only disclosed once a year. The FSP now requires these disclosures on a quarterly basis to provide qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, provides additional guidance designed to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and

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non-credit components of impaired debt securities that are not expected to be sold. This FSP also requires increased and more timely disclosures regarding expected cash flows, credit losses, and aging of securities with unrealized losses. The FSPs are effective for interim and annual periods ending after June 15, 2009. The adoption of the above FSPs did not have a material impact on either our consolidated financial position or results of operations.

In May 2009, the FASB issued Statement of Financial Accounting Standards No. 165, Subsequent Events, or SFAS 165. SFAS 165 is effective on a prospective basis for interim and annual financial periods ending after June 15, 2009. SFAS 165 provides authoritative guidance largely similar to the current guidance in the auditing literature with some exceptions that are not intended to result in significant changes in practice. The modifications to the subsequent events guidance in existing auditing literature are: (i) to name the two types of subsequent events either as recognized subsequent events (currently known as Type I subsequent events) or non-recognized subsequent events (currently known as Type II subsequent events); (ii) to modify the definition of subsequent events to refer to events or transactions that occur after the balance sheet date but before the financial statements are issued (for public entities); and (iii) to require entities to disclose the date through which an entity has evaluated subsequent events and the basis for that date. Accordingly, we have adopted SFAS 165 for the interim period ended June 30, 2009 and evaluated subsequent events for recognition or disclosure through August 13, 2009, the date on which the accompanying unaudited condensed consolidated financial statements being presented were issued as part of this Quarterly Report on Form 10-Q, and not beyond that date.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles — A Replacement of FASB Statement No. 162, or SFAS 168. The FASB Accounting Standards Codification, or Codification, will become the source of authoritative U.S. GAAP recognized by the FASB applicable to non-governmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. On the effective date of this Statement, the Codification will supersede all then-existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the Codification will no longer be authoritative. SFAS 168 will be effective for us for the nine-month period ending September 30, 2009 and the adoption is not expected to have a material effect on either our consolidated financial position or results of operations.

2. Fair Value Measurement

The following tables summarize the fair value of our financial assets as of June 30, 2009 and December 31, 2008 that were recorded at fair value on a recurring basis consistent with the fair value hierarchy.

	June 30, 2009
	Total Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Cash and cash equivalents	$	11,933		$	11,330	$	603	$	—
Marketable securities	10,306			—		10,306		—
Restricted cash	150			150		—		—
Total fair value of current financial assets	22,389			11,480		10,909		—
Restricted cash—non-current	1,203			1,203		—		—
Auction rate securities:
Balance as of December 31, 2008	367			—		—		367
Other-than-temporary loss on investments	(14		)	—		—		(14		)
Balance as of June 30, 2009	353			—		—		353
Total fair value of financial assets	$	23,945		$	12,683	$	10,909	$	353

	December 31, 2008
	Total Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Cash and cash equivalents	$	35,999	$	33,549	$	2,450	$	—
Marketable securities	8,588		—		8,588		—
Restricted cash	150		150		—		—
Total fair value of current financial assets	44,737		33,699		11,038		—
Restricted cash—non-current	1,203		1,203		—		—
Auction rate securities	367		—		—		367
Total fair value of financial assets	$	46,307	$	34,902	$	11,038	$	367

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Our financial assets valued using Level 1 inputs consist primarily of cash, money market funds, and certificate of deposit at a financial institution. Our financial assets valued using Level 2 inputs consist primarily of U.S. government agencies debt instruments, commercial paper, and corporate debt securities. The fair value of these instruments was determined by our institutional portfolio managers whose valuations were based upon market-corroborated inputs such as broker/dealer quotes, reported trades, bids and offers that we believe are reasonable. The fair value of our remaining auction rate security was measured using Level 3 inputs as determined by a discounted cash flow model that considers expected cash flows from the auction rate instrument including expected interest payments, market yields for similarly rated instruments, our estimates of time to liquidity for the security and a marketability discount.

As of June 30, 2009, the fair value of our remaining auction rate instrument was $353,000, net of an estimated $147,000 loss representing a 29.4% reduction in the carrying value for this instrument. We revisited our assumptions used in the discounted cash flow model as of June 30, 2009 and recorded an additional $14,000 loss on marketable securities for the three and six months ended June 30, 2009 in our statement of operations. We continue to classify this auction rate instrument as an other non-current asset on the balance sheet as we do not expect that the instrument will likely become liquid in the next 12 months.

Marketable securities held at June 30, 2009 and December 31, 2008 are summarized below:

	June 30, 2009
	Amortized Cost		Unrealized Gains		Unrealized Losses		Unrealized Other-than- temporary Impairment		Fair Value
	(in thousands)
Available-for-sale marketable securities:
U.S. government agencies debt	$	5,980	$	4	$	—	$	—	$	5,984
Commercial paper	1,998		1		—		—		1,999
Corporate debt securities	2,319		4		—		—		2,323
Auction rate securities	353		—		—		—		353
Total marketable securities	$	10,650	$	9	$	—	$	—	$	10,659
Maturing:
Within 1 year	$	8,790							$	8,796
Between 1 and 2 years	1,507								1,510
Auction rate securities maturing beyond 1 year	353								353
	$	10,650							$	10,659

	December 31, 2008
	Amortized Cost		Unrealized Gains		Unrealized Losses		Unrealized Other-than-temporary Impairment		Fair Value
	(in thousands)
Available-for-sale marketable securities:
U.S. government agencies debt	$	6,010	$	31	$	—	$	—	$	6,041
Commercial paper	997		2		—		—		999
Corporate debt securities	1,538		10		—		—		1,548
Auction rate securities	367		—		—		—		367
Total marketable securities	$	8,912	$	43	$	—	$	—	$	8,955
Maturing:
Within 1 year	$	7,007							$	7,040
Between 1 and 2 years	1,538								1,548
Auction rate securities maturing beyond 1 year	367								367
	$	8,912							$	8,955

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3. Revenue Recognition

We generated no revenue for the three and six months ended June 30, 2009. We recognized $1.1 million and $2.2 million for the three and six months ended June 30, 2008, respectively, as license fees revenue and $164,000 and $232,000 for the three and six months ended June 30, 2008, respectively, as collaboration service revenue in connection with our prior collaboration agreement with Procter & Gamble Pharmaceuticals, Inc., or P&G. Effective with P&G’s notice of termination on July 2, 2008, we no longer provide any support services to P&G for the development of ATI-7505 and therefore those services are no longer a source of revenue for us. In accounting for our prior collaboration agreement with P&G, we have consistently reported activities between third parties and us on a gross basis and therefore the adoption of EITF Issue No. 07-1, Accounting for Collaborative Arrangements, effective for interim periods ending after March 15, 2009, did not have a material impact on our consolidated financial statements.

4. Debt Financing

As of June 30, 2009, we have loan commitments outstanding with Lighthouse Capital Partners V, L.P., or Lighthouse, General Electric Commercial Finance, or GE, and Oxford Finance Corporation, or Oxford. The total principal amount borrowed under the Lighthouse agreements was $19.0 million and the total unpaid principal balance outstanding as of June 30, 2009 was $12.2 million. We recorded interest expense related to the Lighthouse loan agreement, including amortization of expense related to the terminal payment and the warrants issued under the agreement, of $461,000 and $446,000 for the three months ended June 30, 2009 and 2008, respectively, and $921,000 and $902,000 for the six months ended June 30, 2009 and 2008, respectively. The total principal amount borrowed under the GE agreements was $1.9 million and the total unpaid principal balance outstanding as of June 30, 2009 was $177,000. We recorded interest expense related to the GE loan agreements of $6,000 and $22,000 for the three months ended June 30, 2009 and 2008, respectively, and $15,000 and $61,000 for the six months ended June 30, 2009 and 2008, respectively. The total principal amount borrowed under the Oxford loan agreement was $1.0 million and the total unpaid principal balance outstanding as of June 30, 2009 was $856,000. We recorded interest expense related to the Oxford loan agreement, including amortization of expense related to the terminal payment and the warrant issued under the agreement, of $29,000 and zero for the three months ended June 30, 2009 and 2008, respectively, and $60,000 and zero for the six months ended June 30, 2009 and 2008, respectively.

5. Warrants

We issue freestanding warrants from time to time pursuant to various contractual arrangements. As of June 30, 2009, the following warrants to purchase our common stock were issued and outstanding:

Warrant Holder	Issue Date		In Connection With	Warrant to Purchase	Shares	Exercise Price (per share)		Expire Date
ATEL	12/23/2002		Leasing arrangement	Common Stock	5,611	$	8.91	11/13/2012
Lighthouse(1)	3/28/2005		Debt financing	Common Stock	100,704	$	9.93	(1	)
Lighthouse(2)	10/19/2007		Debt financing	Common Stock	83,332	$	10.80	(2	)
Lighthouse(3)	10/17/2008		Debt restructure	Common Stock	158,770	$	3.975	(3	)
Various investors(4)	(4	)	Private placement of equity	Common Stock	2,894,864	$	2.64	11/14/2013
Oxford(5)	12/31/2008		Equipment financing	Common Stock	8,547	$	2.34	12/31/2013
					3,251,828

(1) Exercisable, in whole or in part, anytime at the option of the holder or deemed to have been automatically exercised in full immediately prior to the expiration of the warrant; expires at the earlier of (i) November 7, 2009 or (ii) the effective date of a merger, as defined in the agreement.

(2) Exercisable, in whole or in part, at anytime at the option of the holder or deemed to have been automatically exercised in full immediately prior to the expiration of the warrant; expires at the earlier of (i) the close of business on October 19, 2014, or (ii) the effective date of a merger, as defined in the agreement.

(3) Exercisable, in whole or in part, at anytime at the option of the holder or deemed to have been automatically exercised in full immediately prior to the expiration of the warrant; expires at the earlier of (i) the close of business on October 17, 2013, or (ii) the effective date of a merger, as defined in the agreement.

(4) Warrants to purchase 2,446,928 shares of our common stock were issued on November 14, 2008 and warrants to purchase 447,936 shares of our common stock were issued on November 24, 2008; exercisable, in whole or in part, at anytime at the option of the holder for a term of five years from November 14, 2008.

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(5) Exercisable, in whole or in part, at anytime at the option of the holder for a term of five years from the date of issuance or deemed to have been automatically exercised in full immediately prior to the expiration of the warrant if the fair market value of one share of our common stock is greater than the exercise price of the warrant on such date.

In June 2008, the FASB ratified EITF Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock, or EITF 07-5. EITF 07-5 provides guidance on how to determine if certain instruments (or embedded features) are considered indexed to our own stock. EITF 07-5 requires companies to use a two-step approach to evaluate an instrument’s contingent exercise provisions and settlement provisions in determining whether the instrument is considered to be indexed to its own stock and thus exempt from the application of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. Although EITF 07-5 is effective for fiscal years beginning after December 15, 2008, any outstanding instrument at the date of adoption requires retrospective application of the accounting through a cumulative effect adjustment to retained earnings upon adoption. The adoption of EITF 07-5 did not have a material impact on our consolidated financial position or results of operations.

The fair value of our capitalized warrants issued in connection with the placement of our long-term debt was amortized to interest expense as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2009		2008		2009		2008
	(in thousands)
Lighthouse—Warrant 1	$	13	$	23	$	27	$	47
Lighthouse—Warrant 2	13		16		26		167
Lighthouse—Warrant 3	27		—		54		—
Oxford	1		—		2		—
Total warrant amortization expense	$	54	$	39	$	109	$	214

6. Stock-Based Compensation

The components of our stock-based compensation expense recognized for the three and six months ended June 30, 2009 and 2008 were as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2009		2008		2009		2008
	(in thousands)
Research and development:
Officer compensation	$	76	$	84	$	144	$	160
Employee and consultant compensation	163		161		314		332
Selling, general and administrative:
Director and officer compensation	355		279		626		555
Employee and consultant compensation	39		48		77		90
Total stock-based compensation expense	$	633	$	572	$	1,161	$	1,137

We issued an aggregate 36,144 shares of our common stock upon the exercise of stock options and 24,128 shares of our common stock upon the conclusion of the initial offering period under our 2007 Employee Stock Purchase Plan during the six months ended June 30, 2009.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and the results of operations should be read in conjunction with the condensed consolidated financial statements and notes to condensed consolidated financial statements included elsewhere in this quarterly report on Form 10-Q. This discussion contains forward looking statements that involve risks and uncertainties. When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that characterize our business. In particular, we encourage you to review the risks and uncertainties described in Part II - Item 1A. “RISK FACTORS” elsewhere in this report. These risks and uncertainties could cause actual results to differ materially from those projected in forward-looking statements contained in this report or implied by past results and trends. Forward-looking statements are statements that attempt to forecast or anticipate future developments in our business; we encourage you to review the examples of our forward-looking statements under the heading “Cautionary Note Regarding Forward-Looking Statements” that appears at the end of this discussion. These statements, like all statements in this report, speak only as of their date (unless another date is indicated), and we undertake no obligation to update or revise these statements in light of future developments.

Overview

ARYx Therapeutics, Inc., or ARYx, is a biopharmaceutical company focused on developing a portfolio of internally discovered product candidates designed to eliminate known safety issues associated with well-established, commercially successful drugs. We use our RetroMetabolic Drug Design technology to design structurally unique molecules that retain the efficacy of these original drugs but are metabolized through a potentially safer pathway to avoid specific adverse side effects associated with these compounds. Our product candidate portfolio includes: an oral antiarrhythmic agent, budiodarone (ATI-2042), designed to have the efficacy of amiodarone, in Phase 2b clinical development for the treatment of atrial fibrillation, a form of irregular heartbeat; an oral anticoagulant, tecarfarin (ATI-5923), designed to have the same therapeutic benefits as warfarin, in Phase 2/3 clinical development for the treatment of patients who are at risk for the formation of dangerous blood clots; an oral prokinetic agent, ATI-7505, designed to have the same therapeutic benefits as cisapride, in Phase 2b clinical development for the treatment of chronic constipation, gastroparesis, functional dyspepsia, irritable bowel syndrome with constipation, and gastroesophageal reflux disease; and, a novel, next-generation atypical antipsychotic agent, ATI-9242, currently in Phase 1 clinical testing for the treatment of schizophrenia and other psychiatric disorders. Additionally, we have several product candidates in preclinical development. Each of our product candidates is an orally available, patentable new chemical entity designed to address similar indications as those of the original drug upon which each is based. Our product candidates target what we believe to be multi-billion dollar market opportunities.

Since our inception, we have incurred significant net losses, and we expect to continue to incur net losses for the next several years as we develop our own product candidates, potentially acquire or in-license additional products or product candidates, conduct clinical trials, manufacture materials for use in non-clinical studies and clinical trials, expand our research and development activities, seek regulatory approvals and engage in commercialization preparation activities. It is very expensive to gain approval of and launch a pharmaceutical product. Many expenses are incurred before revenue is received. We are unable to predict the extent of any future losses or when we will become profitable, if at all.

We are engineering potentially safer oral product candidates that retain the efficacy of commercially successful drugs for well-established chronic markets. We have established proof of concept with our three leading product candidates, budiodarone, tecarfarin, and ATI-7505. The following is a summary of our product candidates that are currently in clinical development:

Budiodarone

Budiodarone is an oral antiarrhythmic agent in Phase 2 clinical development for the treatment of patients with atrial fibrillation. Budiodarone was designed to have the efficacy of amiodarone, a drug that has been used for many years, despite its adverse side effects, because physicians consider it to be the most effective drug for treating patients with atrial fibrillation. Amiodarone accumulates in many different organs and can only be metabolized by CYP450, potentially leading to serious side effects that are not immediately reversible upon withdrawal of the drug. Since budiodarone is predominantly metabolized through the esterase pathway, it should avoid accumulation in organs and have fewer drug-drug interactions. We

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have completed a Phase 2 pilot study (CLN-208) with budiodarone involving six atrial fibrillation patients with implanted recordable pacemakers who did not respond to previous drug therapy. This pilot study suggested that the effect of budiodarone improved as the dose increased. Based upon the results of this pilot study, we conducted an additional Phase 2b clinical trial to further demonstrate the efficacy of budiodarone in patients with atrial fibrillation. The clinical trial, which enrolled 72 patients, was a multi-centered, randomized, double blind, placebo-controlled study of the efficacy and safety of budiodarone in patients with paroxysmal atrial fibrillation, or PAF. All patients entering this study had previously implanted permanent pacemakers with appropriate diagnostic and recording capabilities. In December 2008, we announced successful top-line efficacy results from this Phase 2b clinical trial. By achieving statistical significance at the two highest doses of the three tested, the results essentially mirrored the findings of the earlier Phase 2 pilot study also conducted in paroxysmal atrial fibrillation patients. The Phase 2b study also demonstrated that patients in the study quickly returned to their pre-treatment level of atrial fibrillation once the treatment ended. We have also announced the complete safety results from this Phase 2b clinical trial which indicate that budiodarone is generally safe and well-tolerated, and appears to avoid the tissue accumulation evident with amiodarone. We are actively seeking a large pharmaceutical company partner for the full development and eventual commercialization of budiodarone, in the event we obtain requisite regulatory approval.

Tecarfarin

Tecarfarin is an oral anticoagulant in Phase 2/3 clinical development for the treatment of patients who are at risk for the formation of dangerous blood clots, such as those with atrial fibrillation or those at risk of venous thromboembolism. Tecarfarin was designed to have the same therapeutic benefits as the drug warfarin which for over 50 years has been the oral anticoagulant of choice. Despite its widespread use, warfarin has several significant limitations. It is metabolized by CYP450 and has many drug-drug interactions that often lead to serious side effects. We designed tecarfarin to be metabolized through the esterase pathway, eliminating metabolism through CYP450 and avoiding drug-drug interactions. Warfarin also has a very steep dose response curve which means that a small change in dose may lead to a substantial change in the anticoagulation status of the patient. These two factors can create significant challenges in maintaining therapeutic levels of warfarin and this can put patients at risk for either life-threatening clotting or bleeding, especially in patients with compromised CYP clearance. In preclinical testing and in clinical testing to date, it appears that tecarfarin may be inherently more stable than warfarin due to its predictable metabolism through the esterase pathway that has a much larger capacity than CYP450. The rate of anticoagulation for both warfarin and tecarfarin is measured by the standard assay known as International Normalized Ratio, or INR.

We have treated over 400 patients with tecarfarin measuring the drug’s ability to maintain those patients within the target therapeutic range of INR of 2 to 3 (2.5 to 3.5 for heart valve patients). Two of the clinical trials performed were Phase 2 studies (CLN-504 and CLN-509) and the third was the recently completed Phase 2/3 trial, EmbraceAC (CLN-505). The tecarfarin efficacy results in each were nearly identical, appearing to demonstrate tecarfarin’s ability to maintain patients’ INR within the target therapeutic range during a consistent percentage of the time treated: 71.5% (CLN-504); 73.9% (CLN-509); and 74% (EmbraceAC). Statistical significance was achieved in CLN-504 when comparing the tecarfarin response to the same patients’ historical experience with warfarin: 71.5% time within therapeutic range versus 59.3% time within therapeutic range, respectively (p= 0.0009). However, statistical significance was not achieved at the primary endpoint in the 607-patient EmbraceAC clinical trial, directly measuring the ability of tecarfarin to maintain patients within the target therapeutic range of INR as compared to warfarin patients. The endpoint was missed due to the virtually unprecedented time within therapeutic range in the warfarin-treated patients of 73.2% (p=0.506). We believe the warfarin outcome resulted from the intense monitoring and dose control provided by the study’s central dosing methodology, executed in accord with our agreement on the study design with the U.S. Food and Drug Administration, or FDA. A second Phase 3 study must be conducted, again directly comparing tecarfarin to warfarin but in a “real-world” setting in which all monitoring and dosing decisions will be made at the study sites. This will be similar to how tecarfarin was dosed in CLN-504 and how warfarin is typically dosed and titrated in clinical practice. Similar studies conducted in the past with warfarin have typically shown a time in therapeutic range of 56% to 66%, considerably less than was seen in the EmbraceAC study which was highly controlled. Subsequent additional analyses of the data generated in the EmbraceAC trial, looking at specific subpopulations in the study, support our belief that a real-world study would demonstrate the importance of warfarin’s dependence on CYP450 metabolism versus tecarfarin’s avoidance of that metabolic pathway in maintaining patients within the target therapeutic range of INR. In previous discussions, the FDA indicated that the ability to maintain patients within the targeted INR will likely be an acceptable surrogate and primary endpoint for tecarfarin’s clinical development. Using INR maintenance as a surrogate and primary endpoint should reduce both the size of and time to complete our planned clinical trials for tecarfarin compared to clinical trials measuring survival rates or other outcomes. Based upon our earlier discussions with the FDA, we believe the completed EmbraceAC clinical trial may qualify as a registration study. We are continuing to actively seek a pharmaceutical company partner for the full development and eventual commercialization of tecarfarin, in the event we obtain requisite regulatory approval. This potential partner will be responsible for conducting the required second Phase 3 study.

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ATI-7505

ATI-7505 is an oral prokinetic drug that speeds up the motion of contents through the gut, which has successfully completed a series of Phase 2 clinical trials for the treatment of multiple gastrointestinal disorders including gastroesophageal reflux disease, or GERD, functional dyspepsia and chronic idiopathic constipation. ATI-7505 was designed to have the same therapeutic benefits as cisapride, a drug marketed by Johnson & Johnson as Propulsid in the United States. Launched in 1993, cisapride was withdrawn from the market in 2000 due to serious cardiovascular side effects. These side effects occurred as blood levels of the drug rose significantly when CYP450 clearance was inhibited because of the presence of other drugs cleared by the same metabolic pathway. We designed ATI-7505 to be metabolized through the esterase pathway, eliminating metabolism through CYP450 as well as the off-target cardiovascular effects. More than 900 subjects have been treated with ATI-7505 as part of our clinical trial program, which includes four Phase 2 trials to date. In June 2006, we entered into a collaboration agreement with Procter & Gamble Pharmaceuticals, Inc., or P&G, to develop and commercialize ATI-7505. On July 2, 2008, we received notice from P&G that it elected to exercise its option to terminate the collaboration agreement effective July 2, 2008. P&G subsequently announced that it is exiting pharmaceutical drug development. Upon termination of the collaboration agreement by P&G, all rights to ATI-7505 reverted to ARYx. Also on July 2, 2008, we announced the overall successful results of a Thorough QT study, or TQT study, on ATI-7505, which we believe supports the agent’s favorable cardiac safety profile. In March 2009, we received written confirmation from the FDA that based on the FDA’s review of results from our TQT study of ATI-7505, the FDA concurs with our interpretation of the results that the findings were negative, meaning ATI-7505 does not significantly increase the QT interval at the proposed therapeutic or supratherapeutic doses. Since the QT interval is an important measure of cardiac safety, this result supports our belief that ATI-7505 does not lead to cardiac liabilities. On August 22, 2008, we announced the results of a Phase 2b clinical trial testing the safety and efficacy of ATI-7505 in patients with chronic idiopathic constipation. The clinical trial, conducted by P&G, was designed to enroll 400 patients evaluating four doses of the agent compared to placebo. As a result of the termination of the collaboration between ARYx and P&G, the study was terminated early after only 214 patients had been enrolled. In spite of the early termination of the study, ATI-7505 achieved statistical significance at the study’s primary endpoint in the 80 milligram twice daily dose. In addition, all doses tested demonstrated a clinically meaningful and desired increase in spontaneous bowel movements over baseline compared to placebo after one week of treatment. We are now actively seeking a new pharmaceutical company partner to complete the development and eventually commercialize ATI-7505, in the event we obtain requisite regulatory approval.

ATI-9242

ATI-9242 is a novel antipsychotic agent in Phase 1 clinical development for the treatment of schizophrenia and other psychiatric disorders. ATI-9242’s receptor profile is targeted at the treatment of both the positive and the negative symptoms of schizophrenia as well as the improvement of cognitive function. To date, preclinical work has supported this profile. ATI-9242 is designed to avoid certain drug-drug interactions by avoiding CYP450 enzymes for metabolism and reduce certain metabolic problems associated with this class of therapy, including weight gain and type 2 diabetes. The Phase 1 single-dose clinical trial, testing the safety and tolerability of ATI-9242, is underway and is expected to be completed as financial resources allow.

Research and Development Expense

Our research and development, or R&D, expense consists of expenses incurred in identifying, testing and developing our product candidates. These expenses consist primarily of fees paid to contract research organizations and other third parties to assist us in managing, monitoring and analyzing our clinical trials, clinical trial costs paid to sites and investigators’ fees, costs of non-clinical studies including toxicity studies in animals, costs of contract manufacturing services, costs of materials used in clinical trials and non-clinical studies, laboratory related expenses, R&D support costs including certain regulatory, quality assurance, project management and administration, allocated expenses such as facilities and information technology that are used to support our research and development activities and related personnel expenses, including stock-based compensation. R&D costs are expensed as incurred.

Clinical trial costs are a significant component of our R&D expense. Currently, we conduct our clinical trials primarily through coordination with contract research organizations and other third-party service providers. We recognize research and development expense for these activities based upon a variety of factors, including actual and estimated patient enrollment, clinical site initiation activities, direct pass-through costs and other activity-based factors.

The following table summarizes our R&D expense for the three and six months ended June 30, 2009 and 2008:

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	Three Months Ended June 30,					Six Months Ended June 30,
	2009		2008			2009			2008
	(in thousands)
Direct R&D expense by product candidate:
Budiodarone	$	69	$	1,389		$	707		$	3,338
Tecarfarin	2,665		4,494			5,491			6,081
ATI-7505	64		546			116			1,092
ATI-9242	51		57			(56		)	133
Other research programs	56		394			100			648
Total direct R&D expense	2,905		6,880			6,358			11,292
R&D personnel, administrative and other expense	3,366		3,178			6,702			6,392
Less: R&D portion of the cost of collaboration service revenue	—		(13		)	—			(39		)
Total R&D expense	6,271		$	10,045		$	13,060		$	17,645

From our inception through June 30, 2009, we estimate that approximately $25.0 million was incurred for our budiodarone product candidate, approximately $38.3 million of expense was incurred for our tecarfarin product candidate, approximately $22.6 million was incurred for our ATI-7505 product candidate, approximately $5.0 million was incurred for our ATI-9242 product candidate, and approximately $64.7 million was incurred for costs related to our R&D personnel, administrative and other research programs.

The expenditures summarized in the above table reflect costs directly attributable to each product candidate and to our other research programs. We do not allocate salaries, employee benefits, or other indirect costs to our product candidates or other research programs and have included those expenses in “R&D personnel, administrative and other expense” in the above table. The portion of our R&D expense that is identified as cost of collaboration service revenue is included within a separate category of expense in our condensed consolidated financial statements and is subtracted from total expenses in the above table to derive total research and development expense as reported in our condensed consolidated financial statements.

At this time, due to the risks inherent in the clinical trial process and given the various stages of development of our product candidates, we are unable to estimate with any certainty the costs we will incur in the continued development of our product candidates. Clinical development timelines, the probability of success and development costs can differ materially from expectations. While we are currently focused on advancing each of our product candidates, our future research and development expense will depend on the clinical success of each product candidate, as well as ongoing assessments as to each product candidate’s commercial potential. In addition, we cannot forecast with any degree of certainty which product candidates will be subject to future collaborations, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements.

The process of developing and obtaining FDA approval of products is costly and time consuming. Development activities and clinical trials can take years to complete, and failure can occur at any time during the development and clinical trial process. In addition, the results from early clinical trials may not be predictive of results obtained in subsequent and larger clinical trials, and product candidates in later stages of clinical trials may fail to show the desired safety and efficacy despite having progressed successfully through initial clinical testing. Although our approach to identifying and developing new product candidates is designed to mitigate risk, the successful development of our product candidates is highly uncertain. Further, even if our product candidates are approved for sale, they may not be successfully commercialized and therefore the future revenue we anticipate may not materialize.

If we fail to complete the development of any of our product candidates in a timely manner, it could have a material effect on our operations, financial position and liquidity. In addition, any failure by us or our partners to obtain, or any delay in obtaining, regulatory approvals for our product candidates could have a material adverse effect on our results of operations. A further discussion of the risks and uncertainties associated with completing our programs on schedule, or at all, and certain consequences of failing to do so are discussed in Part II—Item 1A. “Risk Factors” section of this report.

Critical Accounting Policies and Significant Estimates

We have prepared our consolidated financial statements in accordance with U.S. generally accepted accounting principles. Accordingly, we have had to make estimates, assumptions and judgments that affect the amounts reported in our consolidated financial statements. These estimates, assumptions and judgments about future events and their effects on our results cannot be determined with certainty, and are made based upon our historical experience and on other assumptions that are believed to be reasonable under the circumstances. These estimates may change as new events occur or additional information is obtained, and we may periodically be faced with uncertainties, the outcomes of which are not within our control and may not be known for a prolonged period of time.

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Our critical accounting policies are more fully described in Note 1 of the audited consolidated financial statements for the year ended December 31, 2008, which are included in our annual report on Form 10-K filed with the Securities and Exchange Commission. There have been no material changes in our critical accounting policies and significant estimates during the three and six months ended June 30, 2009.

Results of Operations

Comparison of Three and Six Months Ended June 30, 2009 and 2008

Revenue

	Three Months Ended									Six Months Ended
	June 30,				Change					June 30,				Change
	2009		2008		$			%		2009		2008		$			%
	(In thousands, except %)
Collaboration service revenue	$	—	$	164	$	(164	)	(100	)%	$	—	$	232	$	(232	)	(100	)%
Technology license fees	—		974		(974		)	(100	)%	—		1,948		(1,948		)	(100	)%
Total revenue	$	—	$	1,138	$	(1,138	)	(100	)%	$	—	$	2,180	$	(2,180	)	(100	)%

We generated no revenue for the three and six months ended June 30, 2009. Revenue for the three months ended June 30, 2009, as compared to the same period in 2008, decreased by $1.1 million. Revenue for the six months ended June 30, 2009, as compared to the same period in 2008, decreased by $2.2 million. Our only source of revenue in 2008 was in connection with our prior collaboration agreement with P&G for the licensing of our ATI-7505 product candidate and for providing pharmaceutical development and other services to P&G. The decrease in revenue was due to the termination of the collaboration agreement with P&G in July 2008.

Cost of Collaboration Service Revenue

	Three Months Ended									Six Months Ended
	June 30,				Change					June 30,				Change
	2009		2008		$			%		2009		2008		$			%
	(In thousands, except %)
Cost of collaboration service revenue	$	—	$	164	$	(164	)	(100	)%	$	—	$	232	$	(232	)	(100	)%

We incurred costs for certain services provided in connection with our prior collaboration agreement with P&G, including costs for pharmaceutical development, patent filing and maintenance and other activities related to the ATI-7505 product candidate. We did not generate any collaboration service revenue nor associated cost for the three and six months ended June 30, 2009. The $164,000 and $232,000 decreases in cost of revenue for the three and six months ended June 30, 2009, respectively, as compared to the same periods in 2008, were the result of the termination of the collaboration agreement with P&G in July 2008.

Research and Development Expense

	Three Months Ended									Six Months Ended
	June 30,				Change					June 30,				Change
	2009		2008		$			%		2009		2008		$			%
	(In thousands, except %)
Research and development expense	$	6,271	$	10,045	$	(3,774	)	(38	)%	$	13,060	$	17,645	$	(4,585	)	(26	)%

For the three months ended June 30, 2009, as compared to the same period in 2008, our research and development expense decreased by $3.8 million, or 38%. The decrease was primarily due to:

· a $1.3 million reduction in expenditures as a result of the substantive completion of our budiodarone Phase 2b clinical study in December 2008;

· a $1.2 million reduction in drug manufacturing cost and a $450,000 reduction in non-clinical studies expenditures associated with our tecarfarin development program;

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· a $500,000 reduction in expenditures related to the substantial completion of a ATI-9242 Phase 1 clinical study;

· a $300,000 reduction in expenditures related to our other research programs.

For the six months ended June 30, 2009, as compared to the same period in 2008, our research and development expense decreased by $4.6 million, or 26%. The decrease was primarily due to:

· a $2.6 million reduction in expenditures as a result of the substantive completion of our budiodarone Phase 2b clinical study in December 2008;

· a $2.2 million reduction in drug manufacturing and non-clinical studies expenditures associated with our tecarfarin development program;

· a $1.1 million reduction in clinical trial expenditures as a result of the completion of a pilot clinical study on tecarfarin, partially offset by a $2.6 million increase in clinical trial expenditures related to the double-blinded, placebo-controlled tecarfarin Phase 2/3 clinical trial; and

· a $1.2 million reduction in expenditures related to the completion of five cohorts of patient studies in a ATI-9242 Phase 1 clinical study.

Selling, General and Administrative Expense

	Three Months Ended									Six Months Ended
	June 30,				Change					June 30,				Change
	2009		2008		$			%		2009		2008		$			%
	(In thousands, except %)
Selling, general and administrative expense	$	2,622	$	2,664	$	(42	)	(2	)%	$	5,225	$	5,596	$	(371	)	(7	)%

The lower selling, general and administrative expense for the three and six months ended June 30, 2009 as compared to the same periods in 2008 was primarily due to a reduction in legal expenses in connection with the initiation of our Phase 2/3 clinical trial on tecarfarin, lower international patent filing costs, and a restructuring of executive bonuses to a contingent milestone basis.

Interest and Other Income, Net

	Three Months Ended									Six Months Ended
	June 30,				Change					June 30,				Change
	2009		2008		$			%		2009		2008		$			%
	(In thousands, except %)
Interest and other income, net	$	11	$	308	$	(297	)	(96	)%	$	65	$	857	$	(792	)	(92	)%

Interest and other income, net of other expenses, consist primarily of interest income from our investments in marketable securities reduced by certain expenses such as state franchise tax. Lower interest income for the three and six months ended June 30, 2009 as compared to the same periods in 2008 was attributable to lower prevailing short-term interest rates and a lower cash balance in our investment portfolio.

Interest Expense

	Three Months Ended								Six Months Ended
	June 30,				Change				June 30,				Change
	2009		2008		$		%		2009		2008		$		%
	(In thousands, except %)
Interest expense	$	496	$	469	$	27	6	%	$	996	$	963	$	33	4	%

The increase in interest expense for the three and six months ended June 30, 2009 as compared to the same periods in 2008 was primarily due to additional equipment financing provided to us by Oxford Finance Corporation in December 2008.

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Other-Than-Temporary Impairment Loss

	Three Months Ended							Six Months Ended
	June 30,				Change			June 30,				Change
	2009		2008		$		%	2009		2008		$		%
	(In thousands, except %)
Other-than-temporary impairment loss	$	14	$	—	$	14	N/A	$	14	$	—	$	14	N/A

For the three and six months ended June 30, 2009, we recorded an additional $14,000 impairment loss due to an estimated decline in fair value of our remaining auction rate security that we determined to be other than temporary. As of June 30, 2009, the carrying value of this instrument was $353,000.

Liquidity and Capital Resources

	Six Months Ended
	June 30,
	2009			2008
	(In thousands)
Cash (used in) provided by:
Operating activities	$	(22,091	)	$	(22,250	)
Investing activities	(1,931		)	(6,223		)
Financing activities	(44		)	7,533
Total cash (used) provided	$	(24,066	)	$	(20,940	)

As of June 30, 2009, we had $22.6 million in cash, cash equivalents and marketable securities. While our cash resources as of June 30, 2009 are less than the amount needed for us to maintain our current operations for the next 12 months, we believe that our cash, cash equivalents and marketable securities on hand will be sufficient to fund our operations through the end of the first quarter of 2010. Since our inception, we have incurred significant net operating losses and, as of June 30, 2009, we had an accumulated deficit of $173.2 million. Our ability to continue operations is dependent upon our ability to obtain substantial additional capital to continue our R&D programs and to bring any potential future products to market. In order to satisfy our projected cash needs for at least the next 12 months, we are considering various options that may be available to us, including entering into collaborative arrangements for one or more of our product candidates, public or private equity financings, debt financing or a combination of the aforementioned. However, there is no assurance that we will be able to raise additional capital on terms acceptable to us or at all. Furthermore, any additional equity financings may be dilutive to stockholders and debt financing, if available, may involve covenants that place substantial restrictions on our business. If we fail to raise sufficient capital as and when needed, we have developed contingency plans that may require us to delay, reduce the scope of, or eliminate one or more of our R&D programs, partner one or more of our product candidates at an earlier stage of development than we might otherwise choose, or to reduce personnel and related costs and other discretionary expenditures that are within our control.

Due to adverse developments in global financial markets, we have experienced reduced liquidity with respect to our investment in a single auction rate instrument. If the need arose to liquidate this security before maturity, we may experience realized losses upon liquidation. Due to the short duration of all instruments held within our investment portfolio with the exception of one auction rate instrument, we believe that we have the ability to hold all but one of these securities to maturity when they are expected to be redeemed at par value.

Net cash used in operating activities was $22.1 million and $22.3 million for the six months ended June 30, 2009 and 2008, respectively. Net cash used in each of these periods was primarily used towards the funding of our operating costs and expenses in connection with the conduct of our research, development and administrative activities.

Cash used in investing activities primarily consists of purchases, sales and maturities of marketable securities, as well as changes in restricted cash balances and purchases of property and equipment. Cash used in investing activities during the six months ended June 30, 2009 decreased, as compared to the same period in 2008, primarily due to lower net purchases of marketable securities. Net purchases of marketable securities were $1.8 million for the six months ended June 30, 2009, compared to $5.4 million for the same period in 2008. Purchases of property and equipment were $89,000 for the six months ended June 30, 2009, compared to $556,000 for the same period in 2008. Cash used in investing activities for the six months ended June 30, 2008 also included a $300,000 increase in restricted cash.

Net cash used in financing activities was $44,000 for the six months ended June 30, 2009, and net cash provided by financing activities was $7.5 million for the six months ended June 30, 2008. Net cash used in financing activities for the six months ended June 30, 2009 primarily consisted of principal payments on our long-term debt offset by proceeds from employee purchases of our common stock pursuant to an offering under our 2007 Employee Stock Purchase Plan. Net cash provided by financing activities for the six months ended June 30, 2008 was primarily due to the utilization of the $9.0 million loan facility extended to us by Lighthouse Capital Partners, net of $1.5 million principal payments on our long-term debt.

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Our future funding requirements will depend upon many factors, including:

· the terms and timing of any collaborative, licensing and other arrangements that we may establish, if any;

· the scope, rate of progress, results and cost of our preclinical testing, clinical trials and other research and development activities;

· the cost, timing and outcomes of regulatory approvals;

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

· the cost and timing of establishing sales, marketing and distribution capabilities;

· the cost of establishing clinical and commercial supplies of our product candidates and any products that we may develop;

· the timing, receipt and amount of sales or royalties generated, if any, from our product candidates; and

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

In order to provide for our long-term objective of product commercialization and continued investment in our R&D pipeline, 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 R&D programs. We may seek to raise any necessary additional funds through public or private equity, debt financings, collaborative arrangements with corporate partners or other sources. If we raise additional funds through the issuance of debt securities, these securities could have rights that are senior to the holders of our common stock and could contain covenants that restrict our operations. If we raise additional funds by issuing equity securities, dilution to our existing stockholders may result. In addition, if we raise additional funds through the sale of equity securities, new investors could have rights superior to our existing stockholders. To the extent that we raise additional capital through licensing arrangements or arrangements with collaborative partners, 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 for a higher profit margin. The terms of future financings may restrict our ability to raise additional capital, which could delay or prevent the further development of our product candidates or commercialization of our products. Our failure to raise capital when needed may harm our business and operating results.

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Contractual Obligations

There were no material changes to our contractual obligations from those disclosed in our annual report on Form 10-K for the year ended December 31, 2008, filed with the Securities and Exchange Commission on March 27, 2009, other than scheduled payments made through June 30, 2009.

Recent Accounting Pronouncements

See Note 1 of the Notes to our Condensed Consolidated Financial Statements included elsewhere in this report for recent accounting pronouncements that could have an effect on us.

Off-Balance Sheet Arrangements

Since inception, except for standard operating leases, we have not engaged in any off-balance sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There were no material changes to our market risk from those disclosed in our annual report on Form 10-K for the year ended December 31, 2008, filed with the Securities and Exchange Commission on March 27, 2009.

ITEM 4T. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.

As of June 30, 2009, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations described below, our disclosure controls and procedures were effective as of June 30, 2009.

Limitations on the Effectiveness of Controls

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. 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 the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Changes in Internal Control over Financial Reporting

No change was made in our internal control over financial reporting during the quarter ended June 30, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time we are involved in legal proceedings arising in the ordinary course of our business. We believe there is no litigation pending that could have, individually or in the aggregate, a material adverse effect on our results of operations or financial condition.

ITEM 1A. RISK FACTORS

We have identified the following risks and uncertainties that may have a material adverse effect on our business, financial condition or results of operations. The risks described below are not the only ones we face. Additional risks not presently known to us or that we currently believe are immaterial may also significantly impair our business operations. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks, and our investors may lose all or part of their investment. We have marked with an asterisk (*) those risks described below that reflect substantive changes from the risks described in our Annual Report on Form 10-K for the year ended December 31, 2008, filed with the Securities and Exchange Commission on March 27, 2009. In assessing these risks, you should also refer to the other information contained in this quarterly report on Form 10-Q, including our financial statements and related notes.

Risks Related to Our Business

We will need substantial additional funding and may be unable to raise capital when needed, which would force us to limit or cease our operations and related product development programs.*

As of June 30, 2009, we had $22.6 million in cash, cash equivalents and marketable securities on hand, which is less than the amount needed for us to maintain our current operations for the next 12 months. Our ability to continue operations is dependent upon our ability to obtain substantial additional capital. Our operations have consumed substantial amounts of cash since inception. We expect to continue to spend substantial amounts of cash to fund our operations, including research and development expenses and costs associated with the conduct of clinical trials for our product candidates. It is our intention to enter into collaboration arrangements to commercialize our product candidates. Within those arrangements, we may retain the commercial right to co-promote our products to selected physicians through a specialty sales force. However, should the collaboration arrangements fail to provide sufficient revenue to fund our operations adequately, we will need to raise additional capital to fund our operations and complete development of our product candidates. If any of our product candidates receive regulatory approval for commercial sale, we may need to raise additional capital to fund our portion of the commercialization efforts. Our future funding requirements will depend on many factors, including:

· the terms and timing of any collaborative, licensing and other arrangements that we may establish, if any;

· the scope, rate of progress, results and cost of our preclinical testing, clinical trials and other research and development activities;

· the cost, timing and outcomes of regulatory approvals;

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

· the cost and timing of establishing sales, marketing and distribution capabilities for our specialty sales force;

· the cost of establishing clinical and commercial supplies of our product candidates and any products that we may develop;

· the timing, receipt and amount of sales or royalties, if any, from our potential products;

· 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.

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Until we can generate a sufficient amount of product revenue, if we ever do, we expect to finance future cash needs through corporate collaboration and licensing arrangements, public or private equity offerings, debt financings or through interest income earned on cash balances.

If we raise additional funds by issuing equity securities, our stockholders will experience dilution. Any debt financing or additional equity that we raise may contain terms that are not favorable to our stockholders or us. If we raise additional funds through collaboration and licensing arrangements with third parties, we may be required to relinquish some rights to our technologies or our product candidates, grant licenses on terms that are not favorable to us or enter into a collaboration arrangement for a product candidate at an earlier stage of development than we might otherwise choose.

We do not expect our existing capital resources to be sufficient to enable us to fund the completion of the development of any of our product candidates. Although we believe our current cash on hand is sufficient to fund our operations through the end of the first quarter of 2010, our operating plan may change, and we may need additional funds sooner than planned to meet operational needs and capital requirements for product development and commercialization. Additional funds may not be available when we need them on terms that are acceptable to us, or at all. If adequate funds are not available on a timely basis, we may:

· terminate or delay clinical trials for one or more of our product candidates;

· reduce our headcount and capital or operating expenditures;

· delay our establishment of sales and marketing capabilities or other activities that may be necessary to commercialize our product candidates; or

· curtail significant drug research and development programs that are designed to identify new product candidates.

We have incurred significant operating losses since inception and expect to continue to incur substantial and increasing losses for the foreseeable future. We may never achieve or sustain profitability.

We have a limited operating history and have incurred significant losses since our inception. As of June 30, 2009, we had an accumulated deficit of approximately $173.2 million. We expect our research and development expenses to continue to be a significant portion of our operating costs that may increase as we continue to expand our development programs subject to adequate funding. Subject to regulatory approval for any of our product candidates, we expect to incur significant expenses associated with the potential establishment of a North American specialty sales force and increased manufacturing expenses. Although it is not expected to occur in the next several years, the cost of establishing a small North American specialty sales force will be substantial. As a result, we expect to continue to incur substantial and increasing losses for the foreseeable future. These losses have had and will continue to have an adverse effect on our stockholders’ equity and working capital.

Because of the numerous risks and uncertainties associated with drug development, we are unable to predict the timing or amount of increased expense or when or if we will be able to achieve or sustain 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 financings, debt financings and a single corporate partnership with P&G that was terminated in July 2008. We have devoted substantially all of our efforts to research and development, including clinical trials. If we are unable to develop and commercialize any of our product candidates, if development is delayed, if sales revenue from any FDA-approved product candidate is insufficient or if we fail to enter into partnering arrangements for our product candidates on terms favorable to us, we may never become profitable. Even if we do become profitable, we may not be able to sustain or increase our profitability on a quarterly or annual basis.

In periods of worsening economic conditions, it may be difficult and costly for us to raise additional capital.

As a result of worsening market conditions, banks and other credit grantors have faced liquidity concerns and have tightened their lending standards, investors have become more risk adverse and economic growth has been negatively impacted. These factors are contributing to reduced credit availability and rising costs for issuers needing to raise additional capital. If these factors continue to affect the credit and equity markets, our ability to raise capital may be adversely affected, if not completely hindered.

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Global credit and financial market conditions could negatively impact the value of our current portfolio of cash equivalents or short-term investments.

Currently, there remains much caution in the U.S. economy due to a global credit crisis that has resulted in tightening credit markets and rising liquidity concerns across most industries, including the banking and investments sector. While as of the date of this filing we are not aware of any material losses, or other significant deterioration in the fair value of our cash equivalents or investments in marketable securities since June 30, 2009, no assurance can be given that further deterioration in conditions of the global credit and financial markets would not negatively impact our current portfolio of cash equivalents or investments in marketable securities or our ability to meet our financing objectives to allow us to continue our operations.

Our success depends substantially on our most advanced product candidates, which are still under development. If we are unable to bring any or all of these product candidates to market, or experience significant delays in doing so, our ability to generate product revenue and our likelihood of success will be harmed.

We have three product candidates in late stage clinical development, with tecarfarin in Phase 2/3 , and budiodarone and ATI-7505 in Phase 2b. A fourth product candidate, ATI-9242, entered into a Phase 1 clinical trial in April 2008. Our ability to generate product revenue in the future will depend heavily on the successful development and commercialization of these product candidates. Our other product candidates are in the discovery stage. Any of our product candidates could be unsuccessful for a variety of reasons, including that they:

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

· may not offer therapeutic, safety or other improvements over existing or future drugs used to treat the same conditions;

· may not be capable of being produced in commercial quantities at acceptable costs; or

· may not be accepted in the medical community or by third-party payors.

We do not expect any of our current product candidates to be commercially available in the next several years, 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. The results of our clinical trials to date do not provide assurance that acceptable efficacy or safety will be shown upon completion of Phase 3 clinical trials.

We expect to depend on collaborative arrangements to complete the development and commercialization of each of our product candidates. Potential collaborative arrangements will likely place the development of our product candidates outside of our control and will likely require us to relinquish important rights or may otherwise be on terms unfavorable to us.

We plan to enter into collaborative arrangements with third parties to develop and commercialize each of our lead product candidates. Dependence on collaborative arrangements for development and commercialization of our product candidates will subject us to a number of risks, including:

· we may not complete a collaborative arrangement in time to avoid delays in clinical development, if at all, and if no collaborative arrangement is achieved, product development may be halted altogether;

· we may not be able to control the amount and timing of resources that our collaborators may devote to the development or commercialization of product candidates or to their marketing and distribution;

· collaborators may delay clinical trials, provide insufficient funding for a clinical trial program, stop a clinical trial or abandon a product candidate, repeat or conduct new clinical trials or require a new formulation of a product candidate for clinical testing;

· we may have limited control over our clinical trial design;

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· disputes may arise between us and our collaborators 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 resources;

· our collaborators may experience financial difficulties;

· collaborators may not properly maintain or defend our intellectual property rights or may use our proprietary information in such a way as to invite litigation that could jeopardize or invalidate our proprietary information or expose us to potential litigation;

· business combinations or significant changes in a collaborator’s business strategy may adversely affect a collaborator’s willingness or ability to fulfill its obligations under any arrangement;

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

· any collaborative arrangement may be terminated or allowed to expire, which would delay the development and may increase the cost of developing our product candidates.

Collaborative arrangements do not currently exist for any of our product candidates. If we do not establish collaborations for each of our budiodarone, tecarfarin, ATI-7505 and ATI-9242 product candidates or future product candidates, we may have to alter our development and commercialization plans.

Our strategy includes selectively collaborating with leading pharmaceutical and biotechnology companies to assist us in furthering the development and potential commercialization of some of our product candidates, including budiodarone, tecarfarin, ATI-7505 and ATI-9242. We intend to seek partners because the commercialization of each of our first four product candidates involves a large, primary care market that must be served by large sales and marketing organizations and because we do not currently have the capabilities to perform Phase 3 clinical trials. We face significant competition in seeking appropriate collaborators, and these collaborations are complex and time-consuming to negotiate and document. We may not be able to negotiate collaborations on acceptable terms, if at all. We are unable to predict when, if ever, we will enter into any collaborations because of the numerous risks and uncertainties associated with establishing collaborations. If we are unable to negotiate an acceptable collaboration, we may have to curtail the development of a particular product candidate, reduce or delay its development program or one or more of our other development programs, delay its potential commercialization or reduce the scope of our sales or marketing activities or increase our expenditures and undertake development or commercialization activities at our own expense. 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, if at all. If we do not have sufficient funds, we will not be able to bring our product candidates to market and generate product revenues.

The commercial success of our potential collaborations will depend in part on the development and marketing efforts of our potential partners, over which we will have limited control. If our collaborations are unsuccessful, our ability to develop and commercialize and to generate future revenue from the sale of our products will be significantly reduced.

Our dependence on future collaboration arrangements will subject our company to a number of risks. Our ability to develop and commercialize each of our product candidates will depend on our and our potential collaboration partner(s)’ ability to establish the safety and efficacy of each respective product candidate, obtain and maintain regulatory approvals and achieve market acceptance of the product candidate(s) once commercialized. Our potential collaboration partner(s) may elect to delay or terminate development of our product candidates, independently develop products that compete with ours, or fail to commit sufficient resources to the marketing and distribution of our product candidates. The termination of a collaboration agreement may cause us to incur additional and unanticipated costs that may be material to our operations.

Business combinations, significant changes in business strategy, litigation and/or financial difficulties may also adversely affect the willingness or ability of our potential collaboration partners to fulfill their obligations to us. If a partner fails to perform in the manner we expect, our potential to develop and commercialize the respective product candidate(s) through other collaborations and to generate future revenue from the sale of the product candidate(s) may be significantly reduced. If a conflict of interest arises between us and our collaboration partner(s), they may act in their own self-interest and not in the interest of our company or our stockholders. If a collaboration partner breaches or terminates their collaboration agreement with us or otherwise fails to perform their obligations thereunder in a timely manner, the clinical development or commercialization of the respective product candidate(s) could be delayed or terminated. For example, we experienced this when P&G terminated our collaboration agreement to develop and commercialize ATI-7505, and we may experience a similar result with potential collaboration partners in the future with respect to any of our product candidates.

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If we are not able to obtain required regulatory approvals, we will not be able to commercialize our product candidates, our ability to generate revenue will be materially impaired and our business will not be successful.

Our product candidates and the activities associated with their development and commercialization are subject to comprehensive regulation by the FDA and other federal and state regulatory agencies in the United States and by comparable authorities in other countries. The inability to obtain FDA approval or approval from comparable authorities in other countries would prevent us and our collaborative partners from commercializing our product candidates in the United States or other countries. Future collaborative agreements will likely cause us to give up control of interactions and regulatory approval processes with the FDA and other regulatory bodies. We or our partners may never receive regulatory approval for the commercial sale of any of our product candidates. We have only limited experience in preparing and filing the applications necessary to gain regulatory approvals and have not received regulatory approval to market any of our product candidates in any jurisdiction. The process of applying for regulatory approval is expensive and time-consuming, and can vary substantially based upon the type, complexity and novelty of the product candidates involved.

Because our product candidates are modeled after drugs which are known to have safety problems, the FDA and other regulatory agencies may require additional safety testing which may delay our clinical progress, increase our expected costs or make further development unfeasible. For instance, because of known problems with the drug after which it was modeled, we were required to conduct significant monitoring for cardiac toxicity in our clinical studies of ATI-7505.

Changes in regulatory approval policies during the development period, changes in, or the enactment of, additional regulations or statutes or changes in the regulatory review team for each submitted product application may cause delays in the approval or rejection of an application. Even if the FDA or a foreign regulatory agency approves a product candidate, the approval may impose significant restrictions on the indicated uses, conditions for use, labeling, advertising, promotion, marketing and/or production of such product and may impose requirements for post-approval studies, including additional research and development and clinical trials. The FDA and other agencies also may impose various civil or criminal sanctions for failure to comply with regulatory requirements, including substantial monetary penalties and withdrawal of product approval.

The FDA has substantial discretion in the approval process and may refuse to accept any application or decide that our data are insufficient for approval and require additional preclinical, clinical or other studies. For example, varying interpretations of the data obtained from preclinical and clinical testing could delay, limit or prevent regulatory approval of a product candidate. Moreover, the FDA may not agree that certain target indications are approvable. For instance, the FDA has never approved a drug for postprandial distress syndrome, or PDS, and we cannot be certain that the FDA will recognize PDS as an indication for which ATI-7505 or other drugs can be approved. As another example, while we believe we have clear direction from the FDA as to the development path for our tecarfarin product candidate based on our initial discussions, the FDA may change their judgment on the appropriate development pathway for tecarfarin at any time. Similarly, the clinical trials to be required by the FDA for approval of new anti-arrythmic therapies may change as they consider the approval of similar therapies submitted by competing pharmaceutical companies.

We will need to obtain regulatory approval from authorities in foreign countries to market our product candidates in those countries. We have not yet initiated the regulatory process in any foreign jurisdictions. Approval by one regulatory authority does not ensure approval by regulatory authorities in other jurisdictions. If we fail to obtain approvals from foreign jurisdictions, the geographic market for our product candidates would be limited.

Safety issues relating to our product candidates or the original drugs upon which our product candidates have been modeled, or relating to approved products of third parties that are similar to our product candidates, could give rise to delays in the regulatory approval process.

Discovery of previously unknown problems with an approved product may result in restrictions on its permissible uses, including withdrawal of the medicine from the market. Each of the opportunities upon which we have chosen to focus is based upon our belief that our RetroMetabolic Drug Design technology can be used to create a new product based upon an existing product which is efficacious in treating a specific condition, but which has a known safety problem. Each of our four lead product candidates is modeled on drugs which have significant safety problems. Budiodarone is modeled on amiodarone which is used, but not approved, for atrial fibrillation in spite of known safety problems due to its accumulation in the body and interaction with other drugs. Both amiodarone and budiodarone contain iodine which can accumulate in the thyroid and must be monitored for safety purposes. In addition, budiodarone is partially metabolized by CYP450 and, at certain levels has

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caused drug-drug interactions with warfarin, which increased INR and could increase the risk of hemorrhage complications. Tecarfarin is modeled on warfarin which is known to have safety risks because of its potential for bleeding and for interactions with numerous other drugs as listed on the package insert for the product. ATI-7505 is modeled on cisapride which was withdrawn from the market due to fatal cardiac problems. ATI-9242 is modeled to retain certain of the positive features of the class of atypical antipsychotic drugs while lessening certain of the safety issues that vary but exist within the class. The receptor profile which yields the positive and avoids the negative features of this class of drugs is a matter of great debate. While we have designed ATI-9242 to have an appropriate balance across a very complex set of receptors, we may have targeted an inappropriate profile or the profile attained may result in an unanticipated lack of efficacy or safety problems. Although we have designed our drugs to largely address each of the original drugs’ key safety problems, we will need to continue to demonstrate this through continued clinical testing. It is possible that the FDA may impose additional requirements on the development or approval of our products because of its concern about the original drug’s safety problems. These potential additional barriers could delay, increase the cost of, or prevent the commercialization of our product candidates.

Our product candidates are engineered to be broken down by the body’s natural metabolic processes in a manner we believe to be safer than that of the original drug. There can be no assurance that the products we develop will actually be metabolized as we expect. While we have designed the breakdown products to be safe, it is possible that there will be unexpected toxicity associated with these breakdown products that could cause our products to be poorly tolerated by, or toxic to, humans. Additionally, while we believe we have addressed the key safety problem of each of the original drugs, it is possible that our change to the chemical structure may result in new unforeseen safety issues. Any unexpected toxicity or suboptimal tolerance of our products would delay or prevent commercialization of these product candidates. Additionally, problems with approved products marketed by third parties that utilize the same therapeutic target as our product candidates could adversely affect the development of our product candidates. For example, the product withdrawals of Vioxx by Merck & Co., Inc. and Bextra by Pfizer because of safety issues caused other drugs that have the same therapeutic target, such as Celebrex from Pfizer, to receive additional scrutiny from regulatory authorities. Another prokinetic, tegaserod marketed by Novartis Pharmaceuticals Corporation as Zelnorm, was temporarily withdrawn from the market and then reintroduced in a very limited manner due to certain cardiac effects reportedly related to its off-target effects. It is possible that we or a future collaboration partner may be required by regulatory agencies to perform tests, in addition to those we have planned, in order to demonstrate that ATI-7505 does not have the safety problems associated with Zelnorm. Any failure or delay in commencing or completing clinical trials or obtaining regulatory approvals for our product candidates would delay commercialization of our product candidates and severely harm our business and financial condition.

Any failure or delay in commencing or completing clinical trials for our product candidates could severely harm our business.

To date, we have not completed the clinical trial program of any product candidate. The commencement and completion of clinical trials for our product candidates may be delayed or terminated as a result of many factors, including:

· our inability or the inability of our collaborators or licensees to manufacture or obtain from third parties materials sufficient for use in preclinical studies and clinical trials;

· delays in patient enrollment, which we previously experienced in certain trials, and variability in the number and types of patients available for clinical trials;

· difficulty in maintaining contact with patients after treatment, resulting in incomplete data;

· poor effectiveness of product candidates during clinical trials;

· poor patient compliance while participating in one of our clinical trials;

· unforeseen safety issues or side effects; and

· governmental or regulatory delays and changes in regulatory requirements, policies and guidelines.

Any delay in commencing or completing clinical trials for our product candidates would delay commercialization of our product candidates and severely harm our business and financial condition. It is also possible that none of our product candidates will complete clinical trials in any of the markets in which our collaborators or we intend to sell those product candidates. Accordingly, our collaborators or we would not receive the regulatory approvals needed to market our product candidates, which would severely harm our business and financial condition.

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We rely on third parties to conduct 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 or commercialize our product candidates.

We do not have the ability to independently conduct clinical trials for our product candidates, and thus for each of our product candidates we must rely on third parties such as contract research organizations, medical institutions, clinical investigators and contract laboratories, to conduct our clinical trials. We have, in the ordinary course of business, entered into agreements with these third parties. To date, we have utilized numerous vendors to provide clinical trial management, data collection and analysis and laboratory and safety analysis services in the conduct of our clinical trials. In addition, to date we have conducted our clinical trials at numerous sites in North America and Europe. Nonetheless, we are responsible for confirming that each of our clinical trials is conducted in accordance with its general investigational plan and protocol. Moreover, the FDA requires us to comply with regulations and standards, commonly referred to as good clinical practices, for conducting and recording and reporting the results of clinical trials to assure that data and reported results are credible and accurate and that the trial participants are adequately protected. Our reliance on third parties that we do not control does not relieve us of these responsibilities and requirements. If these third parties do not successfully carry out their contractual duties or regulatory obligations or meet expected deadlines, if the third parties need to be replaced or if the quality or accuracy of the data they obtain is compromised owing to the failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our clinical trials may be extended, delayed, suspended or terminated, and we may not be able to obtain regulatory approval for, or successfully commercialize, our product candidates.

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 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. When referring to “our” patents and other intellectual property in this section, we are referring both to patents and other intellectual property that we own or license. We rely on composition of matter patents for the compounds we develop. We cannot guarantee that any patents will issue from any of our pending or future patent applications. Alternatively, 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 future 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, as applied to both existing and future patents and other intellectual property:

· 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 the disclosed inventions;

· others may independently develop similar or alternative technologies or duplicate our technologies;

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

· any patents issued to us or our collaborators may not provide protection for commercially viable products or may be challenged by third parties;

· the patents of others may have an adverse effect on our ability to do business; or

· regulators or courts may retroactively diminish the value of our intellectual property.

Even if valid and enforceable patents cover our product candidates and technologies, the patents will provide protection only for a limited amount of time. As our patents are based on a parent drug where much research has been conducted, we may encounter many competitive patents from covered analogs of the parent drug. Our know-how and trade secrets may only provide a competitive advantage for a short amount of time. Furthermore, we cannot guarantee that our patents, present or future, will have scope sufficient to prevent competing products.

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Our ability and our potential collaborators’ ability to obtain and enforce patents is highly uncertain because of the complexity of the scientific and legal issues involved and the subjective nature of issues upon which reasonable minds may differ. Legislative, judicial, and administrative bodies, both foreign and domestic, may issue laws, decisions, and regulations, respectively, that (a) detrimentally affect our ability to obtain protection for our technologies, (b) increase our costs of obtaining and maintaining patents, (c) detrimentally affect our ability to enforce our existing patents, (d) narrow the scope of our patent protection, and/or (e) otherwise diminish the value of our intellectual property in any of the following ways: 1) U.S. Federal Courts and foreign judicial authorities may render decisions that alter the application of the patent laws and detrimentally affect our ability to enforce our patents and obtain patent protection for our technologies; 2) the U.S. Patent and Trademark Office, or USPTO, and foreign counterparts may change the nature of how patent applications are examined and issue regulations that detrimentally affect our ability to obtain patent protection for our technologies and/or increase the costs for obtaining and maintaining protection; and/or 3) Congress and other foreign legislative bodies may make changes to their respective patent laws that may make obtaining and enforcing patents more difficult and/or costly, and/or otherwise 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 such patents are invalid and/or unenforceable. Defending against such challenges could be costly, and the outcome is inherently uncertain and may result in the loss of some or all of our rights. 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 FDA regulations and policies provide incentives to manufacturers to challenge patent validity or create modified, non-infringing versions of a drug 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.

Similarly, we may choose to challenge the patents and other rights alleged or asserted by third parties. Such challenges, whether judicial or administrative in nature, could be costly and the outcome uncertain. A negative outcome could detrimentally affect our ability to do business.

In addition, we may enter into agreements to license technologies and patent rights. Should we fail to comply with the terms of those license agreements, including payment of any required maintenance fees or royalties, or should the licensors fail to maintain their licensed interest in the licensed patents, we could lose the rights to those technologies and patents.

As of June 30, 2009, we held 45 issued or allowed U.S. patents and had 17 patent applications pending before the USPTO. For some of our inventions, corresponding foreign patent protection is pending. Of the 45 U.S. patents that we hold, 40 patents are compound and composition related, having expiration dates from 2013 to 2025. Our composition of matter patent for budiodarone, our compound for the treatment of atrial fibrillation, issued in April 2002 and has an expiration date in 2020. The composition of matter patent for tecarfarin, our compound for anticoagulation, issued in August 2007 and has an expiration date in 2025. The composition of matter patent for ATI-7505, our compound for the treatment of gastrointestinal disorders, issued in February 2007 and has an expiration date in 2025. Our composition of matter patent applications for ATI-9242, our product candidate for the treatment of schizophrenia and other psychiatric disorders, are currently pending, one in the United States and two in foreign jurisdictions. Although third parties may challenge our rights to, or the scope or validity of, our patents, to date we have not received any communications from third parties challenging our patents or patent applications covering our clinical candidates.

While budiodarone, tecarfarin and ATI-7505 are all covered in the United States by issued composition of matter patents, additional patent applications would be required to extend patent protection beyond 2020, 2025 and 2025, respectively (assuming the validity and enforceability of the current composition of matter patents). We cannot guarantee that any patents will be issued from our pending or future patent applications, and any patents that issue from such pending or future patent applications would be subject to the same risks described herein for currently issued patents.

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. In most cases, these individuals or entities are at the least precluded from publicly disclosing our confidential information and are only allowed to disclose other data or information generated during the course of the research after we have been afforded an opportunity to consider whether patent and/or other proprietary protection should be sought. 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.

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Failure to adequately protect our trade secrets and other intellectual property could substantially harm our business and results of operations.

We also rely on trade secrets to protect our technology, especially where we do not believe that patent protection is appropriate or obtainable. This is particularly true for our RetroMetabolic Drug Design technology. However, trade secrets are difficult to protect. Our employees, consultants, contractors, outside scientific collaborators and other advisors are required to sign confidential disclosure agreements but they 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 obtain or maintain trade secret protection could adversely affect our competitive business position.

Third-party claims of intellectual property infringement would require us to spend significant time and money and could prevent us from developing or commercializing our products.

Our commercial success depends in part on not infringing the patents and proprietary rights of other parties and not breaching any licenses that we have entered into with regard to our technologies and products. Because others may have filed, and in the future are likely to file, patent applications covering products or other technologies of interest to us that are similar or identical to ours, patent applications or issued patents of others may have priority over or dominate our patent applications or issued patents. There are numerous issued and applied for patents related to the original molecules and analogs of such from which our products are engineered. If the patents are determined to be valid and construed to cover our products, the development and commercialization of any or all could be affected. We do not believe that our activities infringe the patents of others or that the patents of others inhibit our freedom to operate, but we cannot guarantee that we have identified all United States and foreign patents and patent applications that pose a risk of infringement. We may be forced to litigate if an intellectual property dispute arises, and it is possible that others may choose to challenge our position and that a judge or jury will disagree with our conclusions. We could incur substantial costs in litigation if we are required to defend against patent suits brought by third parties. If we do not successfully defend an infringement action, are unable to have infringed patents declared invalid, and do not obtain a license to the patented technology, we may,

· incur substantial monetary damages;

· encounter significant delays in marketing our products; and

· be unable to conduct or participate in the manufacture, use or sale of our products or methods of treatment.

Similarly, if we initiate suits to defend our patents, such litigation could be costly and there is no assurance we would be successful in such processes. Any legal action against our collaborators or us claiming damages and seeking to enjoin commercial activities relating to the affected products and processes could, in addition to subjecting us to potential liability for damages, require our collaborators or us to obtain a license to continue to manufacture or market the affected products and processes. Licenses required under any of these patents may not be available on commercially acceptable terms, if at all. Failure to obtain such licenses could materially and adversely affect our ability to develop, commercialize and sell our product candidates. We believe that there may continue to be significant litigation in the biotechnology and pharmaceutical industry regarding patent and other intellectual property rights. If we become involved in litigation, it could consume a substantial portion of our management and financial resources and we may not prevail in any such litigation.

Furthermore, our commercial success will depend, in part, on our ability to continue to conduct research to identify additional product candidates in current indications of interest or opportunities in other indications. Some of these activities may involve the use of genes, gene products, screening technologies and other research tools that are covered by third-party patents. In some instances, we may be required to obtain licenses to such third-party patents to conduct our research and development activities, including activities that may have already occurred. It is not known whether any license required under any of these patents would be made available on commercially acceptable terms, if at all. Failure to obtain such licenses could materially and adversely affect our ability to maintain a pipeline of potential product candidates and to bring new products to market. If we are required to defend against patent suits brought by third parties relating to third-party patents that may be relevant to our research activities, or if we initiate such suits, we could incur substantial costs in litigation. Moreover, the results of any such litigation are uncertain, and an adverse result from any legal action in which we are involved could subject us to damages and/or prevent us from conducting some of our research and development activities.

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If third parties do not manufacture our product candidates in sufficient quantities or at an acceptable cost, clinical development and commercialization of our product candidates would be delayed.

We presently do not have sufficient quantities of our product candidates to complete clinical trials of any of our lead product candidates. We do not currently own or operate manufacturing facilities, and we rely and expect to continue to rely on a small number of third-party manufacturers and active pharmaceutical ingredient formulators for the production of clinical and commercial quantities of our product candidates. We do not have long-term agreements with any of these third parties, and our agreements with these parties are generally terminable at will by either party at any time. If for any reason, these third parties are unable or unwilling to perform under our agreements or enter into new agreements, we may not be able to locate alternative manufacturers or formulators or enter into favorable agreements with them. Any inability to acquire sufficient quantities of our product candidates in a timely manner from these third parties could delay clinical trials and prevent us from developing and commercializing our product candidates in a cost-effective manner or on a timely basis.

The starting materials for the production of budiodarone are provided by the following vendors: SCI Pharmtech, Inc., Lexen Inc., Panchim, Julich GmbH and Weylchem Inc. To date, Ricerca, Biosciences, LLC, ScinoPharm Ltd. and SCI Pharmtech have produced all of budiodarone’s active pharmaceutical ingredient. Historically, we have relied on Ricerca, ScinoPharm and SCI Pharmtech as single-source suppliers for budiodarone’s active pharmaceutical ingredients. In the event that Ricerca, Biosciences, LLC, ScinoPharm Ltd. or SCI Pharmtech is unable or unwilling to serve as the supplier of budiodarone, we might not be able to manufacture budiodarone’s active pharmaceutical ingredient. This could delay the development of, and impair our ability to, commercialize budiodarone. To produce budiodarone drug product, drug substance is processed into 50 milligram or 200 milligram capsule forms by Patheon Inc. of Mississauga, Ontario.

The starting materials for the production of tecarfarin are provided by Synquest Labs, Inc. and Chem Uetikon, GmbH. To date, the active pharmaceutical ingredient for tecarfarin has been produced by ChemShop BV of the Netherlands and Corum Inc. of Taiwan on an ongoing purchase order basis. Should ChemShop BV or Corum Inc. be unable or unwilling to serve as the supplier of tecarfarin, a delay in the development of tecarfarin could occur, impairing our ability to commercialize tecarfarin on our existing timeline. Tecarfarin’s active pharmaceutical ingredient is processed into 1 milligram, 2 milligram, 5 milligram or 10 milligram tablets by QS Pharma of Boothwyn, PA.

The starting materials for the production of ATI-7505 are provided by the following vendors: SCI Pharmtech, Inc., Corum, Inc. and Lexen Inc. To produce ATI-7505 drug products, drug substance is processed into 20 milligram or 40 milligram tablet form by Pharmaceutics International, Inc. of Hunt Valley, MD. In the event that any of these vendors are unable or unwilling to produce sufficient quantities of material for the manufacture of ATI-7505, the development and/or commercialization of ATI-7505 could be delayed or impaired.

The starting materials for the production of ATI-9242 are provided by the following vendors: Corum Inc., Alfa Aesar, Apollo Scientific Ltd., and SKECHEM. To date, the active pharmaceutical ingredient for ATI-9242 has been produced exclusively by Corum Inc. in Taiwan. In the event that Corum Inc. is unable or unwilling to serve as the supplier of ATI-9242, we would not be able to manufacture ATI-9242’s active pharmaceutical ingredient. This could delay the development of, and impair our ability to, commercialize ATI-9242. To produce ATI-9242 drug product, drug substance is processed into 20 milligram capsule form by Xcelience LLC of Tampa, FL.

All of our current arrangements with third-party manufacturers and suppliers for the production of our product candidates are on a purchase order basis. We currently do not have long-term supply contracts with any of the third-party manufacturers and suppliers for our product candidates, and they are not required to supply us with products for any specified periods, in any specified quantities or at any set price, except as may be specified in a particular purchase order. We have no reason to believe that any of the current manufacturers and suppliers for our product candidates is the sole source for the materials they supply us. However, if we were to lose one of these vendors and were unable to obtain an alternative source on a timely basis or on terms acceptable to us, our clinical and production schedules could be delayed. In addition, to the extent that any of these vendors uses technology or manufacturing processes that are proprietary, we may be unable to obtain comparable materials from alternative sources.

If we are required to obtain alternate third-party manufacturers, it could delay or prevent the clinical development and commercialization of our product candidates.

We may not be able to maintain or renew our existing or any other third-party manufacturing arrangements on acceptable terms, if at all. If we are unable to continue relationships with our current suppliers, or to do so at acceptable costs, or if these suppliers fail to meet our requirements for these product candidates for any reason, we would be required to obtain alternative suppliers. Any inability to obtain qualified alternative suppliers, including an inability to obtain or delay in obtaining approval of an alternative supplier from the FDA, would delay or prevent the clinical development and commercialization of these product candidates.

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Changes in manufacturing site, process or scale can trigger additional regulatory requirements that could delay our ability to perform certain clinical trials or obtain product approval.

The manufacturing and formulation of each of our lead product candidates that have been tested in humans to date has been performed by entities other than those that will likely manufacture the products for future clinical trials or commercial use. There is a possibility that analysis of future clinical trials will show that the results from our earlier clinical trials have not been replicated. The failure to replicate these earlier clinical trials would delay our clinical development timelines. New impurity profiles that occur as a result of changing manufacturers may lead to delays in clinical trial testing and approvals.

Use of third-party manufacturers may increase the risk that we will not have adequate supplies of our product candidates.

Our current and anticipated future reliance on third-party manufacturers will expose us and our future collaborative partners to risks that could delay or prevent the initiation or completion of our clinical trials, the submission of applications for regulatory approvals, the approval of our product by the FDA or the commercialization of our products, and may result in higher costs or lost product revenues. In particular, our contract manufacturers could:

· encounter difficulties in achieving volume production, quality control and quality assurance or suffer shortages of qualified personnel, which could result in their inability to manufacture sufficient quantities of drugs to meet our clinical schedules or to commercialize our product candidates;

· terminate or choose not to renew manufacturing agreements, based on their own business priorities, at a time that is costly or inconvenient for us;

· fail to establish and follow FDA-mandated current good manufacturing practices, or cGMPs, which are required for FDA approval of our product candidates, or fail to document their adherence to cGMPs, either of which could lead to significant delays in the availability of material for clinical studies and delay or prevent marketing approval for our product candidates; and

· breach or fail to perform as agreed under manufacturing agreements.

If we are not able to obtain adequate supplies of our product candidates, it will be more difficult for us to develop our product candidates and compete effectively. Our product candidates and any products that we may develop may compete with other product candidates and products for access to manufacturing facilities.

In addition, Lexen, SCI Pharmtech, Scinopharm, Corum Inc. and ChemShop BV are located outside of the United States. This may give rise to difficulties in importing our product candidates or their components into the United States as a result of, among other things, FDA import inspections, incomplete or inaccurate import documentation, or defective packaging.

If our preclinical studies do not produce successful results or our clinical trials do not demonstrate safety and efficacy in humans, we will not be able to commercialize our product candidates.

To obtain the requisite regulatory approvals to market and sell any of our product candidates, we must demonstrate, through extensive preclinical studies and clinical trials, that the product candidate is safe and effective in humans. To date, we have not completed all required clinical trials of any product candidate. Preclinical and clinical testing is expensive, can take many years and has an uncertain outcome. A failure of one or more of our clinical trials could occur at any stage of testing. In addition, success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful, and interim results of a clinical trial do not necessarily predict final results. We may experience numerous unforeseen events during, or as a result of, preclinical testing and the clinical trial process, which could delay or prevent our ability to commercialize our product candidates, including:

· regulators or institutional review boards may not authorize us to commence a clinical trial at a prospective trial site;

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· our preclinical studies or clinical trials may produce negative or inconclusive results, which may require us to conduct additional preclinical or clinical testing or to abandon development projects;

· we may suspend or terminate our clinical trials if the participating patients are being exposed to unacceptable health risks;

· regulators or institutional review boards may suspend or terminate clinical research for various reasons, including noncompliance with regulatory requirements;

· the effects of our product candidates may not be the desired effects or may include undesirable side effects; and

· our preclinical studies or clinical trials may show that our product candidates are not superior to the original drugs on which our product candidates are modeled.

For instance, our preclinical studies and clinical trials may indicate that our product candidates cause unexpected drug-drug interactions and result in adverse events. For example, budiodarone’s preclinical studies contain results that are currently being monitored in the clinic. Inhibition of testicular function was observed in one animal species as part of these studies. No such effect has been observed to date in the clinic and monitoring continues. In published studies, a similar effect is thought to be correlated with the accumulation of amiodarone in tissues. A possible renal effect was also observed at high doses in our rat and dog toxicology studies for budiodarone. While we will continue to monitor patients for these effects, there is no assurance these effects will not occur in patients as part of our clinical trials for budiodarone, and have a resulting adverse effect on our ability to obtain requisite regulatory approval to market and sell budiodarone. Similarly, in the clinical testing of budiodarone in patients whose condition also required treatment with warfarin, dose adjustments of warfarin were sometimes required. As is common to most clinical trials, the potential for drug-drug interactions will be monitored. As another example, due to the result of our Phase 2/3 clinical trial of tecarfarin, additional clinical trials of tecarfarin will be necessary in order to demonstrate clinical superiority to warfarin. Even if we adequately demonstrate that tecarfarin is safe and effective and obtain FDA approval, we may not be permitted to market it as superior to warfarin. In a canine toxicology study of ATI-7505 performed by our former collaboration partner, P&G, six deaths occurred at doses that were 10 and 20 times greater than doses currently being used in clinical trials. Our clinical trials to date have indicated only mild to moderate side effects in humans. However, further observation is warranted.

Even when our product candidates do not cause any adverse effects, clinical studies of efficacy may show that our product candidates do not have significant effects on target symptoms or may be inconclusive. For example, ATI-7505 was tested in two Phase 2 clinical trials in which the primary endpoints were not met in comparison to placebo. Although these studies did support ATI-7505’s efficacy against certain symptoms as secondary endpoints, if future studies show that ATI-7505 is not sufficiently efficacious to justify its use as a therapy, our business and prospects may be materially adversely affected. In addition, we may need to reformulate the ATI-9242 drug product should we find in our on-going Phase 1 testing that adequate blood levels are not achieved with our current formulation.

Unforeseen events could cause us to experience significant delays in, or the termination of, clinical trials. Any such events would increase our costs and could delay or prevent our ability to commercialize our product candidates, which would adversely impact our financial results.

We may not be successful in our efforts to identify or discover additional candidates using our RetroMetabolic Drug Design Technology.

An important element of our strategy is to continue to identify existing molecules which have demonstrated efficacy, but have safety problems that are amenable to our RetroMetabolic Drug Design technology. Other than budiodarone, tecarfarin, ATI-7505 and ATI-9242, all of our programs are in the preclinical or discovery stage. Research programs to identify new product candidates require substantial technical, financial and human resources. These programs may initially show promise in identifying potential product candidates, yet fail to yield product candidates for clinical development for a number of reasons, including:

· the research methodology used may not be successful in identifying potential product candidates; or

· potential product candidates may, on further study, be found not to retain the efficacy profile of the original molecule or be shown to retain harmful side effects or other characteristics suggesting that they are unlikely to be effective products. For instance, at high doses our budiodarone product candidate interacts with warfarin and causes prolonged INR which could increase the risk of hemorrhage complications.

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If we are unable to develop suitable product candidates through internal research programs or otherwise, we may not be able to increase our revenues in future periods, which could result in significant harm to our financial position and adversely impact our stock price.

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 our products could be suspended.

Even if we receive regulatory approval to market a particular product candidate, the approval could be conditioned on our conducting additional costly post-approval studies, implementing a Risk Evaluation and Mitigation Strategy, or REMS, if the FDA determines that a REMS is necessary to ensure the benefits of the drug outweigh the risks, or could limit the indicated uses included in our 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, the manufacturer of the product and its facilities will continue to be subject to FDA review and periodic inspections to ensure adherence to applicable GMPA regulations. After receiving marketing approval, the manufacturing, labeling, packaging, adverse event reporting, storage, advertising, promotion and record keeping related to the product will remain subject to extensive regulatory requirements.

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 our products, manufacturers or manufacturing processes are discovered, we could be subject to administrative or judicially imposed sanctions, including:

· restrictions on the products, manufacturers or manufacturing processes;

· warning letters;

· civil or criminal penalties or fines;

· injunctions;

· product seizures, detentions or import bans;

· voluntary or mandatory product recalls and publicity requirements which could vary in foreign jurisdictions;

· 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.

Because we have a number of product candidates and are considering a variety of target indications, we may expend our limited resources to pursue a particular candidate or indication and fail to capitalize on candidates or indications that may be more profitable or for which there is a greater likelihood of success.

Because we have limited financial and managerial resources, we must focus on research programs and product candidates for the specific opportunities that we believe are the most amenable to our RetroMetabolic Drug Design and are the most commercially promising. As a result, we may forego or delay pursuit of opportunities with other product candidates or other indications that later prove to have greater commercial potential. Our resource allocation decisions may cause us to fail to capitalize on viable commercial products or profitable market opportunities. In addition, we may spend valuable time and managerial and financial resources on research programs and product candidates for specific indications that ultimately do not yield any commercially viable products. If we do not accurately evaluate the technical feasibility and the commercial potential or target market for a particular product candidate, we may relinquish valuable rights to that product candidate through collaboration, licensing or other royalty arrangements in situations where it would have been more advantageous for us to retain sole rights to development and commercialization.

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The commercial success of any products that we may develop will depend upon the degree of market acceptance among physicians, patients, healthcare payors and the medical community.

Any products that we may develop may not gain market acceptance among physicians, patients, healthcare payors and the medical community. If these products do not achieve an adequate level of acceptance, we may not generate material product revenues and we may not 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;

· demonstration that we have adequately addressed the specific safety problem of the original molecule;

· the prevalence and severity of any side effects;

· potential or perceived advantages over alternative treatments;

· perceptions about the relationship or similarity between our product candidates and the original drug upon which each RetroMetabolic Drug Design candidate was based;

· advantage over other drugs may not be sufficiently great enough to obtain premium pricing;

· the timing of market entry relative to competitive treatments;

· the ability to offer our product candidates for sale at competitive prices;

· relative convenience and ease of administration;

· the strength of marketing and distribution support;

· sufficient third-party coverage or reimbursement; and

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

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 product revenue.

We do not have a sales and marketing organization and have no experience in the sales, marketing and distribution of pharmaceutical products. It is our intention to use collaborative arrangements to gain access to large sales and marketing organizations in order to commercialize our product candidates. Additionally, in the event we enter into any collaboration arrangements for any of our product candidates, we may retain the right to co-promote the sales of any ultimate product(s) by establishing a small specialty sales force to market such product(s) to specific physician groups. There are risks involved with establishing our own sales and marketing capabilities and entering into arrangements with third parties to perform these services. Developing an internal sales force is expensive and time-consuming and could delay any product launch. On the other hand, if we enter into arrangements with third parties to perform sales, marketing and distribution services, our product revenues are likely to be lower than if we market and sell any products that we develop ourselves.

We may decide to establish our own specialty sales force and engage pharmaceutical or other healthcare companies with an existing sales and marketing organization and distribution system to sell, market and distribute our products. We may not be able to establish these sales and distribution relationships on acceptable terms, or at all. Factors that may inhibit our efforts to commercialize our products without collaborators or licensees include:

· our inability to convince future corporate partners to allow us to retain commercialization rights for specific physician groups;

· our inability to obtain financing to establish the specialty sales force;

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

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· the inability of sales personnel to obtain access to or persuade adequate numbers of physicians to prescribe our 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 toward 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 we will establish our own sales and marketing capabilities. If we are not able to partner with a third party and are not successful 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.

Our ability to generate revenue from any products that we may develop will depend on reimbursement and drug pricing policies and regulations.

Many patients may be unable to pay for any products that we may develop. In the United States, many patients will rely on Medicare, Medicaid, private health insurers and other third-party payors to pay for their medical needs. Our ability to achieve acceptable levels of reimbursement for drug treatments by governmental authorities, private health insurers and other organizations will have an effect on our ability to successfully commercialize, and attract collaborative partners to invest in the development of, our product candidates. We cannot be sure that reimbursement in the United States, Europe or elsewhere will be available for any products that we may develop, and any reimbursement that may become available may be decreased or eliminated in the future. Third-party payors increasingly are challenging prices charged for medical products and services, and many third-party payors may refuse to provide reimbursement for particular drugs when an equivalent generic drug is available. Although we believe that the safety profile of any products that we may develop will be sufficiently different from the original drugs from which they are modeled to be considered unique and not subject to substitution by a generic of the original drug in the case of budiodarone and tecarfarin, it is possible that a third-party payor may consider our product candidate and the generic original drug as equivalents and only offer to reimburse patients for the generic drug. In the case of ATI-7505, the original molecule, cisapride, was withdrawn from the market and no generic version exists, but there are many competitive products which may limit the amount we can charge for this product candidate. There are five atypical antipsychotics which currently dominate an estimated $16.0 billion market for such drugs. Most will be generic competitors of ATI-9242 if it ever reaches the marketplace. While we have designed ATI-9242 to have the improved efficacy and safety features over the existing atypical antipsychotics, these desired features may not be proven in clinical testing or payors may be unwilling to pay a higher price for improved features when generic alternatives are available. Even if we show improved safety with our product candidates, pricing of the existing original drug may limit the amount we will be able to charge for each of our product candidates. If reimbursement is not available or is available only at limited levels, we may not be able to successfully commercialize our product candidates, and may not be able to obtain a satisfactory financial return on products that we may develop.

The trend toward managed healthcare in the United States and the changes in health insurance programs, as well as legislative proposals to reform healthcare or reduce government insurance programs, may result in lower prices for pharmaceutical products, including any products that may be offered by us. In addition, any future regulatory changes regarding the healthcare industry or third-party coverage and reimbursement may affect demand for any products that we may develop and could harm our sales and profitability.

If our competitors are able to develop and market products that are more effective, safer or less costly than any products that we may develop, our commercial opportunity will be reduced or eliminated.

We face competition from established 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 products that we may develop. 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.

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We believe generic amiodarone will continue to provide competition to budiodarone for the treatment of atrial fibrillation, even though it is not labeled for use in atrial fibrillation. Amiodarone will continue to be used off-label in spite of its safety problems because of its generic pricing. Other treatments for atrial fibrillation, such as sotalol, marketed by Bayer HealthCare Pharmaceuticals, Inc., flecainide, marketed by 3M Company, and propafenone, marketed by Reliant Pharmaceuticals, Inc., do not have equivalent efficacy to amiodarone, but will continue to compete in the atrial fibrillation marketplace. Merck and Cardiome Pharma Corp. are in Phase 2b testing with an oral product, vernakalant (oral), for the treatment of atrial fibrillation, including as a follow-on therapy to vernakalant (IV), an intravenous formulation, for which a New Drug Application has been submitted to the FDA. Sanofi-aventis has obtained FDA approval to market in the United States their oral product, dronedarone (Multaq®), for the treatment of atrial fibrillation. Their Phase 3 clinical trial data demonstrated improved outcomes of reduction in the risk of cardiovascular related hospitalizations for patients suffering from atrial fibrillation. While we believe a similar endpoint will be required for budiodarone approval, the FDA may require additional outcome studies for the approval of other treatments for atrial fibrillation, including budiodarone. Should this be required, the Phase 3 clinical trials necessary for budiodarone may be more expensive and time consuming than we currently anticipate. However, based upon a recent meeting of the FDA advisory panel considering the regulatory approval of dronedarone, it appears that long-term survival studies will not be required. There are other companies developing devices or procedures to treat atrial fibrillation through ablation, including CryoCor, Inc. and CryoCath Technologies, Inc.

Competition for tecarfarin for use as an oral anticoagulant will continue to come from generic coumadin owing to its pricing and the years of experience physicians and patients have with the drug. Other oral anticoagulants are in development throughout the pharmaceutical and biotechnology industry. Most of these development programs fall into either the factor Xa or direct thrombin inhibitor categories. We are aware that Johnson & Johnson in collaboration with Bayer AG has a factor Xa before the FDA for approval, and that Bristol-Myers Squibb Company in collaboration with Pfizer, Inc., Eli Lilly and Company and Portola Pharmaceuticals, Inc. each have factor Xa programs in Phase 2 or Phase 3 testing. We are aware of a direct thrombin inhibitor program at Boehringer-Ingelheim GmbH. The first direct thrombin inhibitor presented to the FDA for approval, ximelagatran, previously marketed as Exanta by AstraZeneca plc, has not been recommended for approval due to idiosyncratic liver toxicity problems. Although we believe tecarfarin’s mechanism of action (VKOR inhibition as with warfarin) and broadly available inexpensive monitoring methodology (INR) provide an advantage, these factor Xa and direct thrombin inhibitor programs will likely present major competition in this market. In addition, there may be other compounds of which we are not aware that are at an earlier stage of development and may compete with our product candidates. If any of those compounds are successfully developed and approved, they could compete directly with our product candidates.

ATI-7505 has potential use in five indications: chronic constipation, functional dyspepsia, GERD, gastroparesis and IBS with constipation. Some of these indications may not be recognized by the FDA as sufficiently defined to enable regulatory approval of a drug for treatment. ATI-7505 is a prokinetic which has been shown to increase motility in the upper and lower gastrointestinal tract, including the ability to improve gastric emptying and colonic motility. Products which affect the gastrointestinal system’s motility could be useful in the treatment of each of these disorders. Other prokinetics are on the market or in development which will also compete with ATI-7505, including tegaserod, marketed by Novartis Pharmaceuticals Corporation as Zelnorm, which was temporarily withdrawn from the market and recently re-introduced with restrictive use labeling, TD-5108, which is being developed by Theravance, and erythromycin. Many additional prokinetics are in development targeting these indications. We believe the most significant competition to ATI-7505 for the treatment of GERD is proton pump inhibitors and H2 blockers, which are currently on the market in both prescription formulations and strengths as well as in over-the-counter forms. Many major pharmaceutical companies currently market proton pump inhibitors and H2 blockers generating worldwide sales of over $17.0 billion in 2006. ATI-7505 is targeted, in part, at the approximately 20-25% of GERD patients who do not receive adequate relief from proton pump inhibitors, which reduce the creation of acid in the stomach. ATI-7505 will face competition from prokinetics as well as many inexpensive over-the-counter drug products for the treatment of these gastrointestinal disorders. Substantial competition also exists with products indicated to treat chronic idiopathic constipation, an indication for which ATI-7505 has demonstrated efficacy in a Phase 2b clinical trial.

Competition for ATI-9242 will likely come from the five largest selling atypical antipsychotics: Risperdal by Janssen Pharmaceutica, Seroquel by AstraZeneca Pharmaceuticals LP, Zyprexa by Eli Lilly and Company, Abilify by Bristol-Myers Squibb/Otsuka America Pharmaceutical, Inc. and Geodon by Pfizer Inc., which sold a collective $15.7 billion in 2007. It is likely that virtually all of these would be sold as generic versions by the time ATI-9242 could come to market. Other antipsychotics are in development which may also be competitive to ATI-9242.

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 quickly discover and develop novel compounds that could make our product candidates obsolete. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. In addition, these companies compete with us in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient

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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 medicines before we do. We are also aware of other companies that may currently be engaged in the discovery of medicines that will compete with the product candidates that we are developing. In addition, in the markets that we are targeting, we expect to compete against current market-leading medicines. 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 fail to attract and keep senior management and key scientific personnel, we may be unable to successfully develop or commercialize our product candidates.

Our success depends on our continued ability to attract, retain and motivate highly qualified management, clinical and scientific personnel and on our ability to develop and maintain important relationships with leading clinicians. If we are not able to retain Dr. Goddard, our Chairman and Chief Executive Officer, Dr. Milner, our President, Research and Development, Mr. Varian, our Chief Operating Officer and Chief Financial Officer, Dr. Canafax, our Vice President and Chief Development Officer, and Dr. Druzgala, our Senior Vice President and Chief Scientific Officer, we may not be able to successfully develop or commercialize our product candidates. Competition for experienced scientists may limit our ability to hire and retain highly qualified personnel on acceptable terms. In addition, none of our employees have employment commitments for any fixed period of time and could leave our employment at will. We carry “key person” insurance in the amount of $1.0 million for each of Drs. Milner and Druzgala, but do not carry “key person” insurance covering any other members of senior management or key scientific personnel. If we fail to identify, attract and retain qualified personnel, we may be unable to continue our development and commercialization activities.

We will need to hire additional employees in order to commercialize our product candidates. Any inability to manage future growth could harm our ability to commercialize our product candidates, increase our costs and adversely impact our ability to compete effectively.

In order to commercialize our product candidates, we will need to expand the number of our managerial, operational, financial and other employees. Because the projected time frame for hiring these additional employees depends on the development status of our product candidates and because of the numerous risks and uncertainties associated with drug development and our existing capital resources, we are unable to project when we will hire these additional employees. While to date we have not experienced difficulties in recruiting, hiring and retaining qualified individuals, the competition for qualified personnel in the pharmaceutical and biotechnology field is intense.

Future growth will impose significant added responsibilities on members of management, including the need to identify, recruit, maintain and integrate additional employees. Our future financial performance and our ability to commercialize our product candidates and compete effectively will depend, in part, on our ability to manage any future growth effectively.

If product liability lawsuits are brought against us, we will incur substantial liabilities and may be required to limit commercialization of any products that we may develop.

We face an inherent risk of product liability exposure related to the testing of our product candidates in human clinical trials and will face an even greater risk if we commercially sell any products that we may develop. If we cannot successfully defend ourselves against claims that our product candidates or products that we may develop caused injuries, we will incur substantial liabilities. 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 trial participants;

· costs to defend the related litigation;

· increased demands on management’s attention in defending the related litigation;

· substantial monetary awards to clinical trial participants or patients;

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· loss of revenue; and

· the inability to commercialize any products that we may develop.

We have product liability insurance that covers our clinical trials up to an aggregate $10.0 million annual limit. We intend to expand our insurance coverage to include the sale of commercial products if marketing approval is obtained for any products that we may develop. Insurance coverage is increasingly expensive, and we may not be able to maintain insurance coverage at a reasonable cost or obtain insurance coverage that will be adequate to satisfy any liability that may arise.

If we use biological and hazardous materials in a manner that causes contamination, injury or violates laws, we may be liable for damages.

Our research and development activities involve the use of potentially harmful biological materials as well as hazardous materials, chemicals and various radioactive compounds. We cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of these materials. In the event of contamination or injury, we could be held liable for damages that result, and any liability could exceed our resources. We, the third parties that conduct clinical trials on our behalf and the third parties that manufacture our product candidates are subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and waste products. The cost of compliance with these laws and regulations could be significant. The failure to comply with these laws and regulations could result in significant fines and work stoppages and may harm our business.

Our principal facility is located in California’s Silicon Valley, in an area with a long history of industrial activity and use of hazardous substances, including chlorinated solvents. Certain environmental laws, including the U.S. Comprehensive, Environmental Response, Compensation and Liability Act of 1980, impose strict, joint and several liabilities on current operators of real property for the cost of removal or remediation of hazardous substances. These laws often impose liability even if the owner or operator did not know of, or was not responsible for, the release of such hazardous substances. As a result, while we have not been notified of any claim against us, we are not aware of any such release, nor have we been held liable for costs to address contamination at the property beneath our facility in the past, we cannot rule out the possibility that this may occur in the future. We do not carry specific insurance against such a claim.

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

As a public reporting company, we need to comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the Securities and Exchange Commission, including expanded disclosures and accelerated reporting requirements and more complex accounting rules. Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and other requirements will increase our costs and require additional management resources. We are continuing to upgrade our finance and accounting systems, procedures and controls and may need to continue to implement additional finance and accounting systems, procedures and controls as we grow our business and organization and to satisfy new reporting requirements. Compliance with Section 404 first applied to our annual report on Form 10-K for our year ending December 31, 2008, to be followed by a requirement for attestation by our independent auditors as to our compliance as of December 31, 2009. If our independent registered public accounting firm is unable to provide us with an unqualified report as to the effectiveness of our internal controls over financial reporting as of December 31, 2009, investors could lose confidence in the reliability of our internal controls over financial reporting, which could adversely affect our stock price and our ability to raise capital.

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

Our principal facility is located in California’s Silicon Valley near known earthquake fault zones and, therefore, is vulnerable to damage from earthquakes. In October 1989, a major earthquake struck this area and caused significant property damage and a number of fatalities. We are also vulnerable to damage from other types of disasters, including power loss, attacks from extremist organizations, fire, floods and similar events. If any disaster were to occur, our ability to operate our business could be seriously impaired. In addition, the unique nature of our research activities and of much of our equipment could make it difficult for us to recover from this type of disaster. We currently may not have adequate insurance to cover our losses resulting from disasters or other similar significant business interruptions, and we do not currently plan to purchase additional insurance to cover such losses because of the cost of obtaining such coverage. Any significant losses that are not recoverable under our insurance policies could seriously impair our business and financial condition. Our current insurance does not specifically cover property loss or business interruption due to earthquake damage.

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Risks Related to Ownership of Our Common Stock

Our stock price may be extremely volatile, and your investment in our common stock could suffer a decline in value.

You should consider an investment in our common stock risky and invest only if you can withstand a significant loss and wide fluctuations in the market value of your investment. Investors who purchase our common stock may not be able to sell their shares at or above the purchase price. Security market prices for securities of biopharmaceutical companies have been highly volatile. In addition, the volatility of biopharmaceutical company stocks often does not correlate to the operating performance of the companies represented by such stocks. Some of the factors that may cause the market price of our common stock to fluctuate include:

· adverse results or delays in our clinical trials;

· the timing or delay of achievement of our clinical, regulatory, partnering and other milestones, such as the commencement of clinical development, the completion of a clinical trial, the receipt of regulatory approval or the establishment or termination of a commercial partnership for one or more of our product candidates;

· announcement of FDA approval or non-approval of our product candidates or delays in the FDA review process;

· actions taken by regulatory agencies with respect to our product candidates, our clinical trials or our sales and marketing activities;

· the commercial success of any product approved by the FDA or its foreign counterparts;

· regulatory developments in the United States and foreign countries;

· changes in the structure of healthcare payment systems;

· any intellectual property infringement lawsuit involving us;

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

· market conditions for the biotechnology or pharmaceutical industries in general;

· changes in financial estimates or recommendations by securities analysts;

· sales of large blocks of our common stock;

· sales of our common stock by our executive officers, directors and significant stockholders;

· restatements of our financial results and/or material weaknesses in our internal controls; and

· the loss of any of our key scientific or management personnel.

The stock markets in general, and the markets for biotechnology stocks in particular, have experienced extreme volatility and price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of particular companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, class action litigation has often been instituted against companies whose securities have experienced periods of volatility in market price. Any such litigation brought against us could result in substantial costs, which would hurt our financial condition and results of operations, divert management’s attention and resources, and possibly delay our clinical trials or commercialization efforts.

Fluctuations in our operating results could cause our stock price to decline.

The following factors are likely to result in fluctuations of our operating results from quarter to quarter and year to year:

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· adverse results or delays in our clinical trials;

· announcement of FDA approval or non-approval of our product candidates or delays in the FDA review process;

· actions taken by regulatory agencies with respect to our product candidates, our clinical trials or our sales and marketing activities;

· the commercial success of any product approved by the FDA or its foreign counterparts;

· regulatory developments in the United States and foreign countries;

· changes in the structure of healthcare payment systems;

· any intellectual property infringement lawsuit involving us; and

· announcements of technological innovations or new products by us or our competitors.

Because of these potential fluctuations in our operating results, a period-to-period comparison of our results of operations may not be a good indication of our future performance. In any particular financial period the actual or anticipated fluctuations could be below the expectations of securities analysts or investors and our stock price could decline.

If we fail to continue to comply with the listing requirements of The NASDAQ Global Market, the price of our common stock and our ability to access the capital markets could be negatively impacted.*

Our common stock is currently listed on The NASDAQ Global Market. To maintain the listing of our common stock on The NASDAQ Global Market we are required to meet certain listing requirements, including a minimum closing bid price of $1.00 per share, a market value of publicly held shares (excluding shares held by our executive officers, directors and 10% or more stockholders) of at least $5 million and stockholders’ equity of at least $10 million. As of June 30, 2009, our stockholders’ equity was $9.4 million. As a result, we do not meet The NASDAQ Global Market’s stockholders’ equity listing requirement as of June 30, 2009. In the event we receive sufficient additional capital in the near term from a potential collaboration arrangement involving any of our lead product candidates or through an equity financing, our stockholders’ equity could be in excess of $10 million, which may forestall our delisting from The NASDAQ Global Market.

If we fail to comply with the listing standards of The NASDAQ Global Market, we may consider transferring to The NASDAQ Capital Market, provided we met the transfer criteria, which is a lower tier market, or our common stock may be delisted and traded on the over-the-counter bulletin board network. Moving our listing to The NASDAQ Capital Market could adversely affect the liquidity of our common stock. If our common stock were to be delisted by NASDAQ, we could face significant material adverse consequences, including:

· a limited availability of market quotations for our common stock;

· a reduced amount of news and analyst coverage for us;

· a decreased ability to issue additional securities or obtain additional financing in the future;

· reduced liquidity for our stockholders;

· potential loss of confidence by collaboration partners and employees; and

· loss of institutional investor interest and fewer business development opportunities.

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Because a small number of existing stockholders own a large percentage of our voting stock, they may be able to control our management and operations, acting in their best interests and not necessarily those of other stockholders.

Based on our outstanding shares as of June 30, 2009 (which excludes any shares of common stock issuable upon exercise of warrants and options outstanding on such date), our executive officers, directors and holders of 5% or more of our outstanding common stock beneficially own approximately 55% of our common stock. As a result, these stockholders, acting together, will be able to control all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. The interests of this group of stockholders may not always coincide with our interests or the interests of other stockholders.

Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management.

Provisions in our certificate of incorporation and our bylaws may delay or prevent an acquisition of us, a change in our management or other changes that stockholders may consider favorable. These provisions include:

· a classified board of directors;

· a prohibition on actions by our stockholders by written consent;

· the ability of our board of directors to issue preferred stock without stockholder approval, which could be used to adopt a stockholders’ rights plan that would make it difficult for a third party to acquire us;

· notice requirements for nominations for election to the board of directors; and

· limitations on the removal of directors.

Moreover, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits a person who owns in excess of 15% of our outstanding voting stock from merging or combining with us for a period of three years after the date of the transaction in which the person acquired in excess of 15% of our outstanding voting stock, unless the merger or combination is approved in a prescribed manner.

Future sales of our common stock in the public market could cause our stock price to drop substantially.

Sales of a substantial number of shares of our common stock in the public market, or the perception that these sales might occur, could depress the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities.

As of June 30, 2009, we had 27,339,149 shares of common stock outstanding, which excludes any shares of common stock issuable upon exercise of warrants and options outstanding as of such date. The shares outstanding are freely tradable without restriction in the public market unless held by an affiliate of ours. Shares held by our affiliates are eligible for sale in the public market either in accordance with an effective resale registration statement with the Securities and Exchange Commission or pursuant to the volume limitations and manner of sale requirements under Rule 144. Any common stock that is either subject to outstanding options or warrants or reserved for future issuance under our 2001 Equity Incentive Plan, 2007 Equity Incentive Plan, 2007 Non-Employee Directors’ Stock Option Plan and 2007 Employee Stock Purchase Plan could also become eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements, and Rules 144 and 701 under the Securities Act of 1933, as amended. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline.

Certain of our affiliates have rights with respect to registration of a significant number of our shares of common stock under the Securities Act of 1933, as amended. If such holders, by exercising their registration rights, cause a large number of securities to be sold in the public market, these sales could have an adverse effect on the market price for our common stock and may impair our ability to raise additional capital. In addition, as of June 30, 2009, we have filed three registration statements on Form S-8 under the Securities Act of 1933, as amended, to register up to an aggregate of 5,005,132 shares of our common stock for issuance under our stock option and employee stock purchase plans, and intend to file additional registration statements on Form S-8 to register the shares automatically added each year to the share reserves under these plans.

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

Use of Proceeds from the Sale of Registered Securities

On November 7, 2007, our registration statement on Form S-1/A (File No. 333-145813) was declared effective by the Securities and Exchange Commission for our initial public offering. We registered 5,000,000 shares of our common stock for an aggregate offering price of $50.0 million, all of which were sold at $10.00 per share. Of this amount, $3.5 million was paid in underwriters’ discounts and an additional $2.7 million of other expenses were incurred, all of which was incurred during the year ended December 31, 2007. Entities affiliated with MPM Capital and OrbiMed Advisors, LLC, two of our principal stockholders, purchased an aggregate of 600,000 shares of common stock in our initial public offering at the offering price of $10.00 per share. The underwriters of the offering were Morgan Stanley & Co. Incorporated, CIBC World Markets Corp., Jefferies and Company, Inc. and Leerink Swann LLC. No offering expenses were paid directly or indirectly to our directors, officers or their associates, or to persons owning 10% or more of any of our equity securities.

As of June 30, 2009, all $43.8 million of the net proceeds from our initial public offering have been used to fund our (i) external clinical trial activities, including funding manufacturing expenses related to the clinical development of our product candidates; (ii) R&D activities other than external clinical trial expenses; and (iii) general and administrative expenses, working capital needs and other general corporate purposes.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

On May 20, 2009, our Annual Meeting of Stockholders was held at our corporate offices in Fremont, California. Of the 27,372,235 shares of our common stock entitled to vote at the meeting, 22,141,974 shares were represented at the meeting in person or by proxy, constituting a quorum. At this meeting, our stockholders voted on the following two proposals:

(i) Proposal to elect three directors to hold office as Class II directors until our 2012 Annual Meeting of Stockholders:

Name	Shares Voted For	Votes Withheld
Lars G. Ekman, M.D., Ph.D.	21,922,889	219,085
Keith R. Leonard	20,831,697	1,310,277
Paul J. Sekhri	20,829,524	1,312,450

Our Class III directors, David Beier, Paul Goddard, Ph.D., and Herm Rosenman, will each continue to serve on our Board of Directors until our 2010 Annual Meeting of Stockholders and until their respective successor is elected and qualified or such director’s earlier death, resignation or removal. Our Class I directors, Peter G. Milner, M.D. and Nicholas Simon, will each continue to serve on our Board of Directors until our 2011 Annual Meeting of Stockholders and until their respective successor is elected and qualified or such director’s earlier death, resignation or removal.

(ii) Proposal to ratify the selection by the Audit Committee of our Board of Directors of Ernst & Young LLP as our independent registered public accounting firm for the year ending December 31, 2009:

For		Votes Against		Abstain
21,927,643		210,918		3,413

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS

A list of exhibits filed with this report or incorporated herein by reference is found in the Exhibit Index immediately following the signature page of this report.

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SIGNATURE

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

Dated: August 13, 2009

	ARYx Therapeutics, Inc.


	By:	/s/ John Varian
		John Varian
		Chief Operating Officer and Chief Financial Officer

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EXHIBIT INDEX

Exhibit Number		Description of Document

3.2(1)		Amended and Restated Certificate of Incorporation.

3.3(1)		Bylaws.

4.1		Reference is made to Exhibit 3.2 and 3.3 above.

4.2(1)		Specimen Common Stock Certificate.

4.3(1)		Form of Warrant to purchase shares of Series C preferred stock, issued September 3, 2003.

4.4(1)		Form of Warrant to purchase shares of Series C preferred stock, issued December 23, 2002.

4.5(1)		Form of Warrant to purchase shares of Series D preferred stock, issued March 28, 2005.

4.6(1)		Amended and Restated Investor Rights Agreement by and between the Registrant and certain of its security holders.

4.7(1)		Form of Warrant to purchase shares of Series E preferred stock, issued October 19, 2007.

4.8(2)		Form of Warrant to purchase shares of common stock, issued October 17, 2008 to Lighthouse.

4.9(3)		Registration Rights Agreement by and between the Registrant and the investors identified on the signature pages thereto, dated November 11, 2008.

4.10(3)		Form of Warrant to purchase shares of common stock, issued November 11, 2008 to several purchasers.

4.11(4)		Form of Warrant to purchase shares of common stock, issued December 31, 2008 to Oxford Financial Corporation.

10.16(5)*		Non-Employee Director Compensation Arrangements.

10.31(6)*		ARYx Therapeutics, Inc. Executive Severance Benefit Plan.

31.1		Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.

31.2		Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.

32.1		Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Indicates management contract, compensatory plan or arrangement.

(1) Previously filed as the like numbered exhibit to registrant’s Registration Statement on Form S-1 (No. 333-145813), initially filed with the Securities and Exchange Commission on August 30, 2007, as amended, and incorporated by reference herein.

(2) Previously filed as the like-numbered exhibit to registrant’s Current Report on Form 8-K (File No. 001-33782), filed with the SEC on October 23, 2008 and incorporated herein by reference.

(3) Previously filed as the like-numbered exhibit to registrant’s Current Report on Form 8-K (File No. 001-33782), filed with the SEC on November 12, 2008 and incorporated herein by reference.

(4) Previously filed as the like numbered exhibit to registrant’s Annual Report on Form 10-K (File No. 001-33782), filed with the SEC on March 27, 2009 and incorporate herein by reference.

(5) Previously filed as the like numbered exhibit to registrant’s Quarterly Report on Form 10-Q (File No. 001-33782), filed with the SEC on May 14, 2009 and incorporate herein by reference.

(6) Previously filed as the like numbered exhibit to registrant’s Current Report on Form 8-K (File No. 001-33782), filed with the SEC on May 27, 2009 and incorporated herein by reference.