Advanced Life Science (ADLS) - Description of business


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Company Description


We are a biopharmaceutical company focused on the discovery, development and commercialization of novel drugs in the areas of infectious disease, inflammation and oncology. Using our internal discovery capabilities and our network of pharmaceutical and academic partners, we have assembled a promising pipeline of clinical and preclinical product candidates. The following is a summary of each of our primary programs:

·        Infectious Disease. We have an exclusive worldwide license (excluding Japan) from Abbott Laboratories to develop and commercialize cethromycin, a novel ketolide antibiotic in Phase III clinical development for the treatment of respiratory tract infections. In December 2005, we initiated our pivotal Phase III clinical program for the treatment of mild-to-moderate community acquired pneumonia, the indication for which we initially plan to seek FDA approval. Abbott Laboratories completed six Phase III clinical trials of the compound comprising approximately 3,800 human subjects to test safety and efficacy.

Through our 50/50 joint venture, Sarawak MediChem Pharmaceuticals, we have managed the development of Calanolide A, a non-nucleoside reverse transcriptase inhibitor for the treatment of HIV. We completed a series of Phase I clinical trials for Calanolide A, which was well-tolerated by patients and demonstrated effectiveness in reducing viral load in HIV-infected patients. Subject to reaching a satisfactory agreement with our joint venture partner regarding our current business arrangement and our respective funding obligations for the next phase of development, we plan to enroll HIV-infected patients for a Phase IIa clinical trial of Calanolide A.

·        Inflammation. ALS-886 is a novel therapeutic in preclinical development for the treatment of inflammation-related tissue damage, including tissue damage associated with acute respiratory distress syndrome (“ARDS”). Patients suffering from ARDS have a high fatality rate, and there are currently only limited treatment options available. We have established an open investigational new drug application (“IND”) for ALS-886 with the FDA. We expect that the first clinical study will involve approximately 40 patients to determine the safety profile of the compound in human subjects. We intend to seek a partner to assist in the funding and advancement of this program.

·        Oncology. ALS-357 is a compound that has shown evidence of anti-tumor activity against malignant melanoma in preclinical studies. Currently available therapies have not had significant success at

prolonging survival for patients with melanoma that has spread beyond the primary growth site. We believe that ALS-357 has the potential for either a topical or systemic formulation. We established an open IND for ALS-357 with the FDA. The expected Phase I clinical trial protocol contemplates treating 16 patients with in-transit metastatic melanoma by topical application of ALS-357. We intend to seek a partner to assist in the funding and advancement of this program.

In addition to the compounds summarized above, we have additional product candidates in preclinical development. These include compounds derived from natural products to treat infectious diseases, a novel class of synthetic chemotherapeutics to treat various cancers and small molecule inhibitors that may lead to a treatment for Alzheimer’s disease. We have not received FDA approval for any of our product candidates. Our revenues to date have consisted solely of management fees and one-time or limited payment associated with our collaborations or grants. Our cumulative net loss was $46.7 million as of December 31, 2005, and we do not anticipate generating any significant revenues for at least the next several years. Since our inception in 1999, we have financed our operations primarily through public and private equity offerings, loans from our founder and borrowings under our bank line of credit. We will continue to do so until we are able to generate revenues from our product candidates, if ever.

Our Background

On January 1, 1999, MediChem Life Sciences, Inc. (“MediChem”) contributed all of the net assets of its proprietary drug development business, including MediChem’s 50% interest in Sarawak MediChem Pharmaceuticals, Inc. (“SMP”) to a wholly-owned subsidiary, Advanced Life Sciences, Inc. (“ALS Inc.”) in exchange for 1,588,000 shares of common stock.

In June 1999, MediChem exchanged its investment in 100% of the outstanding common stock of ALS Inc. for nonvoting preferred stock issued by ALS Inc. affecting a spin-off of ALS Inc. Prior to the spin-off, Dr. Michael Flavin, the sole stockholder, owned 100% of MediChem and ALS Inc., then a wholly-owned subsidiary of MediChem. As a result of the spin-off, Dr. Flavin became the sole common stockholder of ALS Inc. MediChem holds 100% of the preferred stock of ALS Inc., which was issued in exchange for common stock held at the June 1999 spin-off.

In August 2001, ALS Inc. formed a general partnership, Advanced Life Sciences General Partnership (“ALS GP”), with Dr. Flavin, ALS Inc.’s chief executive officer. ALS Inc. contributed all of its assets and liabilities to ALS GP, with the exception of debt due to Dr. Flavin. In 2002, Dr. Flavin transferred his interest in ALS GP to Flavin Ventures, LLC (“Flavin Ventures”), which he controls. ALS Ventures is not included in the consolidated financial statements of Advanced Life Sciences Holdings, Inc. (“the Company”).

In March of 2002, MediChem was acquired by deCODE genetics, Inc. (“deCODE”). As a result of the merger, Dr. Flavin’s ownership in the merged entity was reduced to a noncontrolling interest with Dr. Flavin holding approximately 1% of the common shares of deCODE genetics, Inc. After the merger was complete, Dr. Flavin resigned his position as chief executive officer of MediChem to focus on his role as chief executive officer of ALS Inc.

In December 2004, ALS Inc. executed a plan of reorganization. The Company, a Delaware corporation, was formed with Dr. Flavin as its chief executive officer. Common shareholders of ALS, Inc. exchanged their 1,629,685 common shares for 1,629,685 common stock of the Company. Under the terms of the reorganization, Flavin Ventures exchanged their 40% ownership of ALS GP for 7,852,330 shares of the Company’s common stock. After the exchange was completed, ALS GP was dissolved, its assets and liabilities assumed by ALS Inc.

In December 2004, according to the plan of reorganization, ALS Ventures, LLC (“Ventures”), a Delaware Limited Liability Company was formed. After its formation, Dr. Flavin and Flavin Ventures simultaneously contributed all of their common shares, 1,588,000 and 7,852,330, respectively, to Ventures.

In April 2005, the Board of Directors of the Company (“the Board”) authorized the Company to file a registration statement with the Securities and Exchange Commission (“the SEC”) covering the proposed sale by the Company of its common stock to the public. In June 2005, the Board approved the amendment and restatement of the Company’s Articles of Incorporation to provide for an increase in the number of authorized shares of common stock and preferred stock to 60,000,000 shares and 5,000,000 shares, respectively, and a 3.97-for-1 stock split of the Company’s common stock. All references in the consolidated financial statements to shares of common stock, common stock options, common stock prices and per share of common stock amounts have been adjusted retroactively for all periods presented to reflect this stock split. In August 2005, the Company completed the initial public offering of its common stock in which the Company sold 6,400,000 shares of common stock to the public at $5.00 per share, resulting in gross proceeds of $32.0 million. The Company also completed a concurrent offering of 600,000 shares to an existing stockholder in exchange for a $3.0 million reduction of a milestone payment obligation under its license agreement with the stockholder. In September 2005, the Company’s underwriters exercised their option to purchase 100,000 shares to cover over-allotments resulting in additional gross proceeds of $500,000. In connection with these offerings, the Company paid approximately $2.3 million in underwriting discounts and incurred other offering expenses of approximately $1.5 million. The net cash proceeds from the offerings were approximately $28.7 million.

In March 2006, the Company raised approximately $33.6 million, net of underwriting discounts, in connection with the issuance of 10,233,464 shares of its common stock and warrants to purchase an additional 5,116,732 shares of its common stock at an exercise price of $3.81 per share.

Our Strategy

Our objective is to become a fully integrated pharmaceutical company that discovers and develops small molecule therapeutics to treat life-threatening diseases in the areas of infectious disease, inflammation and cancer, and then markets these products directly to healthcare providers, including but not limited to,  physicians and hospitals. We plan to sustain our drug development pipeline through our internal drug discovery capabilities and by opportunistically in-licensing promising compounds that fit into our areas of focus. Specific key aspects of our strategy include the following:

Maximize the Commercial Potential of Cethromycin

Initially, we intend to focus a significant portion of our business efforts on the further development of cethromycin for the treatment of mild-to-moderate community acquired pneumonia. Abbott Laboratories, which granted us an exclusive worldwide license (except in Japan) to commercialize cethromycin, completed six Phase III clinical trials of the compound to determine the safety and efficacy of 150 mg once-daily and twice-daily regimens, testing approximately 3,800 human subjects. We initiated the first of two pivotal Phase III clinical trials in December 2005 for the treatment of mild-to-moderate community acquired pneumonia using a 300 mg once-daily dosing regimen.

In addition to treating mild-to-moderate community acquired pneumonia in pivotal Phase III clinical trials, we intend to pursue opportunities for cethromycin in the treatment of other respiratory tract infections such as bronchitis, sinusitis and pharyngitis.

Advance the Development of our Other Infectious Disease, Inflammation and Oncology Product Candidates as Funds are Available or Through a Partnership.

Whereas the development of cethromycin remains our number one priority, we intend to leverage our existing clinical trial experience from developing Calanolide A to advance product candidates in our inflammation and oncology programs through clinical trials. For instance, to advance ALS-886 for the treatment of inflammation-related tissue damage, we plan to conduct Phase I clinical trials that test safety and provide preliminary data regarding efficacy in preventing lung tissue damage in ARDS patients. To develop ALS-357 for the treatment of malignant melanoma, we intend to conduct Phase I clinical trials with a topical formulation to test safety and provide preliminary data regarding efficacy. We also plan to develop a systemic formulation of ALS-357 and initiate related clinical trials. Subject to reaching a satisfactory agreement with our joint venture partner regarding our current business arrangement and our respective obligations for the next phase of development, we plan to enroll HIV-infected patients for a Phase IIa clinical trial of Calanolide A.

Leverage our Drug Discovery and Development Capabilities

We intend to expand our product portfolio by exploiting and enhancing our internal drug discovery and development capabilities using our integrated chemistry and biology skills. We plan to continue utilizing our integrated chemistry and biology drug discovery platform to design, optimize and evaluate high-potential product candidates.

Continue to Develop Strategic Collaborations

We plan to continue developing relationships with key pharmaceutical and biotechnology companies, governmental institutions and academic laboratories in order to in-license promising compounds that are not core to their strategy but fit closely with our corporate strengths. We also intend to identify co-development partners for the out-licensing of certain product candidates. Further, we may choose to establish collaborative partnerships through which certain of our clinical candidates can be marketed and commercialized.

Build Commercial Infrastructure to Market our Products

We plan to retain U.S. marketing and sales rights or co-promotion rights for certain of our products that we believe can be marketed through a focused sales force targeting specialists and high patient volume physicians. For situations in which a large sales force is required to access the market, and for markets outside the United States, we generally plan to commercialize our product candidates through a variety of collaboration arrangements with leading pharmaceutical companies and contract sales organizations.

Our Lead Program

Our most advanced product candidate, cethromycin, is a novel ketolide antibiotic in Phase III clinical development for the treatment of respiratory tract infections. We are initially developing cethromycin as a treatment for mild-to-moderate community acquired pneumonia. Over the last decade, the rapid rise in severe and fatal infections caused by antibiotic-resistant bacteria has posed a serious threat to public health. There is a need to discover new antibiotics that are effective against resistant bacteria. As a new class of antibiotics, ketolides have shown activity against penicillin- and macrolide-resistant Gram-positive pathogens. Clinical trials indicate that cethromycin has enhanced activity towards drug-resistant Streptococcus pneumoniae and Haemophilus influenzae, two of the pathogens commonly found in mild-to-moderate community acquired pneumonia, when compared to published data on antibiotics currently on the market. Cethromycin has also shown in vitro evidence of an extended post-antibiotic effect, meaning that the suppression of bacterial growth persists in the absence of measurable antibiotic concentration. Six

Phase III clinical trials have been completed for the treatment of respiratory tract infections, and cethromycin has demonstrated a clinical cure rate as high as 93% for subjects with mild-to-moderate community acquired pneumonia.

In December 2004, Abbott Laboratories granted us an exclusive worldwide license, except in Japan, to commercialize cethromycin. In December 2005, we initiated our pivotal Phase III clinical trials for the treatment of mild-to-moderate community acquired pneumonia. The trials will include two controlled pivotal Phase III comparator studies and any other studies the FDA may require for new drug application (“NDA”) approval. The pivotal Phase III program will involve approximately 1,000 subjects. During 2005, we expended approximately $1.9 million towards the development of cethromycin.

Market Overview

Bacterial infections occur when bacteria that naturally exist in the body, or that are acquired through inhalation, ingestion or direct penetration, are not controlled by the normal immune defense system. These uncontrolled bacteria can multiply and either excrete toxins or provoke the immune system to mount a response, in either case damaging tissue. Antibiotics work by binding to specific targets in a bacterial pathogen, thereby inhibiting a function that is essential to the pathogen’s survival. Many antibiotics were developed and introduced into the market during the 1970s and 1980s and have proven to be effective in treating most bacterial infections. We believe this historic efficacy prompted pharmaceutical companies to shift their resources to other areas of drug discovery and development. As a result, very few antibiotics from new chemical classes have been introduced in the last several years.

Antibiotic resistance has become widely considered a significant threat to public health, and the problem continues to worsen. The Centers for Disease Control, or CDC, continue to report on new strains of bacteria that are resistant to one or more antibiotics currently on the market. The increasing prevalence of drug-resistant bacteria has led to prolonged illnesses and hospitalizations, increased healthcare costs and significantly higher mortality rates. As a result, there is a strong demand for new treatments that are more effective against resistant strains and do not show potential for inducing the rapid development of additional resistant strains. We do not believe that this demand for new antibiotic therapies is being met by large pharmaceutical companies because of a shift in research and development focus in these companies toward chronic conditions that require sustained medication over long periods of time.

Respiratory tract infections arise when bacterial infections develop in the inhalation passageway, including the nose, throat, sinuses and lungs. The four main types of respiratory tract infections are pneumonia, bronchitis, pharyngitis and sinusitis. Many of these bacterial infections can be life threatening if not treated quickly. Bacterial pneumonia, which involves an infection of the lung itself, is the most severe of the common respiratory tract infections. Pneumonia is often classified as mild-to-moderate community acquired pneumonia or hospital acquired pneumonia, depending upon the setting in which contraction of the bacterial infection occurred. The Textbook of Primary and Acute Care Medicine estimates that, in the United States alone, there are approximately 5-6 million cases of community acquired pneumonia each year.

Current Treatment Options and Limitations

Until recently, there have been three main classes of antibiotics prescribed for respiratory tract infections such as community acquired pneumonia. These are semi-synthetic penicillins (also known as beta-lactams), such as Augmentin ® (amoxicillin and clavulanate potassium) sold by GlaxoSmithKline; macrolides, such as erythromycin or Zithromax® (azithromycin) sold by Pfizer; and fluoroquinolones, such as Cipro ® (ciprofloxacin) sold by Bayer. Penicillins, macrolides and fluoroquinolones have all been shown to have certain shortcomings with respect to the treatment of respiratory tract infections. Studies have shown that, in the United States, approximately 26% of Streptococcus pneumoniae isolates, the most

common pathogens that cause respiratory tract infections such as community acquired pneumonia, are resistant to macrolides. In addition, numerous reports in the medical literature have noted the emergence of penicillin-resistant pneumococci. Because fluoroquinolones have a broad-spectrum activity against both Gram-negative and Gram-positive bacteria, there is a greater potential for bacterial resistance. The wide use of fluoroquinolones also increases the potential for development of resistance among Streptococcus pneumoniae.

Increased bacterial resistance to many of the currently available antibiotics has been caused by certain common medical practices and sociological factors. By necessity, a wide variety of antibiotics is often administered before the specific disease-causing pathogen has been identified. Bacterial resistance is fostered through the erroneous prescription of antibiotics for non-bacterial infections. The lack of full patient compliance with prescribed courses of therapies has further contributed to bacterial resistance against currently marketed antibiotics. Patients will frequently discontinue a prescribed dosing regimen after symptoms subside, but bacteria that are not entirely eradicated may re-emerge in resistant forms.

Ketolides are a new class of antibiotics that show promise to address many of the shortcomings found in the current treatment options for community acquired pneumonia and other respiratory tract infections, such as bronchitis, sinusitis and pharyngitis. Ketolides are effective against penicillin- and macrolide-resistant pathogens known to cause respiratory tract infections. When compared to published data on current fluoroquinolone antibiotic treatments, ketolides have shown a favorable safety profile. The only ketolide available for sale in the United States, Ketek ® (telithromycin), was approved by the FDA in April 2004 and launched commercially by Aventis Pharmaceuticals in August 2004. Ketek has been available for sale in Europe since the summer of 2002. According to data compiled by IMS Health, an independent pharmaceutical information and consulting firm, sales of Ketek in the United States totaled approximately $193 million in 2005. While Ketek has been determined to be effective against resistant pathogens, the FDA has imposed a labeling requirement for Ketek indicating that it may cause visual disturbances including double-vision, blurred vision and difficulty focusing.

ALS Solution

We are developing cethromycin, a novel ketolide antibiotic licensed from Abbott Laboratories, in response to the emerging antibiotic resistance observed in the treatment of community acquired pneumonia. Prior to the initiation of our clinical trials, cethromycin has been tested by Abbott in approximately 3,800 human subjects during clinical trials. We intend to conduct two pivotal Phase III clinical trials of cethromycin for the treatment of mild-to-moderate community acquired pneumonia. We also intend to pursue opportunities for cethromycin in the treatment of other respiratory tract infections such as bronchitis, sinusitis and pharyngitis.

Based on publicly available data regarding current antibiotic compounds, we believe that there is a potential opportunity for further development of cethromycin in the treatment of respiratory tract infections for a number of reasons:

·        cethromycin has shown higher in vitro potency and a broader range of activity than macrolides and Ketek against Gram-positive bacteria associated with respiratory tract infections;

·        cethromycin appears to be clinically effective against penicillin- and macrolide-resistant bacteria;

·        cethromycin has a mechanism of action, unique to ketolides, that may slow the onset of future resistance;

·        cethromycin has shown specific activity against Gram-positive pathogens, unlike fluoroquinolones, while leaving normally-present Gram-negative bacteria undisturbed;

·        cethromycin has shown in vitro evidence of extended post-antibiotic effects against the pathogens commonly seen in respiratory tract infections; and

·        cethromycin, unlike Ketek, has not demonstrated visual disturbance side effects in clinical trials.

We believe that cethromycin, if approved, would build upon the growing market acceptance of ketolide compounds in the antibiotic marketplace.

Abbott Laboratories Collaboration

In December 2004, we entered into an agreement with Abbott Laboratories under which we acquired from Abbott a license to certain patent applications, patents and proprietary technology relating to cethromycin and ABT-210, a second-generation ketolide antibiotic product candidate in preclinical development. Under the terms of the license agreement, we have an exclusive worldwide license (excluding Japan) to develop and commercialize cethromycin. On August 1, 2005, we agreed to amend our license agreement with Abbott in order to terminate our in-license of ABT-210. The license for cethromycin includes rights under U.S. Patent No. 5,866,549 (for cethromycin) and foreign equivalents other than in Japan, and all related applications and patents that are entitled to benefit from the original filing of applications that issued as U.S. Patent No. 5,866,549 or their foreign equivalents. We intend to conduct and fund the remaining clinical development of cethromycin and commercialize the product for the treatment of mild-to-moderate community acquired pneumonia. In February 2005, Abbott transferred to us all of its interests in Investigational New Drug application No. 57,836 relating to cethromycin. Under the terms of our agreement, Abbott received 1,122,569 shares of our common stock and had the right to receive $11.0 million in cash, which was paid in 2005. Of the $11.0 million in payments made during 2005, $9.0 million related to the purchase of the remaining cethromycin inventory from Abbott. We believe that the supply of cethromycin will be sufficient to conduct the clinical trials.  The remaining $2.0 million represented a milestone payment which was due on October 31, 2005, or, if earlier, upon our initiation of pivotal Phase III clinical trials for cethromycin. The original amount of this milestone, $5.0 million, was reduced by $3.0 million in exchange for issuing 600,000 shares of our common stock to Abbott Laboratories through a concurrent offering with our IPO. To date, we have paid a total of $2.0 million in milestone payments under the license agreement. We will owe Abbott $10.0 million if we submit an NDA and $30.0 million if and when the FDA approves the NDA. Pursuant to the August 1, 2005 amendment, we also agreed to pay to Abbott $2.5 million upon cethromycin reaching $200 million in aggregate net sales and $5.0 million upon the drug reaching $400 million in aggregate net sales. Finally, we were originally obligated to pay Abbott royalties, generally equal to 19.0% of net sales, for commercialized products on a country-by-country basis. In exchange for our agreement with Abbott on August 1, 2005 to terminate our in-license of ABT-210 and provide the $2.5 million and $5.0 million sales-related milestone payments, Abbott agreed to reduce its royalty rights for cethromycin if it is approved for commercialization. Under the new terms, we will owe Abbott royalty payments of 19.0% on the first $100 million of aggregate net sales of cethromycin, 18.0% on net sales once aggregate net sales exceed $100 million but are less than $200 million, and 17.0% on all net sales once aggregate net sales exceed $200 million.

The term of the agreement commenced on December 13, 2004 and continues until the expiration of the last patent licensed under the agreement, unless the agreement is otherwise terminated. The primary patent licensed under the agreement, used by us in connection with cethromycin, expires in the U.S. on September 4, 2016, and in most foreign countries or jurisdictions on September 2, 2017, all subject to any term restoration that may be granted for the time necessary for regulatory approval in each respective jurisdiction. Upon the expiration of the license agreement, we maintain a non-exclusive, perpetual and irrevocable license to use Abbott’s proprietary technology and other types of information directly related or used in connection with cethromycin and its manufacture into pharmaceutical products without any further payment obligations to Abbott, except for those payment obligations accruing prior to such expiration. The agreement may be terminated by either party on 30 days notice if the other party ceases its

business operations or if the other party passes a resolution or a court of competent jurisdiction makes an order for winding up its business. Either party may also terminate the agreement for material breach if not cured within 90 days of notice or if not cured within 30 days of notice if the breach relates to a payment provision.

We have the right to sublicense our rights under the agreement at our discretion. In addition, if we determine to co-market or co-distribute cethromycin, Abbott has a 90-day exclusive right of first negotiation to be the co-marketer, co-distributor or exclusive distributor. This exclusive right begins when we notify Abbott of our marketing and/or distributing plans, and we have no further obligation to Abbott, from a marketing perspective, after the 90-day period of time elapses.

Other Collaborations and License Agreements

In addition to our collaboration with Abbott Laboratories, we have entered into a number of license agreements for intellectual property and other rights needed to develop our products.

Sarawak MediChem Pharmaceuticals, Inc.    In 1996, we entered into a 50/50 joint venture with Craun Research Sdn. Bhd., acting as agent for the State Government of Sarawak, Malaysia (“Sarawak Government”), to finance the development of Calanolide A. This joint venture is a Delaware corporation named Sarawak MediChem Pharmaceuticals, Inc (“SMP”). Upon the formation of the joint venture, the Sarawak Government contributed $9.0 million in equity and MediChem Life Sciences, Inc., which assigned its interest in Sarawak MediChem Pharmaceuticals to us, received its 50% equity interest in exchange for its contribution of intellectual property. Subsequent to the formation of the joint venture, the Sarawak Government issued $12.0 million in long-term debt to the joint venture. According to the terms of the debt instruments, $12.0 million of this debt is past due. As a result of this default in payment by SMP, the Sarawak Government has the option under the loan agreement to take over the control and management of the Calanolide A project or the affairs of the joint venture until such time as the loan is repaid in full. To date, the Sarawak Government has not pursued the collection of this debt or sought to control or manage the Calanolide A project. In July 2005, the Sarawak Government exercised certain of its contractual rights by notifying SMP of its intention to appoint its representative as an officer of the joint venture for purposes of assuming control of the affairs and management of SMP effective immediately. In December of 2005, the Sarawak Government nominated and the Board of Directors of SMP approved the appointment of Mr. Jumastapha bin Lamat as the controlling officer of SMP. Since that time we have been transitioning access to the joint venture’s accounting, financial and corporate records to representatives of Mr. Lamat. The Sarawak Government also expressly reserved all contractual and legal remedies available in light of the default and indicated its intent to fully exercise its rights as a creditor of the joint venture. Ultimately, we believe that for the joint venture to continue, the terms of the debt must be amended to extend its maturity to a date after commercialization of Calanolide A.

We previously commenced discussions with the Sarawak Government to restructure and extend the existing $12.0 million debt and determine the source of financing for a Phase IIa clinical trial of Calanolide A. We do not intend to expend any meaningful funds advancing the development of Calanolide A unless and until we restructure the joint venture’s debt and reach a satisfactory agreement with the Sarawak Government to amend our joint venture relationship and establish our respective obligations regarding the future funding of the next phase of developing Calanolide A.

If we are able to restructure our joint venture relationship and determine to proceed with the Phase IIa clinical trial for Calanolide A, upon completion of this trial we will evaluate our strategic alternatives for the joint venture relationship and the future advancement of Calanolide A. We may determine to continue the program through our joint venture, independently or under a new joint venture arrangement. It is also possible that we will elect to transfer our rights in the compound to our current joint venture partner or an independent third party. Factors that we will consider in making this

decision include the success of the Phase IIa clinical trial, the relative financial obligations of us and our joint venture partner and our capabilities at such time to continue development independently.

The term of the joint venture agreement continues indefinitely unless terminated by the written agreement of both parties not to proceed further with the development of Calanolide A. In the event only one of the parties wishes to discontinue development of Calanolide A, the other party has the right, but not the obligation, to purchase the discontinuing party’s equity interest in the joint venture for $9.0 million. If the other party does not choose to exercise its purchase right within six months of receiving written notice from the discontinuing party, then the joint venture is deemed mutually terminated. Upon such mutual termination, the joint venture agreement provides that any liabilities of the joint venture will be settled by the parties equally and all patents or licenses of the joint venture shall be reassigned back to us, including rights to clinical trials. We believe that the equal settlement of liabilities provision in the joint venture agreement was intended to recognize the 50/50 equity ownership of the joint venture and does not constitute our guaranty of the joint venture’s indebtedness to the Sarawak Government. Consequently, if the joint venture is mutually terminated, the joint venture partners would work together to monetize the joint venture’s assets for the purpose of satisfying its liabilities, which currently are solely comprised of indebtedness to a 50% partner, the Sarawak Government. In the event the joint venture’s assets are insufficient to settle its liabilities, we do not believe that the equal settlement of liabilities provision obligates us to contribute funds to the joint venture.

In addition to the financing provided by our joint venture partner, the joint venture’s product portfolio and discovery and preclinical programs have been funded through s innovative research (“SBIR”) grants awarded by the National Institutes of Health. Sarawak MediChem Pharmaceuticals has been successful in being awarded over $1.5 million in SBIR funding to advance the Calanolide analogue development pipeline. The joint venture is also building upon its relationship with the Sarawak Government by collaborating with the Sarawak Biodiversity Center in Malaysia to discover future drug leads for treating infectious diseases and cancer. To date, this drug discovery collaboration with the Sarawak Biodiversity Center has not produced any drug leads for future development.

National Institutes of Health.    In 1996, our joint venture, Sarawak MediChem Pharmaceuticals, acquired an exclusive worldwide license, under patent rights and know-how controlled by the National Institutes of Health (NIH), to develop, make, use and sell Calanolide A and related compounds to treat HIV and other viral infections. The license was originally entered by MediChem Research, Inc., and MediChem subsequently assigned the license to our joint venture. In consideration of this license, our joint venture is obligated to make up to $350,000 in aggregate milestone payments upon the achievement of various development and commercialization milestones. To date, the joint venture has not been required to make any milestone payments. MediChem made an up-front payment of $20,000 to NIH. Since our inception in 1999, the joint venture has paid NIH approximately $133,000 for the reimbursement of patent maintenance expenses, as required by the license agreement. In addition, the joint venture agreed to pay royalties to NIH based on net sales of licensed products. Even if there are no sales of licensed products, the joint venture is obligated to pay NIH a minimum annual royalty of approximately $6,700. Minimum annual royalties paid by the joint venture to NIH since our inception in 1999 are approximately $83,000. The license from NIH is subject to certain reserved rights for the U.S. Government, including the Government’s right to develop, make, use and sell Calanolide A pursuant to any treaties or agreements with foreign governments that the U.S. Government may enter, and the Government’s rights to require us to sublicense the rights granted in the interest of public health and safety. This license may be terminated by NIH if NIH determines we have not achieved certain benchmarks for drug development or we cannot reasonably satisfy unmet health and safety needs of the public.

University of Illinois at Chicago.    In 1999, we acquired an exclusive worldwide license, under patent rights and know-how controlled by UIC, to develop, make, use and sell ALS-357 and related compounds to treat melanoma and other forms of cancer. In consideration for this license, we paid an upfront license fee of $15,000 upon the execution of the agreement. We are also obligated to make up to $135,000 in aggregate milestone payments upon the achievement of various development and commercialization milestones for each of ALS-357 and any other compound developed by us under the licensed technology. To date, we have paid $10,000 in milestone payments. Under the terms of the agreement, we are obligated to reimburse UIC for past patent preparation, filing and prosecution expenses, and have agreed to reimburse UIC for similar expenses related to foreign patents throughout the term of the agreement. To date we have paid UIC approximately $322,000 for patent reimbursement. In addition, we agreed to pay royalties to UIC based on net sales of licensed products by us, our affiliates and sublicensees, as well as a percentage of all other income we receive from sublicensees, but in any event, a minimum royalty of $5,000 annually once commercial sales commence.

Argonne National Laboratory.    In 2003, we acquired an exclusive license, under patent rights and know-how controlled by Argonne National Laboratory, to develop, make, use and sell in the United States and its territories a class of peptides and related compounds to inhibit the formation of amyloid fibrils. These fibrils are implicated in a number of diseases such as Alzheimer’s disease and amyloidosis. In consideration of this license, we agreed to pay royalties to Argonne equal to 4% of net sales of licensed products by us, our affiliates and sublicensees, as well as 10% of any benchmark or milestone fees we receive from sublicensees. We also agreed to reimburse Argonne for the cost of ongoing patent prosecution and maintenance. The license is subject to certain reserved rights for the U.S. Government based on Federal statutes, including the Government’s right to develop, make, use, and sell the amyloid inhibiting peptides pursuant to any treaties or agreements with foreign governments that the U.S. Government may enter, and the Government’s right to require us to sublicense the rights granted in certain limited circumstances. We are obligated to provide at least one half-time employee to this project until completion of Phase I clinical trials. Argonne has the right to terminate the agreement if due diligence requirements, including the devotion of one half-time employee, are not met.

Baxter International.    As part of our spin-off from MediChem Life Sciences in 1999, we obtained the entire right, title and interest to certain patented inventions relating to ALS-886 that were assigned by Baxter International, Inc. to Dr. Michael T. Flavin. We have assumed the obligation of Dr. Flavin to pay Baxter, as a payment for the assignment, 3% of net sales of ALS-886. Further, we are also obliged to share with Baxter 50% of the sublicensing fees we collect, other than royalties. In addition, if we sell the ongoing business of making, using or selling ALS-886, we are obligated to pay Baxter 50% of the fair market value of the right or license to manufacture, use or sell ALS-886 that is conveyed as part of the sale.

Intellectual Property

Patents and Trade Secrets

We have assembled a broad intellectual property portfolio encompassing the use, methods of preparation and methods of manufacture for our product candidates in the areas of infectious disease, inflammation and cancer. Together with our joint venture, we currently have exclusive access to 105 issued U.S. and international patents. In addition, 28 U.S. and international patent applications have been filed and are in various stages of processing.

Key U.S. Patents and Expiration Dates

Drug Candidate

U.S. Patent Number

Expiration Date

Cethromycin

 

 

5866549

 

 

 

9/4/2016

 

 

Calanolide A

 

 

5591770

 

 

 

1/7/2014

 

 

ALS-886

 

 

5504111

 

 

 

4/2/2013

 

 

ALS-357

 

 

5658947

 

 

 

8/19/2014

 

 



The patent positions of companies like ours are generally uncertain and involve complex legal and factual questions. Our ability to maintain and solidify our proprietary position for our technology will depend on our success in obtaining effective claims and enforcing those claims once granted. We do not know whether any of our patent applications or those patent applications that we license will result in the issuance of any patents. Our issued patents and those that may issue in the future, or those licensed to us, may be challenged, invalidated or circumvented, which could limit our ability to stop competitors from marketing related products or the length of term of patent protection that we may have for our products. In addition, there can be no assurance that this patent coverage will be broad enough to prevent third parties from developing or commercializing similar or identical technologies and thus the rights granted under any issued patents may not provide us with any meaningful competitive advantages against our competitors. Furthermore, because of the extensive time required for development, testing and regulatory review of a potential product, it is possible that, before any of our products can be commercialized, any related patent may expire or remain in force for only a short period following commercialization, thereby reducing any advantage of the patent. There can also be no assurance that our technologies will not be deemed to infringe the IP rights of third parties or that we will be able to acquire licenses to the IP rights of third parties under satisfactory terms or at all.

Research and development expenses incurred to develop our intellectual property portfolio, excluding development costs related to cethromycin, totaled approximately $1.2 million for the twelve months ended December 31, 2005.

Competition

The biotechnology and pharmaceutical industries are characterized by rapidly advancing technologies, intense competition and a strong emphasis on proprietary products. We face competition from many different sources, including commercial pharmaceutical and biotechnology enterprises, academic institutions, government agencies and private and public research institutions. We believe that our most significant competitors are Aventis, Pfizer, GlaxoSmithKline and Johnson & Johnson.

Many of our competitors have significantly greater financial resources and expertise in research and development, manufacturing, preclinical testing, clinical trials, regulatory approvals and marketing approved products than we do. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. 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. These third parties compete with us in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient registration for clinical trials, as well as in acquiring technologies and technology licenses complementary to our programs or advantageous to our business.

We rely upon our collaborators for support in advancing certain of our product candidates and intend to rely on our collaborators for the commercialization of these products. Our collaborators may be conducting multiple product development efforts within the same disease areas that are the subjects of their agreements with us. Generally, our agreements with our collaborators do not preclude them from pursuing development efforts using a different approach from that which is the subject of our agreement with them. Therefore, any of our product candidates may be subject to competition with a product candidate under development by a collaborator.

There are also a number of companies working to develop new drugs and other therapies for these diseases that are undergoing clinical trials. The key competitive factors affecting the success of all of our product candidates are likely to be their efficacy, safety, price and convenience. See ‘‘Risk Factors—We will face significant competition from other biotechnology and pharmaceutical companies, and our operating results will suffer if we fail to compete effectively.’’

Government Regulation

Government authorities in the United States, at the federal, state and local level, and other countries extensively regulate, among other things, the research, development, testing, manufacture, labeling, promotion, advertising, distribution, marketing and export and import of pharmaceutical products such as those we are developing. The process of obtaining regulatory approvals and the subsequent substantial compliance with appropriate federal, state, local and foreign statutes and regulations require the expenditure of substantial time and financial resources.

U.S. Government Regulation

In the United States, the FDA regulates drugs under the Federal Food, Drug, and Cosmetic Act and implementing regulations. If we fail to comply with the applicable United States requirements at any time during the product development process, approval process or after approval, we may become subject to administrative or judicial sanctions. These sanctions could include the FDA’s refusal to approve pending applications, withdrawal of an approval, clinical holds, warning letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, civil penalties or criminal prosecution. Any agency enforcement action could have a material adverse effect on us.

The steps required before a drug may be marketed in the United States include:

·        preclinical laboratory tests, animal studies and formulation studies under the FDA’s good laboratory practices regulations;

·        submission to the FDA of an IND application for human clinical testing, which must become effective before human clinical trials may begin;

·        adequate and well-controlled clinical trials in accordance with FDA good clinical practice regulations, to establish the safety and efficacy of the product for each indication;

·        submission to the FDA of an NDA;

·        satisfactory completion of an FDA inspection of the manufacturing facility or facilities at which the product is produced to assess compliance with current good manufacturing practices, or cGMP; and

·        FDA review and approval of the NDA.

Preclinical tests include laboratory evaluations of product chemistry, toxicity and formulation, as well as animal studies. An IND sponsor must submit the results of the preclinical tests, together with manufacturing information and analytical data, to the FDA as part of the IND. The IND must become effective before human clinical trials may begin. An IND will automatically become effective 30 days after receipt by the FDA, unless before that time the FDA raises concerns or questions about issues such as the conduct of the trials as outlined in the IND. In that case, the IND sponsor and the FDA must resolve any outstanding FDA concerns or questions before clinical trials can proceed. If these issues are unresolved, the FDA may not allow the clinical trials to commence.

Clinical trials involve the administration of the investigational product to human subjects under the supervision of qualified investigators. Clinical trials are conducted under protocols detailing, among other things, the objectives of the study, the parameters to be used in monitoring safety and the effectiveness criteria to be evaluated. Each protocol must be submitted to the FDA as part of the IND.

Clinical trials typically are conducted in three sequential phases, but the phases may overlap or be combined. Each trial must be reviewed and approved by an independent Institutional Review Board before it can begin. Phase I clinical trials usually involve the initial introduction of the investigational drug into humans to evaluate the product’s safety, dosage tolerance and pharmacodynamics and, if possible, to gain an early indication of its effectiveness.

Phase II clinical trials usually involve controlled trials in a limited patient population to:

·        evaluate dosage tolerance and appropriate dosage;

·        identify possible adverse effects and safety risks; and

·        evaluate preliminarily the efficacy of the drug for specific indications.

Phase III clinical trials usually further evaluate clinical efficacy and test further for safety in an expanded patient population. Phase I, Phase II and Phase III clinical trials may not be completed successfully within any specified period, if at all. Furthermore, the FDA or we may suspend or terminate clinical trials at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk.

Assuming successful completion of the required clinical testing, the results of the preclinical studies and of the clinical studies, together with other detailed information, including information on the manufacture and composition of the product, are submitted to the FDA in the form of an NDA requesting approval to market the product for one or more indications. The FDA reviews an NDA to determine, among other things, whether a product is safe and effective for its intended use and has a favorable risk/benefit profile.

Under the Pediatric Research Equity Act of 2003, or PREA, NDAs or supplements to NDAs must contain data to assess the safety and effectiveness of the drug for the claimed indications in all relevant pediatric subpopulations and to support dosing and administration for each pediatric subpopulation for which the drug is safe and effective. The FDA may grant deferrals for submission of data or full or partial waivers. In most cases, the NDA must be accompanied by a substantial user fee.

Before approving an application, the FDA will inspect the facility or the facilities where the product is manufactured. The FDA will not approve the product unless current good manufacturing practices (“cGMP”) compliance is considered satisfactory. The FDA will issue an approval letter if it determines that the application, manufacturing process and manufacturing facilities are acceptable. If the FDA determines the application, manufacturing process or manufacturing facilities are not acceptable; it will outline the deficiencies in the submission and often will request additional testing or information.

Notwithstanding the submission of any requested additional information, the FDA ultimately may decide that the application does not satisfy the regulatory criteria for approval.

The testing and approval process requires substantial time, effort and financial resources, and each may take several years to complete. The FDA may not grant approval on a timely basis, or at all. We may encounter difficulties or unanticipated costs in our efforts to secure necessary governmental approvals, which could delay or preclude us from marketing our products. The FDA may limit the indications for use or place other conditions on any approvals that could restrict the commercial application of the products. After approval, some types of changes to the approved product, such as adding new indications, manufacturing changes and additional labeling claims, are subject to further FDA review and approval.

After regulatory approval of a product is obtained, we are required to comply with a number of post-approval requirements. For example, as a condition of approval of an application, the FDA may require post-marketing testing and surveillance to monitor the product’s safety or efficacy. In addition, holders of an approved NDA are required to report certain adverse reactions and production problems to the FDA, to provide updated safety and efficacy information and to comply with requirements concerning advertising and promotional labeling for their products. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes numerous procedural and documentation requirements. Accordingly, manufacturers must continue to expend time, money and effort in the area of production and quality control to maintain compliance with cGMP and other regulations.

We rely, and expect to continue to rely, on third parties for the production of clinical and commercial quantities of our product candidates. Future FDA inspections may identify compliance issues at our facilities or at the facilities of our contract manufacturers that may disrupt production or distribution, or require substantial resources to correct. In addition, discovery of problems with a product, or the failure to comply with requirements, may result in restrictions on a product, manufacturer or holder of an approved NDA, including withdrawal or recall of the product from the market or other voluntary or FDA-initiated action that could delay further marketing. Newly discovered or developed safety or efficacy data may require changes to a product’s approved labeling, including the addition of new warnings and contraindications. Also, new government requirements may be established that could delay or prevent regulatory approval of our products under development.

Foreign Regulation

In addition to regulations in the United States, we will be subject to a variety of foreign regulations governing clinical trials and commercial sale and distribution of our products. Whether or not we obtain FDA approval for a product, we must obtain approval of a product by the comparable regulatory authorities of foreign countries before we can commence clinical trials or marketing of the product in those countries. The approval process varies from country to country, and the time may be longer or shorter than that required for FDA approval. The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary greatly from country to country.

Under European Union regulatory systems, we may submit marketing authorization applications either under a centralized or decentralized procedure. The centralized procedure, which is compulsory for medicines produced by biotechnology and optional for those which are highly innovative, provides for the grant of a single marketing authorization that is valid for all European Union member states. The decentralized procedure provides for mutual recognition of national approval decisions. Under this procedure, the holder of a national marketing authorization may submit an application to the remaining member states. Within 90 days of receiving the applications and assessment report, each member state must decide whether to recognize approval. If a member state does not recognize the marketing

authorization, the disputed points are eventually referred to the European Commission, whose decision is binding on all member states.

Pharmaceutical Pricing and Reimbursement

In both domestic and foreign markets, sales of any products for which we receive regulatory approval for commercial sale will depend in part on the availability of reimbursement from third party payors. Third party payors include government health administrative authorities, managed care providers, private health insurers and other organizations. These third party payors are increasingly challenging the price and examining the cost-effectiveness of medical products and services. In addition, significant uncertainty exists as to the reimbursement status of newly approved healthcare product candidates. We may need to conduct expensive pharmacoeconomic studies in order to demonstrate the cost-effectiveness of our products. Our product candidates may not be considered cost-effective. Adequate third party reimbursement may not be available to enable us to maintain price levels sufficient to realize an appropriate return on our investment in product development.

In 2003, the United States government enacted legislation providing a partial prescription drug benefit for Medicare recipients, beginning in 2006. Government payment for some of the costs of prescription drugs may increase demand for any products for which we receive marketing approval. However, to obtain payments under this program, we would be required to sell products to Medicare recipients through drug procurement organizations operating pursuant to this legislation. These organizations would negotiate prices for our products, which are likely to be lower than we might otherwise obtain. Federal, state, and local governments in the United States continue to consider legislation to limit the growth of healthcare costs, including the cost of prescription drugs. Future legislation could limit payments for pharmaceuticals such as the product candidates that we are developing.

The marketability of any products for which we receive regulatory approval for commercial sale may suffer if the government and third party payors fail to provide adequate coverage and reimbursement. In addition, an increasing emphasis on managed care in the United States has increased and will continue to increase the pressure on pharmaceutical pricing.

Another development that may affect the pricing of drugs is proposed Congressional action regarding drug reimportation into the United States. Proposed legislation would allow the reimportation of approved drugs originally manufactured in the United States back into the United States from other countries where the drugs are sold at a lower price. If legislation or regulations are passed allowing the reimportation of drugs, they could reduce the price we receive for any products that we may develop, negatively affecting our revenues and prospects for profitability. Even without legislation authorizing reimportation, patients have been purchasing prescription drugs from Canadian and other non-United States sources, which have reduced the price received by pharmaceutical companies for their products.

Employees

As of December 31, 2005, we employed 18 people of which there are 7 in research and 11 in administration. Our employees are not represented by any collective bargaining agreements and we believe our employee relations are good.

Available Information

Copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 are available free of charge through our website (www.advancedlifesciences.com) as soon as reasonably practicable after we electronically file the material

with, or furnish it to, the Securities and Exchange Commission at 450 Fifth Street, N.W., Washington DC 20549.

Item 1A.                 Risk Factors.

Risks Related to Our Industry and Business

We are at an early stage of development and may never attain product sales.

We have not received FDA approval for any of our product candidates. Any compounds that we discover or in-license will require extensive and costly development, preclinical testing and/or clinical trials prior to seeking regulatory approval for commercial sales. Our most advanced product candidate, cethromycin, and any other compounds we discover, develop or in-license, may never be approved for commercial sale. The time required to attain product sales and profitability is lengthy and highly uncertain, and we cannot assure you that we will be able to achieve or maintain product sales.

We expect our net operating losses to continue for at least several years, and we are unable to predict the extent of future losses or when we will become profitable, if ever.

We have incurred significant net losses since our formation in 1999. Our cumulative net loss was $46.7 million as of December 31, 2005. Our operating losses are due in large part to the significant research and development costs required to identify, validate and license potential product candidates, conduct preclinical studies and conduct clinical trials of our more advanced product candidates. To date, we have generated only limited revenues, consisting of management fees and one-time or limited payments associated with our collaborations or grants, and we do not anticipate generating any significant revenues for at least the next several years, if ever. We expect to increase our operating expenses over the next several years as we plan to:

·        expand the clinical trial program for cethromycin;

·        continue the preclinical development and commence the clinical development of our other product candidates, such as ALS-886 and ALS-357;

·        expand our research and development activities;

·        acquire or in-license new technologies and product candidates; and

·        increase our required corporate infrastructure and overhead.

As a result, we expect to continue to incur significant and increasing operating losses for the foreseeable future. Because of the numerous risks and uncertainties associated with our research and product development efforts, we are unable to predict the extent of any future losses or when we will become profitable, if ever. Even if we do achieve profitability, we may not be able to sustain or increase profitability on an ongoing basis.

We will require additional funding to satisfy our future capital needs, and future financing strategies may adversely affect holders of our common stock.

Our operations will require significant additional funding in large part due to our research and development expenses, future preclinical and clinical testing costs, the possibility of expanding our facilities, and the absence of any meaningful revenues in the near future. We do not know whether additional financing will be available to us on favorable terms or at all. If we cannot raise additional funds, we may be required to reduce our capital expenditures, scale back product development or programs, reduce our workforce and license to others products or technologies that we may otherwise be able to commercialize.

To the extent we raise additional capital by issuing equity securities, our stockholders could experience substantial dilution. Any additional equity securities we issue may have rights, preferences or privileges senior to those of existing holders of stock, including purchasers of our common stock in the offerings. To the extent that we raise additional funds through collaboration and licensing arrangements, we may be required to relinquish some rights to our technologies or product candidates, or grant licenses on terms that are not favorable to us.

Our business would be materially harmed if our two pivotal Phase III clinical trials of cethromycin are unsuccessful.

We anticipate that our ability to generate any significant product revenues in the near future will depend solely on the successful development and commercialization of cethromycin, our most advanced product candidate. We have commenced two pivotal Phase III clinical trials, the first of which was begun in December 2005, of cethromycin for the treatment of mild-to-moderate community acquired pneumonia. Prior to licensing the compound to us, Abbott Laboratories conducted an initial Phase III clinical trial of cethromycin for the treatment of community acquired pneumonia. Although the results of this study met the primary endpoints for efficacy, this is no assurance that our pivotal Phase III clinical trials will be successful.

The Abbott study used cethromycin dosing levels of 150 mg once-daily and 150 mg twice-daily. Our proposed pivotal Phase III protocol uses a dosing level of 300 mg once-daily, even though Abbott was able to demonstrate efficacy at 150 mg once-daily. We do not expect that the different dosing regimen will reduce the effectiveness of cethromycin in our pivotal Phase III clinical trials, but we could be incorrect. Clinical trials at the higher dosage level are also likely to increase the frequency of adverse side effects. The Abbott study did not include a standard of care comparator arm. Antibiotic products currently in the marketplace are generally effective and, for this reason, the required threshold to demonstrate non-inferiority for new antibiotic compounds is often very high. There can be no assurance that our pivotal Phase III clinical trials of cethromycin will establish non-inferiority when a comparator arm is applied.

The success of our pivotal Phase III clinical trials in treating mild-to-moderate community acquired pneumonia may depend on many factors that are beyond our control and unrelated to the safety or efficacy of cethromycin. For instance, clinical studies may demonstrate lower than expected cure rates because of the lack of patient compliance with prescribed dosing regimens. Cethromycin is our most advanced product candidate, and, as a company, we do not have any prior experience in conducting Phase III clinical trials. If we are unable to complete these trials successfully or ultimately receive FDA marketing approval for cethromycin, our ability to generate revenues and our business will be materially harmed.

Prior clinical trials of cethromycin have shown evidence of side effects that may diminish its prospects for commercialization and wide market acceptance.

The gastrointestinal adverse events reported in prior clinical trials of cethromycin were generally at frequencies consistent with Ketek and other antibiotic treatments. These gastrointestinal side effects included nausea, diarrhea, vomiting and abdominal pain. Taste perversion was the adverse event most frequently observed in prior clinical trials of cethromycin, occurring in 17% of subjects across once-daily dosing regimens of 150 mg, 300 mg and 600 mg. According to available data, taste perversion has not occurred at any significant level for other antibiotic treatments. We do not believe that, by itself, taste perversion presents a safety risk for patients. However, taste perversion may lead to higher levels of patient non-compliance, which could have the effect of reducing overall cure rates in our planned pivotal Phase III clinical trials of cethromycin. If overall cure rates in our pivotal Phase III clinical trials are not sufficient to establish non-inferiority, we may not receive FDA approval for cethromycin and our business will be materially harmed.

Prior pivotal Phase III comparator trials of cethromycin in the treatment of bronchitis and pharyngitis failed to establish non-inferiority, and our inability to expand cethromycin into these indications would harm our ability to generate additional revenues in the future.

Abbott Laboratories conducted four pivotal Phase III comparator trials for cethromycin in treating bronchitis and pharyngitis at a dosing level of 150 mg once-daily. Each of these trials failed to establish non-inferiority against comparator antibiotics. While we believe that the negative outcomes of the Abbott comparator trials were related to dosing levels, we may be incorrect. The failure to meet primary endpoints in the Abbott trials may not have been dose related, as we believe, but rather a result of the compound’s lack of sufficient clinical efficacy. Clinical trials using a 300 mg once-daily regimen are also likely to increase the occurrence of adverse side effects. Even if we receive FDA approval to market cethromycin for the treatment of community acquired pneumonia, our failure to expand cethromycin into other indications would harm our ability to generate additional revenues in the future.

Because we are heavily dependent on our license agreement with Abbott Laboratories and our collaborations with other third parties, our product development programs may be delayed or terminated by factors beyond our control.

In December 2004, we entered into a license agreement with Abbott Laboratories for certain patent applications, patents and proprietary technology relating to cethromycin. We have also entered into a number of license agreements for intellectual property and other rights needed to develop our product candidates that are in earlier stages of development. Our primary collaborators other than Abbott include the National Institutes of Health, the University of Illinois at Chicago, Argonne National Laboratory and Baxter International. A description of our agreements with collaborators can be found under the headings ‘‘Business—Abbott Laboratories Collaboration’’ and ‘‘Business—Other Collaborations and License Agreements.’’ Our collaborations generally present additional risks to our business, such as the risk that our collaborators encounter conflicts of interest to their arrangements with us, inadequately defend our intellectual property rights or develop other products that compete with us. Our ability to generate any significant product revenues in the near future will depend solely on the successful commercialization of cethromycin. If for any reason we are unable to realize the expected benefits of our license agreement with Abbott, or under any of our other collaborations, then our business and financial condition may be materially harmed.

If we are unable to restructure the debt and joint venture relationship with the State Government of Sarawak, Malaysia, then our development program for Calanolide A may be delayed or abandoned.

The intellectual property for Calanolide A is held by Sarawak MediChem Pharmaceuticals, Inc., our 50/50 joint venture with the State Government of Sarawak, Malaysia. The original intent of our business relationship was that we would contribute intellectual property and management to the joint venture and our partner would provide funding. To advance Calanolide A, the Sarawak Government funded $9.0 million by purchasing its 50% equity position and loaned an additional $12.0 million to the joint venture. According to the terms of the loan agreement with the Sarawak Government, $12.0 million of this debt is past due . As a result of this default in payment by the joint venture, the Sarawak Government has the option under the loan agreement to take over the control and management of the Calanolide A project or the affairs of the joint venture until such time as the loan is repaid in full. In July 2005, the Sarawak Government asserted its rights to assume control of the management of the joint venture. In December 2005, the Sarawak Government nominated and the Board of Directors of SMP approved the appointment of Mr. Jumastapha bin Lamat as the controlling officer of SMP. Since that time we have been transitioning access to the joint venture’s accounting, financial and corporate records to representatives of Mr. Lamat. The Sarawak Government also expressly reserved all contractual and legal remedies available in light of the default and indicated its intent to fully exercise its rights as a creditor of the joint venture.

Ultimately, we believe that in order for the joint venture to continue, the terms of the debt must be amended to extend its maturity to a date after commercialization of Calanolide A.

Further development will require that we and the Sarawak Government agree to restructure and extend the debt and determine the source of financing for Phase IIa clinical trials of Calanolide A. No agreement has yet been reached, and we do not intend to expend any meaningful funds advancing the development of Calanolide A unless and until we restructure the joint venture’s debt and reach a satisfactory agreement with the Sarawak Government to amend our joint venture relationship and establish our respective obligations regarding the future funding of the next phase of developing Calanolide A. As a result, we are unable to predict when, or if at all, we will proceed with our plans to commence Phase IIa clinical trials for Calanolide A.

Further, our joint venture agreement with the Sarawak Government provides that, upon termination of the joint venture, any liabilities of the joint venture will be settled by the parties equally and all patents or licenses of the joint venture shall be reassigned back to us, including rights to clinical trials. If we and the Sarawak Government are unable to restructure the debt of the joint venture or if any dispute arises with the Sarawak Government, then our ability to continue the development of Calanolide A may be adversely affected, and we may cease future participation in the program. See ‘‘Business—Other Collaborations and License Agreements—Sarawak MediChem Pharmaceuticals, Inc.’’

Because the results of preclinical studies for our preclinical product candidates are not necessarily predictive of future results, our product candidates may not have favorable results in later clinical trials or ultimately receive regulatory approval.

Only two product candidates in our development pipeline, cethromycin and Calanolide A, have been tested in clinical trials. Our other product candidates have only been through preclinical studies. Positive results from preclinical studies, particularly in vitro studies, are no assurance that later clinical trials will succeed. Preclinical trials are not designed to establish the clinical efficacy of our preclinical product candidates. We will be required to demonstrate through clinical trials that these product candidates are safe and effective for use before we can seek regulatory approvals for their commercial sale. There is typically an extremely high rate of failure as product candidates proceed through clinical trials. If our product candidates fail to demonstrate sufficient safety and efficacy in any clinical trial, we would experience potentially significant delays in, or be required to abandon, development of that product candidate. This would adversely affect our ability to generate revenues and may damage our reputation in the industry and in the investment community.

The future clinical testing of our product candidates could be delayed, resulting in increased costs to us and a delay in our ability to generate revenues.

Our product candidates will require preclinical testing and extensive clinical trials prior to submitting a regulatory application for commercial sales. We do not know whether planned clinical trials will begin on time, if at all. Delays in the commencement of clinical testing could significantly increase our product development costs and delay product commercialization. In addition, many of the factors that may cause, or lead to, a delay in the commencement of clinical trials may also ultimately lead to denial of regulatory approval of a product candidate. Each of these results would adversely affect our ability to generate revenues.

The commencement of clinical trials can be delayed for a variety of reasons, including delays in:

·        demonstrating sufficient safety to obtain regulatory approval to commence a clinical trial;

·        reaching agreement on acceptable terms with prospective contract research organizations and trial sites;

·        manufacturing sufficient quantities of a product candidate; and

·        obtaining institutional review board approvals to conduct clinical trials at prospective sites.

In addition, the commencement of clinical trials may be delayed due to insufficient patient enrollment, which is a function of many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites, the availability of effective treatments for the relevant disease, and the eligibility criteria for the clinical trial. Because community acquired pneumonia is generally seasonal in nature, achieving sufficient patient enrollment for our pivotal Phase III clinical trials of cethromycin may be particularly difficult.

The FDA required one of our competitors, Aventis Pharmaceuticals, to undertake a 24,000 patient safety study prior to approving Ketek ® for commercialization. We do not expect the FDA to require a similarly sized trial for cethromycin because Ketek was the first ketolide introduced and no previous safety testing had been conducted for this class of antibiotics. Abbott’s studies to date and our ongoing clinical program will include monitoring of cardiac and hepatic safety. Since that time, Ketek has been administered to over ten million patients and, to our knowledge, has not demonstrated any severe safety risks with the exception of one recent article that reported the case history of three patients who experienced liver toxicity. The FDA, through a bulletin on their website, recommended physicians watch for potential liver toxicity issues of patients prescribed Ketek.  If the FDA does require a large safety trial for cethromycin, however, it would significantly increase our costs and extend the time required to receive regulatory approval.

We will depend on outside parties to conduct our clinical trials, and any failure of those parties to fulfill their obligations could result in costs and delays beyond our control that prevent us from obtaining regulatory approval or successfully commercializing product candidates.

We intend to engage contract research organizations to perform data collection and analysis and other aspects of our clinical trials of cethromycin and our other product candidates. We do not have the physical and human resources to conduct our clinical trials independently. The contract research organizations we engage will interact with clinical investigators and medical institutions to enroll patients in our clinical trials. As a result, we will depend on these clinical investigators, medical institutions and contract research organizations to perform the studies and trials properly. If these parties do not successfully carry out their contractual duties or obligations or meet expected deadlines, or if the quality, completeness or accuracy of the clinical data they obtain is compromised due to the failure to adhere to our clinical protocols or for other reasons, our clinical trials may be extended, delayed or terminated. Many of these factors will be outside of our oversight and beyond our control. We may not be able to enter into replacement arrangements without undue delays or considerable expenditures. If there are delays in testing or regulatory approvals as a result of the failure to perform by third parties, our drug discovery and development costs will increase, and we may not be able to obtain regulatory approval for our product candidates. In addition, we may not be able to establish or maintain relationships with these parties on favorable terms, if at all.

Even if we successfully complete clinical trials of cethromycin or any other product candidate, we may fail to obtain FDA approval of a new drug application.

The FDA may not approve in a timely manner, or at all, any NDA we submit. If we are unable to submit an NDA for cethromycin or any other product candidate, or if any NDA we submit is not approved by the FDA, we will be unable to commercialize that product in the United States. The FDA can and does reject NDAs, and often requires additional clinical trials, even when product candidates performed well or achieved favorable results in large-scale Phase III clinical trials. The FDA imposes substantial requirements on the introduction of pharmaceutical products through lengthy and detailed laboratory and clinical testing procedures, sampling activities and other costly and time-consuming procedures. Satisfaction of these requirements typically takes several years and may vary substantially based upon the type and complexity of the pharmaceutical product. A number of our product candidates are novel compounds, which may further increase the period of time required for satisfactory testing procedures.

Data obtained from preclinical and clinical activities are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. In addition, delays or rejections may be encountered based on changes in, or additions to, regulatory policies for drug approval during the period of product development and regulatory review. The effect of government regulation may be to delay or prevent the commencement of clinical trials or marketing of our product candidates for a considerable period of time, to impose costly procedures upon our activities and to provide an advantage to our competitors that have greater financial resources or are more experienced in regulatory affairs. The FDA may not approve our product candidates for clinical trials or marketing on a timely basis or at all. Delays in obtaining or failure to obtain such approvals would adversely affect the marketing of our product candidates and our liquidity and capital resources.

Drug products and their manufacturers are subject to continual regulatory review after the product receives FDA approval. Later discovery of previously unknown problems with a product or manufacturer may result in additional clinical testing requirements or restrictions on such product or manufacturer, including withdrawal of the product from the market. Failure to comply with applicable regulatory requirements can, among other things, result in fines, injunctions and civil penalties, suspensions or withdrawals of regulatory approvals, product recalls, operating restrictions or shutdown and criminal prosecution. We may lack sufficient resources and expertise to address these and other regulatory issues as they arise.

If we fail to obtain regulatory approvals in other countries for our product candidates under development, we will not be able to generate revenues in such countries.

In order to market our products outside of the United States, we must comply with numerous and varying regulatory requirements of other countries. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods. The time required to obtain approval in other countries might differ from that required to obtain FDA approval in the United States. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may negatively impact the regulatory process in others. The risks involved in the non-U.S. regulatory approval process, as well as the consequences for failing to comply with applicable regulatory requirements, generally include the same considerations as in the United States. A description of U.S. regulatory considerations can be found under the section entitled ‘‘—Even if we successfully complete clinical trials of cethromycin or any other product candidate, we may fail to obtain FDA approval of a new drug application.’’

Even if we successfully develop and obtain approval for cethromycin or any of our other product candidates, our business will not be profitable if those products do not achieve and maintain market acceptance.

Even if any of our product candidates are approved for commercial sale by the FDA or other regulatory authorities, the degree of market acceptance of any approved product candidate by physicians, healthcare professionals, patients and third-party payors, and our resulting profitability and growth, will depend on a number of factors, including:

·        our ability to provide acceptable evidence of safety and efficacy;

·        relative convenience and ease of administration;

·        the prevalence and severity of any adverse side effects;

·        the availability of alternative treatments;

·        the details of FDA labeling requirements, including the scope of approved indications and any safety warnings;

·        pricing and cost effectiveness;

·        the effectiveness of our or our collaborators’ sales and marketing strategy;

·        our ability to obtain sufficient third-party insurance coverage or reimbursement; and

·        our ability to have the product listed on insurance company formularies.

If any of our product candidates achieve market acceptance, we may not be able to maintain that market acceptance over time if new products or technologies are introduced that are received more favorably or are more cost effective. Complications may also arise, such as antibiotic or viral resistance, that render our products obsolete. We rely on the favorable resistance profile of cethromycin exhibited in clinical trials to be a potential competitive distinction from currently marketed compounds. Even if we receive FDA approval to market cethromycin, antibiotic resistance may emerge that will substantially harm our ability to generate revenues from its sale.

We are initially seeking FDA approval for cethromycin as a 7 day treatment regimen. There are currently a number of antibiotic products that are marketed as 5-day therapies. In the event that the marketplace considers this to be a significant competitive distinction, it is uncertain whether we will be able to make cethromycin available for a lower dosing period. In addition, we expect that cethromycin, if approved for sale, would be used primarily in the outpatient setting.

Our most advanced product candidate, cethromycin, will face significant competition in the marketplace if it receives marketing approval from the FDA.

Initially, we plan to conduct pivotal Phase III clinical trials of cethromycin for the treatment of mild-to-moderate community acquired pneumonia. We also intend to pursue opportunities for cethromycin in the treatment of other respiratory tract infections such as bronchitis, sinusitis and pharyngitis. There are several classes of antibiotics that are primary competitors for the treatment of one or more of these indications, including:

·        macrolides such as Biaxin ® (clarithromycin), a product of Abbott Laboratories; and Zithromax ® (azithromycin), a product of Pfizer Inc.;

·        one other ketolide antibiotic, Ketek ® (telithromycin), recently launched in the United States and Europe by Aventis Pharmaceuticals;

·        semi-synthetic penicillins such as Augmentin ® (amoxicillin and clavulanate potassium), a product of GlaxoSmithKline; and

·        fluoroquinolones such as Levaquin ® (levofloxacin), a product of Ortho-McNeil Pharmaceutical, Inc.; Tequin ® (gatifloxacin), a product of Bristol-Myers Squibb Company; FACTIVE® (gemifloxacin mesylate) tablets, a product of Oscient Pharmaceuticals; and Cipro ® (ciprofloxacin) and Avelox ® (moxifloxacin), both products of Bayer Corporation.

If cethromycin is approved by the FDA, it will not be the first ketolide antibiotic introduced to the marketplace. Ketek has been available for sale in Europe since 2002 and in the United States since August 2004. There are several additional ketolide product candidates in preclinical development or entering clinical development, including ABT-210, a second-generation ketolide antibiotic product candidate that we transferred back to Abbott Laboratories in July 2005. If ultimately approved by the FDA, these product candidates may have improved efficacy, ease of administration or side effect profiles when compared to cethromycin. The availability of additional ketolide antibiotics may have an adverse affect on our ability to generate product revenues and achieve profitability.

The availability of generic equivalents may adversely affect our ability to generate product revenues from cethromycin.

Many generic antibiotics are currently prescribed to treat respiratory tract infections. As competitive products lose patent protection, makers of generic drugs will likely begin to market additional competing products. Companies that produce generic equivalents are generally able to offer their products at lower prices. Ketek may lose patent protection as early as 2015, which would enable generic drug manufacturers to sell generic ketolide antibiotics at a lower cost than cethromycin. Generic equivalents of Biaxin and Zithromax, two macrolide antibiotic products are available. Cethromycin, if approved for commercial sale, may be at a competitive disadvantage because of its higher cost relative to generic products. This may have an adverse effect on our ability to generate product revenues from cethromycin.

We will face significant competition from other biotechnology and pharmaceutical companies, and our operating results will suffer if we fail to compete effectively.

We are a development stage company with 18 employees. Many of our competitors, such as Pfizer, GlaxoSmithKline and Bayer, are large pharmaceutical companies with substantially greater financial, technical and human resources than we have. The biotechnology and pharmaceutical industries are intensely competitive and subject to rapid and significant technological change. Many of the drugs that we are attempting to discover or develop will compete with existing therapies if we receive marketing approval. Because of their significant resources, our competitors may be able to use discovery technologies and techniques, or partnerships with collaborators, in order to develop competing products that are more effective or less costly than the product candidates we develop. This may render our technology or product candidates obsolete and noncompetitive. Academic institutions, government agencies, and other public and private research organizations may seek patent protection with respect to potentially competitive products or technologies and may establish exclusive collaborative or licensing relationships with our competitors.

As a company, we do not have any prior experience in conducting Phase III clinical trials. Our competitors may succeed in obtaining FDA or other regulatory approvals for product candidates more rapidly than us. Companies that complete clinical trials, obtain required regulatory agency approvals and commence commercial sale of their drugs before we do may achieve a significant competitive advantage, including certain FDA marketing exclusivity rights that would delay or prevent our ability to market certain products. Any approved drugs resulting from our research and development efforts, or from our

joint efforts with our existing or future collaborative partners, might not be able to compete successfully with our competitors’ existing or future products.

Our collaborators and third party manufacturers may not be able to manufacture our product candidates in larger quantities, which would prevent us from commercializing our product candidates.

To date, each of our product candidates has been manufactured in small quantities by our collaborators and third party manufacturers for preclinical and clinical trials. We do not currently have any agreements with third party manufacturers. If any of our product candidates is approved by the FDA or other regulatory agencies for commercial sale, we will need to enter into agreements with third parties to manufacture the product in larger quantities. Due to factors beyond our control, our collaborators and third party manufacturers may not be able to increase their manufacturing capacity for any of our product candidates in a timely or economic manner, or at all. Significant scale-up of manufacturing may require additional validation studies, which the FDA must review and approve. If we are unable to increase the manufacturing capacity for a product candidate successfully, the regulatory approval or commercial launch of that product candidate may be delayed or there may be a shortage in the supply of the product candidate. Our product candidates require precise, high-quality manufacturing. The failure of our collaborators and third party manufacturers to achieve and maintain these high manufacturing standards, including the incidence of manufacturing errors, could result in patient injury or death, product recalls or withdrawals, delays or failures in product testing or delivery, cost overruns or other problems that could seriously harm our business.

If we are unable to establish sales and marketing capabilities or enter into agreements with third parties to sell and market any products we may develop, we may be unable to generate revenues.

We do not currently have product sales and marketing capabilities. If we receive regulatory approval to commence commercial sales of any of our product candidates, we will have to establish a sales and marketing organization with appropriate technical expertise and distribution capabilities or make arrangements with third parties to perform these services. If we receive approval to commercialize cethromycin for the treatment of community acquired pneumonia, we intend to market the product directly in the United States. Our ability to generate any significant revenues in the near-term is dependent entirely on the successful commercialization and market acceptance of cethromycin. Factors that may inhibit our efforts to commercialize cethromycin or other product candidates without strategic partners or licensees include:

·        difficulty recruiting and retaining adequate numbers of effective sales and marketing personnel;

·        the inability of sales personnel to obtain access to, or persuade adequate numbers of, physicians to prescribe our products;

·        the lack of complementary products to be offered by sales personnel, which may put us at a competitive disadvantage against companies with broader product lines; and

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

As an alternative to establishing our own sales and marketing organization, we may engage other pharmaceutical or health care companies with existing distribution systems and direct sales organizations to assist us in North America and abroad. We may not be able to negotiate favorable distribution partnering arrangements, if at all. To the extent we enter co-promotion or other licensing arrangements; any revenues we receive will depend on the efforts of third parties and will not be under our control. If we are unable to establish adequate sales, marketing and distribution capabilities, whether independently or with third parties, our ability to generate product revenues, and become profitable, would be severely limited.

Off-label promotion of our products could result in substantial penalties.

If any of our product candidates receives marketing approval, we will only be permitted to promote the product for the uses indicated on the label cleared by the FDA. Our pivotal Phase III clinical trials of cethromycin are for the treatment of mild-to-moderate community acquired pneumonia, although we believe that cethromycin may have other applications in bronchitis, pharyngitis and sinusitis. If we request additional label indications for cethromycin or our other product candidates, the FDA may deny those requests outright, require extensive clinical data to support any additional indications or impose limitations on the intended use of any approved products as a condition of approval. U.S. Attorneys’ offices and other regulators, in addition to the FDA, have recently focused substantial attention on off-label promotional activities and have initiated civil and criminal investigations related to such practices. If it is determined by these or other regulators that we have promoted our products for off-label use, we could be subject to fines, legal proceedings, injunctions or other penalties.

If our efforts to obtain rights to new products or product candidates from third parties are not successful, we may not generate product revenues or achieve profitability.

Our long-term ability to earn product revenues depends on our ability to identify, through internal research programs, potential product candidates that may be developed into new pharmaceutical products and/or obtain new products or product candidates through licenses from third parties. If our internal research programs do not generate sufficient product candidates, we will need to obtain rights to new products or product candidates from third parties. We may be unable to obtain suitable products or product candidates from third parties for a number of reasons, including:

·        we may be unable to purchase or license products or product candidates on terms that would allow us to make an appropriate return from resulting products;

·        competitors may be unwilling to assign or license product or product candidate rights to us;

·        we may not have access to the capital necessary to purchase or license products or product candidates; or

·        we may be unable to locate suitable products or product candidates within, or complementary to, our areas of interest.

If we are unable to obtain rights to new products or product candidates from third parties, our ability to generate product revenues and achieve profitability may suffer.

Because our product candidates and development and collaboration efforts depend on our intellectual property rights, adverse events affecting our intellectual property rights will harm our ability to commercialize products.

Our success will depend to a large degree on our own, our licensees’ and our licensors’ ability to obtain and defend patents for each party’s respective technologies and the compounds and other products, if any, resulting from the application of such technologies. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. No consistent policy regarding the breadth of claims allowed in biotechnology patents has emerged to date. Accordingly, we cannot predict the breadth of claims that will be allowed or maintained, after challenge, in our or other companies’ patents.

The degree of future protection for our proprietary rights is uncertain, and we cannot ensure that:

·        we were the first to make the inventions covered by each of our pending patent applications;

·        we were the first to file patent applications for these inventions;

·        others will not independently develop similar or alternative technologies or duplicate any of our technologies;

·        any of our pending patent applications will result in issued patents;

·        any patents issued to us or our collaborators will provide a basis for commercially viable products, will provide us with any competitive advantages or will not be challenged by third parties;

·        we will develop additional proprietary technologies that are patentable; or

·        the patents of others will not have a negative effect on our ability to do business.

We are a party to certain in-license agreements that are important to our business, and we generally do not control the prosecution of in-licensed technology. Accordingly, we are unable to exercise the same degree of control over this intellectual property as we exercise over our internally developed technology. Moreover, some of our academic institution licensors, research collaborators and scientific advisors have rights to publish data and information in which we have rights. If we cannot maintain the confidentiality of our technology and other confidential information in connection with our collaborations, then our ability to receive patent protection or protect our proprietary information will be impaired. In addition, some of the technology we have licensed relies on patented inventions developed using U.S. government resources. Under applicable law, the U.S. government has the right to require us to grant a nonexclusive, partially exclusive, or exclusive license for such technology to a responsible applicant or applicants, upon terms that are reasonable under the circumstances, if the government determines that such action is necessary.

Confidentiality agreements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information and may not adequately protect our intellectual property.

We rely on trade secrets to protect our technology, particularly when we do not believe patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. In order to protect our proprietary technology and processes, we rely in part on confidentiality and intellectual property assignment agreements with our corporate partners, employees, consultants, outside scientific collaborators and sponsored researchers and other advisors. These agreements may not effectively prevent disclosure of confidential information nor result in the effective assignment to us of intellectual property, and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information or other breaches of the agreements. In addition, others may independently discover our trade secrets and proprietary information, and in such case we could not assert any trade secret rights against such party. Enforcing a claim that a party illegally obtained and is using our trade secrets is difficult, expensive and time consuming, and the outcome is unpredictable. In addition, courts outside the United States may be less willing to protect trade secrets. Costly and time-consuming litigation could be necessary to seek to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

Market acceptance and sales of our product candidates will be severely limited if we cannot arrange for favorable reimbursement policies.

Our ability to commercialize any product candidates successfully will depend in part on the extent to which governmental authorities, private health insurers and other organizations establish reimbursement levels for the cost of our products and related treatments. Third-party payors are increasingly challenging the prices charged for medical products and services. Also, the trend toward managed healthcare in the United States, as well as legislative proposals to reform healthcare, control pharmaceutical prices or reduce government insurance programs, may also result in exclusion of our product candidates from reimbursement programs. Because many generic antibiotics are available for the treatment of respiratory tract infections, our ability to list cethromycin on insurance company formularies will depend on its

effectiveness compared to lower-cost products. The cost containment measures that health care payors and providers are instituting, and the effect of any health care reform, could materially and adversely affect our ability to earn revenues from the sales of cethromycin and our other product candidates.

The recent Medicare prescription drug coverage legislation and future legislative or regulatory reform of the healthcare system could limit future revenues from our product candidates.

In the United States, there have been a number of legislative and regulatory proposals to change the healthcare system in ways that could affect our ability to market and sell our product candidates profitably. In particular, in December 2003, President Bush signed into law new Medicare prescription drug coverage legislation. Under this legislation, the Centers for Medicare and Medicaid Services, or CMS, the agency within the Department of Health and Human Services that administers Medicare and will be responsible for reimbursement of the cost of drugs, has asserted the authority of Medicare to elect not to cover particular drugs if CMS determines that the drugs are not ‘‘reasonable and necessary’’ for Medicare beneficiaries or to elect to cover a drug at a lower rate similar to that of drugs that CMS considers to be ‘‘therapeutically comparable.’’ Changes in reimbursement policies or health care cost containment initiatives that limit or restrict reimbursement for our products may cause our revenues to decline.

Another development that may affect the pricing of drugs is regulatory action regarding drug reimportation into the United States. The Medicare Prescription Drug, Improvement and Modernization Act of 2003, which became law in December 2003, requires the Secretary of the U.S. Department of Health and Human Services to promulgate regulations allowing drug reimportation from Canada into the United States under certain circumstances. These provisions will become effective only if the Secretary certifies that such imports will pose no additional risk to the public’s health and safety and result in significant cost savings to consumers. To date, the Secretary has made no such finding, but he could do so in the future. Proponents of drug reimportation may also attempt to pass legislation that would remove the requirement for the Secretary’s certification or allow reimportation under circumstances beyond those anticipated under current law. If legislation is enacted, or regulations issued, allowing the reimportation of drugs, it could decrease the reimbursement we receive for any products that we may commercialize, negatively affecting our anticipated revenues and prospects for profitability.

We will need to increase the size of our organization, and we may encounter difficulties managing our growth, which could adversely affect our results of operations.

We are currently a development stage company with 18 employees. We will need to expand and effectively manage our managerial, operational, financial and other resources in order to successfully pursue our research, development and commercialization effort. To manage any growth, we will be required to continue to improve our operational, financial and management controls, reporting systems and procedures and to attract and retain sufficient numbers of talented employees. We may be unable to successfully manage the expansion of our operations or operate on a larger scale and, accordingly, may not achieve our research, development and commercialization goals.

If we are unable to attract and retain qualified scientific, technical and key management personnel, or if any of our key executives, Michael T. Flavin, Ph.D., Ze-Qi Xu, Ph.D., or John L. Flavin, discontinues his employment with us, it may delay our research and development efforts.

We are highly dependent upon the efforts of our senior management team and scientific staff. The loss of the services of one or more members of the senior management team might impede the achievement of our development objectives. In particular, we are highly dependent upon and our business would be significantly harmed if we lost the services of Michael T. Flavin, Ph.D., our founder and Chairman and Chief Executive Officer, Ze-Qi Xu, Ph.D., our Executive Vice President and Chief Scientific Officer, or John L. Flavin, our President. We do not currently have any key man life insurance

policies. We have entered into employment agreements with members of our senior management team, but this does not ensure that we will retain their services for any period of time in the future. Our research and drug discovery programs also depend on our ability to attract and retain highly skilled chemists, biologists and preclinical and clinical personnel. We may not be able to attract or retain qualified scientific personnel in the future due to intense competition among biotechnology and pharmaceutical businesses, particularly in the Chicago area. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will significantly impede the achievement of our research and development objectives and our ability to meet the demands of our collaborators in a timely fashion.

Our business will expose us to potential product liability risks and there can be no assurance that we will be able to acquire and maintain sufficient insurance to provide adequate coverage against potential liabilities.

Our business will expose us to potential product liability risks that are inherent in the testing, manufacturing and marketing of pharmaceutical products. The use of our product candidates in clinical trials also exposes us to the possibility of product liability claims and possible adverse publicity. These risks will increase to the extent our product candidates receive regulatory approval and are commercialized. We do not currently have any product liability insurance, although we plan to obtain product liability insurance in connection with future clinical trials of our product candidates. There can be no assurance that we will be able to obtain or maintain any such insurance on acceptable terms. Moreover, our product liability insurance may not provide adequate coverage against potential liabilities. On occasion, juries have awarded large judgments in class action lawsuits based on drugs that had unanticipated side effects. A successful product liability claim or series of claims brought against us would decrease our cash reserves and could cause our stock price to fall significantly.

We face regulation and risks related to hazardous materials and environmental laws, violations of which may subject us to claims for damages or fines that could materially affect our business, financial condition and results of operations.

Our research and development activities involve the controlled use of hazardous materials and chemicals. The risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of an accident, we could be held liable for any damages or fines that result, and the liability could have a material adverse effect on our business, financial condition and results of operations. We are also subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of hazardous materials and waste products. If we fail to comply with these laws and regulations or with the conditions attached to our operating licenses, the licenses could be revoked, and we could be subjected to criminal sanctions and substantial liability or be required to suspend or modify our operations. In addition, we may have to incur significant costs to comply with future environmental laws and regulations. We do not currently have a pollution and remediation insurance policy.

Our business and operations would suffer in the event of system failures.

Despite the implementation of security measures, our internal computer systems are vulnerable to damage from computer viruses, unauthorized access, natural disasters, terrorism, war and telecommunication and electrical failures. Our drug discovery and preclinical testing systems are highly technical and proprietary. Any system failure, accident or security breach that causes interruptions in our operations could result in a material disruption of our drug discovery programs. To the extent that any disruption or security breach results in a loss or damage to our data or applications, or inappropriate disclosure of confidential or proprietary information, we may incur liability as a result, our drug discovery programs may be adversely affected and the further development of our product candidates may be

delayed. In addition, we may incur additional costs to remedy the damages caused by these disruptions or security breaches.

Item 1B.                Unresolved Staff Comments.

None.


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