ANADYS PHARMACEUTICALS INC - FORM 10-K

ANADYS PHARMACEUTICALS INC - FORM 10-K - March 1, 2010

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EX-31.1 - EX-31.1 - ANADYS PHARMACEUTICALS INC	a55326exv31w1.htm
EX-32.1 - EX-32.1 - ANADYS PHARMACEUTICALS INC	a55326exv32w1.htm
EX-23.1 - EX-23.1 - ANADYS PHARMACEUTICALS INC	a55326exv23w1.htm
EX-31.2 - EX-31.2 - ANADYS PHARMACEUTICALS INC	a55326exv31w2.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

(MARK ONE)


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

For the fiscal year ended December 31, 2009


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

For the transition period from to .

Commission File Number 0-50632

ANADYS PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)


Delaware		22-3193172
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

5871 Oberlin Drive, Suite 200, San Diego, California		92121
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: 858-530-3600

Securities registered pursuant to Section 12(b) of the Act:


Title of each class		Name of each exchange on which registered
Common Stock, $0.001 par value		Nasdaq Global Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o
No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

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


Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller Reporting Company o

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

The aggregate market value of the common stock held by non-affiliates of the registrant computed by reference to the closing price of the registrants common stock reported on the Nasdaq Global Market as of the last business day of the registrant’s most recently completed second fiscal quarter was approximately $66,821,443 as of such date.

As of February 17, 2010, the Registrant had outstanding 37,341,957 shares of common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company’s Proxy Statement to be filed with the Securities and Exchange Commission in connection with the 2010 Annual Meeting of Stockholders are incorporated herein by reference into Part III.

ANADYS PHARMACEUTICALS, INC.
ANNUAL REPORT ON FORM 10-K

Table of Contents


	Page
PART I

Item 1. Business		3
Item 1A. Risk Factors		16
Item 1B. Unresolved Staff Comments		32
Item 2. Properties		32
Item 3. Legal Proceedings		32
Item 4. Reserved		32

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		33
Item 6. Selected Financial Data		35
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations		36
Item 7A. Quantitative and Qualitative Disclosure About Market Risk		42
Item 8. Financial Statements and Supplementary Data		42
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		42
Item 9A. Controls and Procedures		43
Item 9B. Other Information		45

PART III

Item 10. Directors, and Executive Officers and Corporate Governance		46
Item 11. Executive Compensation		46
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		46
Item 13. Certain Relationships and Related Transactions, and Director Independence		47
Item 14. Principal Accounting Fees and Services		47

PART IV

Item 15. Exhibits and Financial Statement Schedules		48
EX-23.1
EX-31.1
EX-31.2
EX-32.1

INFORMATION RELATED TO FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements. These forward-looking statements involve a number of risks and uncertainties. Such forward-looking statements include statements about our development plans and programs, clinical trials, strategies and objectives, and other statements that are not historical facts, including statements which may be preceded by the words “intend,” “will,” “plan,” “expect,” “anticipate,” “estimate,” “aim,” “seek,” “believe,” “hope” or similar words. For such statements, we claim the protection of the Private Securities Litigation Reform Act of 1995. Readers of this Annual Report on Form 10-K are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. We undertake no obligation to update publicly or revise any forward-looking statements. Actual events or results may differ materially from our expectations. Important factors that could cause actual results to differ materially from those stated or implied by our forward-looking statements include, but are not limited to, the risk factors identified in our periodic reports filed with the Securities and Exchange Commission (SEC), including, without limitation, those discussed in “Item 1A. Risk Factors” and in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K.

PART I


Item 1.		Business

Overview

We are currently focusing our efforts on the development of ANA598, a small-molecule, non-nucleoside inhibitor of the NS5B polymerase for the treatment of hepatitis C. We also have investigated ANA773, an oral, small-molecule inducer of endogenous interferons that acts via the Toll-like receptor 7, or TLR7, pathway in a Phase I trial in hepatitis C.

Our expertise is based on two distinct scientific approaches to treating disease. With ANA598 we are focused on developing a direct antiviral, meaning a product candidate that acts by directly interacting with, and blocking the function of, a component of the virus. We discovered ANA598 through an extensive structure-based drug design program that focused on parameters we feel are critical for success in chronic viral diseases, including potency and sustained drug levels in blood. With ANA773, the focus is to stimulate the patients’ own immune systems to block cells infected with the hepatitis C virus from further producing more virus particles and amplifying the infection. ANA773 stimulates the immune system through activating a key receptor on immune cells known as TLR7. Our knowledge of TLR7 is buttressed by an extensive preclinical program exploring the pharmacology of this receptor and by previous clinical experience with other molecules that act via the TLR7 mechanism.

Activation of the TLR7 receptor may also allow the patient’s immune system to attack cancer cells. Accordingly, we have also investigated ANA773 in a separate Phase I trial for the treatment of patients with advanced cancer.

In June 2009, we initiated a strategic restructuring to focus our operations on the development of ANA598, in particular the Phase II study of ANA598 in combination with pegylated interferon and ribavirin. As part of the restructuring, we suspended further development of ANA773. The strategic restructuring resulted in a reduction in our workforce of approximately 40%. We retained the clinical development infrastructure required to conduct the Phase II study of ANA598, key capabilities directed toward pharmaceutical development and next generation non-nucleosides and a streamlined administrative staff.

Anadys retains all commercialization rights to both ANA598 and ANA773, which were discovered at Anadys.

ANA598

ANA598 is a direct antiviral that blocks the hepatitis C virus’ (HCV) ability to multiply by inhibiting the viral RNA polymerase. ANA598 belongs to a class of direct antivirals referred to as non-nucleosides. We believe non-nucleosides will become an important component of future combination regimens used to treat HCV infection, similar to the role played by non-nucleoside inhibitors in HIV therapy. ANA598 has demonstrated positive antiviral response and a favorable safety and tolerability profile in the ongoing Phase II combination trial, as described below. ANA598 has also completed two long-term chronic toxicology studies (26 weeks duration in rats and 39 weeks duration in monkeys) with favorable results. Furthermore, ANA598 has demonstrated the preclinical properties, including potency, pharmacokinetics and early safety, that we believe are prerequisites for successful development in the HCV area.

We are currently conducting a Phase II clinical trial of ANA598 in combination with pegylated interferon-alpha and ribavirin, which is the current standard of care (SOC) for the treatment of hepatitis C. The first dose cohort, receiving ANA598 at 200 mg twice daily (bid), initiated dosing in September 2009 and has completed the 12-week ANA598 dosing portion of the trial. The second dose cohort, receiving ANA598 at 400 mg bid, initiated dosing and fully enrolled in January 2010.

In the ongoing Phase II study, treatment-naïve (previously untreated) genotype 1 patients are to receive ANA598 or placebo in combination with SOC for 12 weeks at dose levels of 200 mg bid or 400 mg bid, each with a loading dose of 800 mg bid on day one. After week 12, patients are to continue receiving standard of care alone. Patients who achieve undetectable levels of virus at weeks four and 12 will be randomized to stop all treatment at week 24 or 48. The primary endpoint of the study is the proportion of patients who achieve undetectable levels of virus at week 12 (defined as complete Early Virological Response, or cEVR). Additional endpoints include safety and tolerability as well as the proportion of patients with undetectable levels of virus at week four (defined as Rapid Virological Response, or RVR). Patients will be followed for 24 weeks after stopping therapy to determine the rate of Sustained Virological Response, or SVR. Approximately 90 patients were to be and have been enrolled in this study – with approximately 30 patients receiving ANA598 and 15 receiving placebo at each dose level. The study is being conducted at a number of clinical sites in the United States.

In December 2009, we reported positive preliminary antiviral response and safety results at week four from the first dose cohort (200 mg bid) and in February 2010, we reported positive preliminary antiviral response and safety results at week 12 for this dose cohort. 56% of patients receiving ANA598 at 200 mg bid in combination with SOC achieved undetectable levels of virus (<15 IU/ml) at week 4, referred to as RVR, and 73% of patients receiving ANA598 at 200 mg bid in combination with SOC achieved undetectable levels of virus (<15 IU/ml) at week 12, referred to as cEVR. We are currently dosing patients at 400 mg bid and expect to analyze and release four week data from this dose cohort prior to the end of the first quarter of 2010 and expect to analyze and release 12-week data from this dose cohort during the second quarter of 2010.

We are in the early stages of Phase II drug development with ANA598. Substantial further investment will be necessary in order to progress ANA598 beyond the events referenced above and through additional clinical testing before we will be able to seek regulatory approval.

ANA773

ANA773 is a novel, oral inducer of endogenous interferons that acts via the TLR7 pathway that we have investigated as a treatment for both HCV and cancer. Both the prodrug and its active substance were discovered, designed and synthesized by Anadys scientists. Pharmacology studies have shown that ANA773 can elicit desired immune responses and that components of the response can be modulated by both dose and schedule of administration. We have also shown in our Phase I HCV clinical study that ANA773 can stimulate the immune system at a tolerated dose. However, we have elected to suspend further development of ANA773 in order to focus our resources on ANA598. Currently, we are not actively pursuing the development of ANA773 for either indication, except to allow currently enrolled patients in the oncology trial described below to continue to receive ANA773 until disease progression is observed. Further development of these programs will be contingent on obtaining additional resources allocated to such programs or entering into a collaborative or licensing arrangement around ANA773 with a third party.

The activities we have completed to date with ANA773 are part of early drug development. In order for us to develop ANA773 further, we will require substantial additional funding or support from a collaborator or licensee. We do not have any plans to further the development of ANA773 at this time. If continued, substantial further investment would be necessary in order to progress ANA773 beyond the events referenced above and through additional clinical testing before regulatory approval could be sought.

ANA773 for HCV

Because interferon-alpha is the foundation of the current standard of care for hepatitis C and the current development of direct antivirals is based on the addition of such direct antivirals to interferon-based regimens, we believe that an oral agent that stimulates interferon production with improved tolerability could potentially displace interferon from future regimens that contain direct antivirals. We believe that ANA773 may offer the opportunity to be such an oral interferon replacement.

In 2009 we concluded a Phase I clinical trial of ANA773 in HCV patients. In the final cohort of the trial, in which patients received 2000 mg of ANA773 every other day over 10 days, the mean maximal decline in viral load was 1.3 log10, compared to a mean maximal decline of 0.3 log₁₀ in patients who received placebo. Five of the eight patients who received 2000 mg ANA773 experienced a maximal decline of greater than 1 log, while none of the eight patients who received placebo experienced a decline of greater than 1 log. The mean end-of-treatment decline was 0.6 log10 in patients who received 2000 mg ANA773 compared to 0.1 log10 in patients who received placebo. ANA773 was well-tolerated in patients throughout the course of the study and there were no serious adverse events reported.

ANA773 for Cancer

We have also investigated ANA773 for the treatment of cancer in a Phase I clinical trial that we initiated in 2008. We plan for currently enrolled patients to continue to receive ANA773 until disease progression is observed and to conclude the trial once all patients reach this point. Through our experience with the development of ANA773 for HCV, we have shown that ANA773 can stimulate the human immune system at a tolerated dose and we continue to believe that ANA773 holds promise as a therapy for cancer.

TLR7 agonists are of particular interest because there is precedent for their use in cancer and small molecule ligands for this receptor have been identified. Topical imiquimod (AldaraÒ) is approved for the treatment of basal cell carcinoma in the United States (U.S.), and has demonstrated activity against other tumor types including melanoma and chronic lymphocytic leukemia. Immunotherapy is potentially synergistic with other treatment modalities and new approaches to manipulate conventional cancer therapies to work in concert with the immune system are being explored.

Industry Background

HCV

Based on available market data, we estimate that the global HCV market in 2009 was between $2 and 3 billion. Due to significant global prevalence and substantial unmet medical need, improving the treatment of chronic HCV infection remains an important priority for the medical community and the pharmaceutical industry. Many patients with chronic HCV infection do not receive the current standard of care due to concerns about adverse events or have incomplete response to the current standard of care. If untreated or inadequately treated, chronic HCV infection can result in significant liver damage (cirrhosis), liver transplantation and liver cancer.

The World Health Organization (WHO) estimates that 170 million persons globally are chronically infected with HCV and 3 to 4 million people are newly infected each year. Cirrhosis develops in about 10% to 20% of people with chronic infection, and liver cancer develops in 1% to 5% of people with chronic infection over a period of 20 to 30 years. It is estimated that more than 3 million people are chronically infected with HCV in the U.S. and that only about 100,000 of these patients are currently under treatment. The National Institutes of Health estimates that HCV results in 10,000 to 12,000 deaths in the U.S. annually and the Center for Disease Control and Prevention estimates that the number of deaths could increase to nearly 40,000 by 2010. HCV also exacerbates the severity of underlying liver disease when it coexists with other hepatic conditions. In particular, liver disease progresses more rapidly among persons with alcoholic liver disease and HIV infection.

There is currently no vaccine available to prevent infection with HCV. The current standard of care for treatment of chronic HCV infection is a combination of pegylated interferon-alpha and ribavirin. Interferon-alpha is administrated by injection and results in abnormally high levels of this cytokine circulating systemically throughout the body. Therapy with interferon-alpha causes a number of side effects in many patients, including depression, drops in blood cell count and flu-like symptoms, sometimes experienced during the entire year-long primary course of therapy that is standard for treatment of patients infected with genotype 1 HCV, the most difficult patient group to treat. These side effects may make patients feel worse than foregoing treatment, which reduces their motivation to initiate or continue HCV therapy. Many patients take additional drugs to treat these side effects, further increasing the cost and the risk of additional side effects to the patient. As a result, poor compliance with the HCV course of therapy may decrease the patient response rate.

In addition to the side effects, current therapies do not provide sustained elimination of the virus, called “sustained virologic response” (SVR), for a large proportion of chronically infected patients. For example, in clinical trials, approximately 50 percent of the genotype 1 patients, which represent the largest portion of HCV patients in the U.S., Europe and Japan, do not achieve sustained virologic response six months after the end of the treatment. Due to the lack of alternative treatments, patients without a sustained virologic response have no other treatment option but to undergo a second 48-week course of interferon-alpha-based therapy with a different brand of interferon-alpha. This second course of therapy subjects the relapsed patient to a similar risk of side effects as the previous course of therapy and offers the benefit of SVR in only a small fraction of patients who complete the 48 week treatment.

In response to the limitations of existing treatments for HCV infection, direct antiviral therapies (including protease, polymerase and NS5a inhibitors) have emerged as a potential addition to or alternative to the current standard of care. Unlike interferons, which work by stimulating the immune system’s response to viral infection, HCV direct antivirals directly target the virus by inhibiting the protease, polymerase or NS5a region of the virus. Accordingly, direct antivirals have the potential to significantly improve treatment outcomes, when added to the standard of care in difficult-to-treat patients, including patients infected with HCV genotype 1. The addition of direct antivirals to the standard of care could also lead to shorter treatment duration, which could increase patient compliance. While direct antivirals will likely initially be used in combination with pegylated interferon-alpha and ribavirin, it may be possible eventually to replace one or both components of the current treatment regimen with a combination of oral therapies directed at HCV, including protease, polymerase and NS5a inhibitors.

Quantification of viral concentration (viral load) in the blood is an accepted surrogate of clinical effect in viral diseases. New treatments are evaluated on the ability to decrease or eliminate detectable viral particles in blood. With viral load as an accepted surrogate, proof of concept in the treatment of viral diseases can be obtained in Phase I human clinical trials. We believe this early proof of concept results in a higher probability of success post Phase I than the probability of success associated with drug development in many other therapeutic areas.

Cancer

Cancer remains a disease with significant unmet medical need. Each year, an estimated 12 million people worldwide are diagnosed with cancer and more than half will eventually die from their disease. According to the American Cancer Society, the number of new cancer cases in the United States is projected at 1.5 million for 2009, and approximately one out of every two men, and one out of every three women, will develop cancer during his or her lifetime. Cancer accounts for nearly one-quarter of all deaths in the United States, exceeded only by heart disease.

Cancer Treatment Today

Current treatments for cancer include surgery, chemotherapy, and radiation, as well as small molecules, antibodies, hormone therapy, and other targeted agents. Surgical and radiation treatments are limited in their effectiveness because they treat the tumor at a specific site, may not remove all the cancer cells, and are not effective if the cancer has spread beyond its initial site. Chemotherapy can treat the cancer at multiple sites, but causes severe side effects because it destroys healthy cells and tissues as well as cancer cells. In many cases, chemotherapy can only reduce tumors in size and not eliminate them completely, resulting in disease recurrence. Targeted molecular therapies, including antibody and small molecule therapies, have shown promise, but typically are most effective for only subsets of the patient population. Furthermore, all drug therapies, both new and old, have been vulnerable to the emergence of tumor resistance and disease recurrence.

Several clinical observations support the importance of tumor immune surveillance in humans. The increased risk of tumor development in immunosuppressed patients, cases of spontaneous tumor regression and the presence of tumor-reactive T cells and B cells correlating with improved prognosis all point to a role for the immune system in controlling tumor growth. Immunotherapy has had success in treating certain tumors and this approach remains of interest for improving cancer treatment options. Immunotherapy is potentially synergistic with other treatment modalities and new approaches to manipulate conventional cancer therapies to work in concert with the immune system will be explored. Rational combinations and sequences of therapy, coupled with treatment strategies based on emerging understanding of immunobiology, may result in therapies that control and/or eradicate established cancer.

Toll-Like Receptors

Toll-like receptors — or TLRs — are a relatively new scientific discovery, though their origins date back hundreds of millions of years. TLRs evolved as a way to protect organisms against pathogens such as viruses and bacteria. This defense mechanism has proven so effective that it is an integral part of the human immune system today and a promising target for innovative new medicines.

In 1997, the first human TLR was cloned. To date, scientists have discovered 10 TLRs in humans, each recognizing generic molecular patterns associated with a variety of invading pathogens.

TLR Agonists in Viral Diseases

Certain TLRs are responsible for fighting bacterial and fungal infections; others respond specifically to viral infections.

Unlike adaptive immunity, which enables the immune system to remember and fight specific infections that it has encountered before, innate immunity is the ability to recognize foreign invaders upon their very first meeting. This function is regulated in part by TLRs, a family of proteins that serve as a first line of defense in the body.

Once a TLR recognizes a particular pathogen, it launches a dual assault. First, it triggers the body’s innate immunity, initiating an inflammatory response to fight the invader that includes induction of interferon, a natural disease fighter that is the basis for many approved products. It then alerts and educates the body’s adaptive immune system so that it will recognize the pathogen in the future. If TLRs fail, the body is left vulnerable to infection.

TLR Agonists in Cancer

As key regulators of both innate and adaptive immune responses, TLRs have been shown in research studies to affect several diseases, including cancer. Clinical studies have demonstrated that activation of TLR7 is effective in treating certain cancers that appear on the skin. Specifically, topical imiquimod (Aldara®) is approved for the treatment of superficial basal cell carcinoma. Unfortunately, however, imiquimod is poorly tolerated when administered orally, limiting its utility for broader indications requiring systemic exposure.

Additional justification for the investigation of TLR7 agonists for the treatment of cancer comes from the many studies conducted with TLR9 agonists. TLR7 and TLR9 agonists share common signaling pathways, partially overlap in cell-type expression, and have comparable direct and indirect activities as immunostimulants. A large body of data exists from animal models and human studies suggesting the potential utility of appropriately modified natural agonists of TLR9 either in monotherapy or combination therapy for the treatment of cancer. TLR7 and TLR9 agonists are, however, administered differently to patients: TLR7 agonists can be administered orally, while TLR9 agonists are thus far only injectable.

Our Strategy

The key elements of our strategy include the following:

•

Advance the Development of ANA598 in HCV. We are developing ANA598, a non-nucleoside inhibitor of the HCV NS5B polymerase. During 2010 we intend to:

	o		Obtain 4-week data from the 400 mg bid cohort in the Phase II clinical trial in HCV infected patients,

	o		Obtain 12-week data from the 400 mg bid cohort in the Phase II clinical trial in HCV infected patients, and

	o		Obtain initial SVR data from patients able to stop SOC at week 24.

	•		Pursue the development of novel, high quality product candidates in major disease areas. We select our product candidates based on demonstrated properties that suggest the potential to change treatment paradigms and become important products in time. Our strategy is to couple high quality candidates with a disciplined investment approach, pursuing time- and cost-efficient paths to obtaining clinical data. During 2010 we intend to identify a non-nucleoside inhibitor of the HCV NS5B polymerase as a pre-clinical candidate that could be suitable as a next generation agent to follow ANA598.

	§		Opportunistically Explore Strategic Alliances around our product candidates. We intend to explore potential strategic alliances and other transactions around ANA598 and ANA773.

We currently have no ongoing collaborations.

Our Development Programs

ANA598 for HCV

ANA598 is a direct antiviral that blocks the hepatitis C virus’ ability to multiply by inhibiting the viral RNA polymerase. ANA598 belongs to a class of direct antivirals referred to as non-nucleosides. We believe non-nucleosides will become an important component of future combination regimens used to treat HCV infection, similar to the role played by non-nucleoside inhibitors in HIV therapy. In 2007 we selected ANA598 as a development candidate. This selection represented the culmination of a comprehensive structure-based drug design program directed towards the viral RNA polymerase. ANA598 has demonstrated positive antiviral response and a favorable safety and tolerability profile in the ongoing Phase II combination trial, as described below. ANA598 has also completed two long-term chronic toxicology studies (26 weeks duration in rats and 39 weeks duration in monkeys) with favorable results. Furthermore, ANA598 has demonstrated the preclinical properties, including potency, pharmacokinetics and early safety, that we believe are prerequisites for successful development in the HCV area.

We believe that non-nucleoside NS5B polymerase inhibitors offer an exciting potential new way to target treating HCV infection, as part of combination regimens which may include other direct antivirals (such as protease inhibitors, nucleoside polymerase inhibitors and/or NS5a inhibitors) and/or immunomodulators (such as pegylated interferon). We believe that polymerase inhibitors have the potential to be equally important components of future regimens as protease inhibitors, which is another class of HCV direct antivirals currently in clinical development by a number of companies, including Vertex (with Mitsubishi and Johnson & Johnson) and Merck. Historically, it has been challenging to identify non-nucleoside polymerase inhibitors that display both potency and sustained drug levels in blood. With ANA598, we believe we have created a product candidate that has the potential to overcome this challenge. We believe that we have the opportunity to be competitive in the effort to develop non-nucleoside polymerase inhibitors for the treatment of HCV, since, to our knowledge the number of non-nucleosides in development is smaller than the number of potentially attractive combinations that can be formed with attractive protease inhibitors and nucleoside polymerase inhibitors in development. We believe that the future evolution of HCV therapy will likely include protease inhibitors, nucleosides and non-nucleosides used in various combinations. Therefore, we view ANA598 as complementary to, rather than competitive with, protease inhibitors and nucleosides that are currently in development as HCV therapies.

Preclinical evaluation of ANA598 required for initiation of clinical investigation was completed in the first quarter of 2008, leading to submission of an Investigational New Drug (IND) to the Food and Drug Administration (FDA), subsequent allowance of the IND by the FDA and initiation of clinical investigation in the second quarter of 2008. In December 2008, we announced that the FDA granted fast track designation to ANA598 for the treatment of chronic HCV infection. We have completed three Phase I studies of ANA598 that have demonstrated potent antiviral activity and good tolerability. We are currently conducting a Phase II study of ANA598 in combination with current standard of care.

In the ongoing Phase II study, treatment-naïve genotype 1 patients are to receive ANA598 or placebo in combination with SOC for 12 weeks at dose levels of 200 mg bid or 400 mg bid, each with a loading dose of 800 mg bid on day one. After week 12, patients are to continue receiving SOC alone. Patients who achieve undetectable levels of virus at weeks four and 12 will be randomized to stop all treatment at week 24 or 48. The primary endpoint of the study is the proportion of patients who achieve undetectable levels of virus at week 12 (defined as cEVR). Additional endpoints include safety and tolerability as well as the proportion of patients with undetectable levels of virus at week four (defined as RVR). Patients will be followed for 24 weeks after stopping therapy to determine the rate of SVR. Approximately 90 patients were to be and have been enrolled in this study – with approximately 30 patients receiving ANA598 and 15 receiving placebo at each dose level. The study is being conducted at a number of clinical sites in the United States.

In December 2009, we reported positive initial antiviral response and safety results from the 200 mg bid dose cohort based on a planned interim analysis of data at four weeks. In the group receiving ANA598 added to SOC, there was a steady increase in the percentage of patients with undetectable levels of virus from week one through week four, with 56% of patients achieving undetectable levels of virus (defined as <15 IU/ml) at week four, referred to as RVR, compared to 20% of patients receiving placebo plus SOC achieving an RVR. In February 2010, we reported positive preliminary antiviral response and safety results at 12 weeks from the 200 mg bid dose cohort. 73% of patients receiving ANA598 at 200 mg bid in combination with SOC achieved undetectable levels of virus (<15 IU/ml) at week 12, referred to as cEVR, compared to 71% of patients receiving placebo plus SOC achieving a cEVR. Based on historical reports of cEVR rates for SOC control arms in larger HCV trials, which generally range from 45% to 60%, the 71% seen in our 200 mg bid dose cohort appears to be anomalously high and may be due to the small number of patients in the control arm. Also, the 200 mg bid 12 week data showed the ability for ANA598 to significantly accelerate the rate of patients achieving undetectable levels of virus when added to current treatment. In clinical trials with other agents, accelerating the rate of achieving undetectable levels of virus is associated with an increased chance of achieving a sustained viral response, or SVR. Although we cannot predict whether this will be the case with ANA598, we hope to show the same benefit at the conclusion of this Phase II trial. Further, no patient in the 200 mg bid dose cohort experienced viral rebound (defined as an increase in viral load of greater than 1 log10 from a prior measurement) while receiving ANA598.

In the ongoing Phase II study, ANA598 at 200 mg bid demonstrated a favorable safety and tolerability profile through 12 weeks, although definitive conclusions regarding safety and tolerability cannot be made until additional results in more patients and potentially over longer duration are known. There were no serious adverse events reported and the profile of adverse events reported was as expected for patients receiving SOC alone, with comparable rates observed between the ANA598 and control arms. The incidence of rash was comparable between groups and consistent with historical reports of rash rates due to interferon and ribavirin. In the ANA598 arm, 41% of patients (12/29) developed a rash while 33% (5/15) of patients in the control group developed a rash. Eleven of the twelve instances of rash in the ANA598 arm were mild. One patient in the ANA598 arm who had achieved undetectable levels of virus by week four developed a grade 3 rash after week seven which began resolving rapidly upon stopping all study medication. In this instance, the rash was characterized as grade 3 due to the extent of body surface covered by the rash, which was maculopapular in nature (red spots, some raised). In accordance with the study design, this patient resumed interferon/ribavirin alone, and continued in the study and maintained undetectable levels of virus through week 12. The five instances of rash in the control arm were mild.

We are currently dosing patients at 400 mg bid and expect to analyze and release four week data from this dose cohort prior to the end of the first quarter of 2010 and expect to analyze and release 12-week data from this dose cohort during the second quarter of 2010. Based on preliminary pharmacokinetic data from the 200 mg bid dose cohort, which show ANA598 levels in the patients’ blood through four weeks, it appears that the 800 mg loading dose given twice on day one has had the desired effect of rapidly dropping viral load and minimizing the difference in response between 1a genotype and 1b genotype patients. Because this loading dose is also being administered to patients in the 400 mg bid cohort, we expect to see a similar early response in patients receiving ANA598 in that cohort. From the data seen to date, it is also apparent that patients in the 200 mg bid cohort achieved undetectable levels of virus after four weeks of dosing even when the level of ANA598 in their blood was among the lowest levels observed across patients. Accordingly, it may be that, for a substantial number of patients, the antiviral response will plateau at 200 mg bid when administered with an effective loading dose, and that we may not see an increase in antiviral response in the 400 mg bid cohort. If this turns out to be the case and if 200 mg bid is identified as the optimal dose to take forward in future clinical trials, we believe that the favorable profile we have seen at the low dose of 200 mg bid will facilitate combining ANA598 with other direct antivirals.

In January and April 2009, we announced data from the ANA598 Phase I study in which ANA598 was dosed as monotherapy over three days in HCV patients at twice-daily doses of 200 mg, 400 mg or 800 mg. The data from the study demonstrated potent antiviral activity and good tolerability of ANA598 as a single agent at all dose levels. The median viral load reduction over three days ranged from 2.4 to 2.9 log10 in the three dose groups studied. No patient at any dose level showed evidence of viral rebound while on ANA598 and there were no serious adverse events reported. Also in April 2009, we reported results from a 14-day study of ANA598 in healthy volunteers. ANA598 was generally well-tolerated in all cohorts in the healthy volunteer study with no serious adverse events. Three instances of mild-to-moderate rash were observed at the higher dose levels. Pharmacokinetic results from this trial confirmed the plasma half-life of ANA598 of approximately 24 hours, and demonstrated that steady-state levels of ANA598 in plasma are reached after six to seven days of dosing.

During 2009 we also completed two long-term chronic toxicology studies of ANA598 (26 weeks duration in rats and 39 weeks duration in monkeys) with favorable results. The completed toxicology studies confirm the favorable toxicology profile of ANA598 and support dosing durations of as long as one year if desirable in future clinical studies.

In 2009, we presented in vitro data showing that combinations of ANA598 with interferon-alpha, the protease inhibitor telaprevir and the nucleoside polymerase inhibitor PSI-6130 appear to be synergistic. Synergistic means that the actual combined effect of the two agents is greater than would be predicted from simply adding the effects of each agent alone. These studies also show that ANA598 retained activity in vitro against mutants known to confer resistance to other classes of direct antivirals, including protease inhibitors, nucleoside inhibitors and non-nucleosides that, through virtue of binding at a different site than ANA598, display a resistance profile distinct from that of ANA598. We also showed that genotypic mutations resistant to ANA598 appear to be fully susceptible to interferon-alpha, telaprevir and PSI-6130. Previously, we have also presented data demonstrating synergy between ANA598 and immunoregulatory proteins termed “cytokines” induced by ANA773, Anadys’ TLR7 agonist oral prodrug which has also been investigated for hepatitis C.

ANA773 for HCV

In 2009 we concluded a Phase I clinical trial of ANA773 in HCV patients. In the first three cohorts of the patient portion of this trial, HCV patients received oral ANA773 or placebo at every other day over 28 days, at doses of 800 mg, 1200 mg or 1600 mg, with six subjects receiving ANA773 and two receiving placebo in each cohort. At these doses, data showed an encouraging trend toward viral load reduction. We then amended the protocol to provide for a higher dose. In this final cohort of the trial, in which patients received 2000 mg of ANA773 every other day over 10 days, the mean maximal decline in viral load was 1.3 log10, compared to a mean maximal decline of 0.3 log10 in patients who received placebo. Five of the eight patients who received 2000 mg ANA773 experienced a maximal decline of greater than 1 log, while none of the eight patients who received placebo experienced a decline of greater than 1 log. The mean end-of-treatment decline was 0.6 log10 in patients who received 2000 mg ANA773 compared to 0.1 log10 in patients who received placebo. ANA773 was well-tolerated in patients throughout the course of the study and there were no serious adverse events reported.

Results from pre-clinical pharmacology studies showed that ANA773 elicited desired immune responses and that the profile of response could be modulated by both dose and schedule of administration. Results of 13-week GLP toxicology studies showed that with every-other-day dosing of ANA773, immune stimulation of a magnitude believed to confer therapeutic potential could be achieved without adverse toxicology findings. The immune stimulation observed with every-other-day dosing of ANA773 in monkeys included induction of interferon-alpha and interferon dependent responses at levels that were sustained over 13 weeks of dosing.

ANA773 for Cancer

We have also investigated ANA773 as a potential treatment for cancer. ANA773 stimulates the body’s immune system through activation of the TLR7 receptor. Through our experience with the development of ANA773 for HCV we have shown that ANA773 can stimulate the human immune system at a tolerated dose.

The pharmacologic consequences of TLR7 activation are broad and include induction of cytokines such as interferon-alpha as well as activation of immune effector cell populations known as natural killer (NK) cells and cytotoxic T lymphocytes (CTLs). The cytokine induction and cellular activation mechanisms both offer the potential for direct control of tumor cell growth. Furthermore, there is evidence to support the concept that activation of NK and CTL cells may be beneficial in enhancing the effect of existing cancer therapies, including monoclonal antibodies and certain chemotherapies.

There is a degree of precedent to support the use of the TLR7 mechanism in cancer. One marketed product that works by stimulating the immune system via the TLR7 mechanism is imiquimod (Aldara®). While the FDA-approved indications for imiquimod are limited to topical treatment of skin diseases, such as superficial basal cell carcinoma, actinic keratosis and warts induced by the human papillomavirus, there are several reports of imiquimod demonstrating activity against skin metastases from solid tumors, such as breast cancer. However, to date no one has successfully developed an oral TLR7 agonist for cancer. We believe the combination of our prodrug approach, described below, and our understanding of TLR7 pharmacology provides us an opportunity to utilize the TLR7 mechanism to systemically treat a broad spectrum of cancers, including solid tumors and B cell diseases, with oral administration of ANA773.

ANA773 is a prodrug of an active TLR7 agonist we believe may confer benefit in cancer treatment. As a prodrug, ANA773 itself does not activate the TLR7 receptor. Rather, the body’s metabolic processes transform ANA773 to an active form after absorption from the digestive tract, resulting in the active TLR7 agonist circulating in the blood. Both ANA773 and the active agent it delivers were designed and synthesized by our scientists. The use of a prodrug provides for efficient delivery of the active agent to the bloodstream and avoids undesirable effects of an active TLR7 agent in the digestive tract prior to absorption. We have shown in multiple preclinical studies that oral delivery of ANA773 produced the desired blood concentrations of the active agent and provided immune stimulation. In our clinical investigations, we have administered ANA773 orally.

We have reported the activity of ANA773 and its active form at multiple scientific conferences. In October 2007, we presented data showing that activation of TLR7 in vivo by the active form of ANA773 leads to the expected cellular responses, including activation of NK cells and CTLs. Earlier in 2007, we presented data from an in vitro study demonstrating that ANA773 and its active metabolite stimulate secretion of interferon alpha and enhance direct tumor cell killing by NK cells. In addition to enhancing direct NK cell killing, the active metabolite of ANA773 also enhanced the ability of rituximab, an antibody against CD20, to trigger immune-mediated cell killing of transformed B cells. We have also presented data from in vivo preclinical studies showing that the schedule of administration had a significant effect on the profile of immune stimulation induced by ANA773. Alternating dosing with periods of no dosing led to more robust NK cell activation and more stable levels of interferon-alpha induction, compared to chronic daily administration. We anticipate that different dosing schedules may be required in different tumor settings if ANA773 is pursued in the future as a therapy for cancer.

Manufacturing and Supply

All of our manufacturing is out-sourced to third parties, with control by our internal managers. We rely on third-party manufacturers to produce sufficient quantities of ANA598 and ANA773 for use in clinical trials. We intend to continue this practice for any future clinical trials and large-scale commercialization of ANA598 and/or ANA773. Both ANA598 and ANA773 are small-molecule drugs. Historically, these drugs have been simpler and less expensive to manufacture than biologic drugs.

Intellectual Property

Our policy is to pursue patents and to otherwise endeavor to protect our technology, inventions and improvements that are commercially important to the development of our business. We also rely upon trade secrets that may be important to the development of our business.

Our success will depend in large part on our ability to:

	•		Obtain and maintain patent and other proprietary protection for the technology, inventions and improvements we consider important to our business;

	•		Defend and enforce our patents;

	•		Preserve the confidentiality of our trade secrets; and

	•		Operate without infringing the patents and proprietary rights of third parties.

We hold issued patents and pending patent applications in the United States and in foreign countries we deem appropriate, covering intellectual property developed as part of our research and development programs. Our intellectual property holdings as of December 31, 2009, include, but are not limited to, the United States and foreign patents and patent applications described below.

In our HCV non-nucleoside polymerase program, we hold two issued United States patents related to our ANA598 program (patent numbers 7,462,611 and 7,582,754) which expire in 2027, one issued patent in Malta expiring in 2028 and 81 pending United States and/or foreign patent applications (in Australia, Brazil, Canada, China, the European Patent Convention, India, Japan, Mexico, Taiwan and certain other foreign jurisdictions) covering ANA598 and/or other non-nucleoside NS5B polymerase inhibitor compounds and the manufacture, pharmaceutical compositions, and methods of use of these compounds.

In our ANA773 program, we hold one issued United States patent (patent number 7,560,544) expiring in 2026, two issued patents in Malta with expiration dates of 2025 and 2027, and 75 pending United States and/or foreign patent applications (in Australia, Brazil, Canada, China, the European Patent Convention, India, Japan, Mexico, Taiwan and certain other foreign jurisdictions) covering ANA773 and related compounds and prodrugs, and the manufacture, pharmaceutical compositions, and methods of use of these compounds.

We also hold one United States patent (patent number 7,576,068) expiring in 2026, one issued patent in Morocco expiring in 2024, one issued patent in Georgia expiring in 2024 and 14 pending United States and/or foreign patent applications (in Australia, Brazil, Canada, China, the European Patent Convention, India, Japan, Mexico, Taiwan and certain other foreign jurisdictions) that relate to methods of use of certain TLR7 agonists and TLR7 agonist prodrugs. In addition, we hold patents and patent applications in the United States and foreign countries covering composition of matter and methods of use of certain other TLR7 agonists and TLR7 agonist prodrugs, with patent expiration dates beginning in 2022.

We intend to continue using our scientific expertise to pursue and file patent applications on new developments with respect to uses, methods and compositions of matter in order to enhance our intellectual property position in our areas of therapeutic focus.

We intend to aggressively prosecute our patent applications and enforce and defend our patents and otherwise protect our proprietary technology. Although we believe our rights under patents and patent applications provide a competitive advantage, the patent positions of pharmaceutical and biotechnology companies are highly uncertain and involve complex legal and factual questions. We may not be able to develop patentable products or processes, and may not be able to obtain patents from pending applications. Even if patent claims are allowed, the claims may not issue, or in the event of issuance, may not be sufficient to protect the technology owned by or licensed to us. Any patents or patent rights that we obtain may be circumvented, challenged or invalidated by our competitors.

We also rely on trade secrets and proprietary know-how, especially when we do not believe that patent protection is appropriate or can be obtained. Our practice is to require our employees, consultants, outside scientific collaborators, sponsored researchers and other advisors to execute confidentiality agreements upon the commencement of employment or other relationships with us. These agreements generally provide that all confidential information developed by or made known to the individual during the course of the individual’s relationship with us is to be kept confidential and not disclosed to third parties. In the case of employees, the agreements generally provide that all discoveries, developments, inventions and other intellectual property conceived or reduced to practice by the individual while employed by us will be our exclusive property. In the case of advisors and consultants, the agreements generally provide that all discoveries, developments, inventions, and other intellectual property conceived or reduced to practice by the individual as a result of performance of services for us and not resulting from research related to work supported by another entity with which the individual is party to a confidentiality agreement, shall be our exclusive property. 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 to us in the event of unauthorized disclosure of confidential information or other breaches of the agreements.

Competition

The biotechnology and pharmaceutical industries are very competitive and subject to rapid and significant technological change. Our product candidates, if approved for sale, will compete with existing therapies. In addition, a number of companies are pursuing the development of pharmaceuticals that target the same diseases and medical conditions that we are targeting. We believe that a significant number of drugs are currently under development and may become available in the future for the treatment of HCV and cancer. Due to the level of focus on developing treatments for these indications, ongoing research efforts are intense and new treatments are being sought out and developed by our competitors. Some of these products use therapeutic approaches that may compete directly or indirectly with ANA598 or ANA773. In addition, less expensive generic forms of currently marketed drugs could lead to additional competition upon patent expiration or invalidations.

HCV

Treating HCV with Interferon-based Therapies

Current standard treatments for HCV include an interferon-based product combined with ribavirin. Although interferons result in antiviral effects, they are injectable products and cause numerous side effects. Next generation interferon-based products, so-called pegylated interferons, were developed to provide an improved dosing regimen and are approved as once-per-week injected products. Currently approved therapies for the treatment of HCV infection include Peg-Intron (pegylated interferon-alpha-2b) and Intron-A (interferon-alpha-2b), which are marketed by Merck, Pegasys (pegylated interferon-alpha-2a) and Roferon-A (interferon-alpha-2a), which are marketed by Roche and several branded and generic versions of ribavirin.

Many patients experience unpleasant side effects when receiving interferon-based products, including flu-like symptoms such as fatigue, pyrexia, myalgia, cough, headache, and rigors, psychiatric reactions, such as depression, irritability and anxiety, as well as neutropenia and thyroid dysfunction. Due to the nature of HCV infection, patients may not show any symptoms from the HCV itself when they initiate therapy. Ironically, harsh side effects often make patients feel sicker than the disease itself. As a result, physicians often delay treatment of HCV-infected patients until tests of liver function demonstrate initial liver degeneration due to the infection. In clinical studies, harsh side effects have caused discontinuation of treatment in approximately 10 to 20 percent of patients. These side effects also require additional drug therapies, which increase the cost to the patient. Further, the optimal dose, treatment length and response rates to interferon and ribavirin therapy vary considerably based on HCV genotype and mode of therapy, i.e., monotherapy or combination therapy.

Direct Antivirals in Development for Treating HCV

In response to the limitations of existing treatments for HCV infection, the development of direct antiviral therapies (including protease, polymerase and NS5a inhibitors) has emerged as a potential addition to or alternative to the standard treatment. Unlike interferons, which work by stimulating the immune system’s response to viral infection, HCV direct antivirals directly target the virus by inhibiting the protease, polymerase or NS5a region of the virus. Accordingly, direct antivirals may significantly improve treatment outcomes, when added to the standard of care in difficult-to-treat patients, including patients infected with HCV genotype 1, relative to treatment with the standard of care alone. The addition of direct antivirals to the standard of care could also lead to shorter treatment duration, which could increase patient compliance. While direct antivirals will likely initially be used in combination with pegylated interferon-alpha and ribavirin, it may be possible eventually to replace one or both components of the current treatment regimen with a combination of oral therapies directed at HCV, including both protease and polymerase inhibitors.

ANA598 belongs to a class of direct antivirals known as non-nucleoside polymerase inhibitors. If approved, ANA598 would likely be used in combination with the current standard of care and/or other direct antiviral agents such as protease inhibitors, other polymerase inhibitors, or NS5a inhibitors. Although any product currently approved or approved in the future for the treatment of HCV infection could potentially decrease or eliminate the commercial opportunity of ANA598, we expect that in a combination setting a non-nucleoside polymerase inhibitor would be complementary with a protease inhibitor, a nucleoside polymerase inhibitor and an NS5a inhibitor. We believe that other non-nucleoside polymerase inhibitors would likely be the most direct competitors of ANA598, but depending on the resistance profiles of the compounds, it is possible that even two non-nucleoside polymerase inhibitors could be complementary. To our knowledge, other non-nucleoside polymerase inhibitor programs are currently under clinical evaluation by Pfizer, Gilead, Merck, Abbott, Boehringer Ingleheim and Vertex. Further, a number of companies have non-nucleoside polymerase inhibitor research programs.

Additional compounds in late stage clinical trials for HCV that may be complementary to or competitive with ANA598 include Zalbin/Joulferon (albinterferon alfa-2b), in development by Human Genome Sciences and Novartis, telaprevir, in development by Vertex Pharmaceuticals, Janssen Pharmaceutica (Johnson & Johnson) and Mitsubishi Tanabe Pharma, boceprevir, narlaprevir and MK-7009 in development by Merck, ITMN-191, in development by Intermune and Roche, TMC-435350, in development by Tibotec and Medivir, BI-201335, in development by Boehringer Ingelheim, and RG7128 in development by Roche and Pharmasset.

Immunological Agents in Development for Treating HCV

Due to the side effects and poor treatment response to interferon therapy discussed above, there are currently a number of agents in development that could potentially replace today’s pegylated interferons. ANA773 is an oral prodrug of a TLR7 agonist that we have evaluated for the treatment of HCV. There are a number of agents in clinical development that could potentially compete with ANA773 as new agents for the treatment of HCV, including, Zalbin/Joulferon (albinterferon alfa-2b), in development by Novartis and Human Genome Sciences, and Locteron, in development by Biolex Therapeutics, both of which are longer-acting versions of interferon alfa. Also, in development as potential improvements to existing interferons are PEG-interferon lambda, in development by Zymogenetics and Bristol Myers-Squibb, and omega interferon in development by Intarcia Therapeutics. IMO-2055, a TLR9 agonist in development by Idera, and SD-101, a TLR9 agonist in development by Dynavax Technologies are also being studied in early stage clinical trials in HCV patients.

Cancer

ANA773 is a prodrug of a TLR7 agonist that we have evaluated for oncology indications. Any product currently approved or approved in the future for the treatment of cancer could decrease or eliminate the commercial opportunity of ANA773. Programs that most directly compete with ANA773 at this time are several TLR9 agonists under evaluation for oncology indications, including IMO-2055, in development by Idera and Merck KGaA, and a cancer program in development by Dynavax.

Competitive Risks

We are in the early stages of a Phase II study of ANA598, which was initiated following completion of three short term Phase I studies, and we have only conducted short term Phase I studies of ANA773. Therefore, it is difficult to predict the efficacy, safety and tolerability that these product candidates will demonstrate in longer term trials, alone or in combination with other agents. It is also difficult to predict how these product candidates will interact with other product candidates in development or on the market, until we perform combination studies. Further, it is difficult to predict whether our product candidates will cause any toxicity issues, potential side effects, or other negative consequences associated with their long-term use. During the course of future clinical trials, we may discover that these product candidates are less effective, require unacceptable dosing regimens, or have a similar side effect profile as the profile associated with current therapies or future competitors. This may result in our product candidates being less advantageous or less desirable from a patient and treating physician perspective as compared to current therapies for HCV or cancer.

We face competition from pharmaceutical and biotechnology companies both in the U.S. and abroad. Our competitors may utilize discovery technologies and techniques or partner with collaborators in order to develop products more rapidly or successfully than we or our future collaborators are able to do. Many of our competitors, particularly large pharmaceutical companies, have substantially greater financial, technical and human resources than we do and far more experience in the discovery and development of product candidates and the commercialization of potential products. In addition, academic institutions, government agencies, and other public and private organizations conducting research may seek patent protection with respect to potentially competitive products or technologies. These organizations may also establish exclusive collaborative or licensing relationships with our competitors.

We believe that our ability to compete depends, in part, upon our ability to create, maintain and license scientifically advanced technology. Further, we need to attract and retain qualified personnel, obtain patent protection or otherwise develop proprietary technology or processes and secure sufficient capital resources for the substantial time period between technological conception and commercial sales of products based upon our technology.

We expect that competition among HCV and cancer therapies approved for sale will be based on various factors, including improved product efficacy, safety and tolerability, ease of administration (e.g., oral vs. intravenous administration), availability, price, reimbursement status and patent position. Potential competitors may develop treatments for HCV or cancer that are more effective and/or safer or more convenient than our product candidates or that would make our technology and product candidates obsolete or non-competitive.

Government Regulations

We are subject to regulation by the FDA and comparable regulatory agencies in foreign countries with respect to the development and commercialization of products and services resulting from our drug discovery activities. These agencies and other federal, state and local entities regulate research and development activities and the testing, manufacture, quality control, safety, efficacy, labeling, storage, record keeping, advertising and promotion of these products and services.

As an initial step in the drug approval process of pharmaceuticals, an applicant typically conducts preclinical laboratory and animal studies of the product candidate. Following these studies, the applicant will submit an IND (or equivalent) application to the FDA (or comparable foreign regulatory agency). Once the IND becomes effective, the applicant can commence clinical studies of the product candidate in humans to determine safety, tolerability and efficacy. Following clinical studies, the marketing of a new drug requires the filing of a New Drug Application (NDA) with the FDA and its subsequent approval (similar requirements exist within foreign agencies). The process required by the FDA and comparable agencies before a pharmaceutical or biologic device may be marketed in the U.S. or in any other country generally requires many years and substantial effort and financial resources, and approval from the FDA may not be received in a timely manner, if at all. The time required to satisfy FDA requirements or similar requirements of foreign regulatory agencies may vary substantially based upon the type, complexity and novelty of the product or the targeted disease. Even if a product receives regulatory approval, later discovery of previously unknown problems with a product may result in restrictions on the product or even complete withdrawal of the product from the market.

Under the FDA’s regulations, the clinical testing program required for marketing approval of a new drug typically involves three sequential phases, which may overlap.

	•		Phase I: Studies are conducted on normal, healthy human volunteers or patients to determine safety, dosage tolerance, absorption, metabolism, distribution and excretion. If possible, Phase I studies may also be designed to gain early evidence of effectiveness.

	•		Phase II: Studies are conducted on small groups of patients afflicted with a specific disease to gain preliminary evidence of efficacy, to determine the common short-term side effects and risks associated with the substance being tested and to determine dosage tolerance and optimal dosage.

	•		Phase III: Involves large-scale studies conducted on disease-afflicted patients to provide statistical evidence of efficacy and safety and to provide an adequate basis for physician labeling.

Frequent reports are required in each phase, and, if unwarranted hazards to subjects are found, the FDA may request modification or discontinuance of clinical testing until further preclinical testing is conducted. Additional testing (Phase IV) may be conducted after FDA approval for marketing is granted and could be designed to evaluate alternative utilizations of drug products prior to their being marketed for such additional utilizations as well as to test for complications resulting from long-term exposure not revealed in earlier clinical testing.

Environmental and Safety Matters

Certain of our development activities involve the controlled use of biological, hazardous and radioactive materials and waste. We are also subject to numerous federal, state and local environmental and safety laws and regulations, including those governing the use, manufacture, storage, handling and disposal of hazardous materials and waste products. The cost of compliance with and any violation of these regulations could have a material adverse effect on our business and results of operations. Although we believe that our safety procedures for handling and disposing of these materials comply with the standards prescribed by state and federal regulations, we cannot assure investors that accidental contamination or injury from these materials will not occur.

To date, compliance with laws and regulations relating to the protection of the environment has not had a material effect on our capital expenditures or our competitive position. However, we are not able to predict the extent of government regulation, and the cost and effect thereof on our results of operations, which might result from any legislative or administrative action pertaining to environmental or safety matters. In the event of contamination or injury, we could be held liable for substantial damages or penalized with fines in an amount exceeding our resources, and our clinical trials could be suspended. In addition, we may have to incur significant costs to comply with future environmental laws and regulations.

Research and Development Expenses

Research and development expenses consist primarily of costs associated with the discovery, preclinical and clinical development of our product candidates. Research and development expenses are the primary source of our expenses and totaled $19.5 million, $26.0 million and $28.2 million for the years ended December 31, 2009, 2008 and 2007, respectively.

Employees

As of March 1, 2010, we had 28 regular, full-time employees and six other employees, including 22 in research and development, and the balance in general and administrative positions, with 18 of our employees holding Ph.D., M.D. or other advanced degrees. None of our employees is represented by a labor union, and we consider our employee relations to be good.

Executive Officers of the Registrant

The following table sets forth information regarding our executive officers as of March 1, 2010:

Steve Worland, Ph.D. was appointed President and Chief Executive Officer and a member of the Board of Directors in 2007. Dr. Worland joined Anadys in 2001 as Chief Scientific Officer and served as President, Pharmaceuticals prior to being named CEO. Prior to joining Anadys, Dr. Worland was Vice President, Head of Antiviral Research at Agouron Pharmaceuticals, a Pfizer Company. Dr. Worland was at Agouron from 1988 through the acquisition of Agouron by Warner-Lambert in 1999, where he held various positions and responsibilities that culminated with him assuming global responsibility for anti-infective strategy as Vice President for Warner-Lambert. At Agouron, Warner-Lambert and Pfizer, Dr. Worland led teams responsible for discovery and clinical development in the areas of HIV, HCV and respiratory infections. Dr. Worland was a National Institutes of Health Postdoctoral Fellow in Molecular Biology at Harvard University from 1985 to 1988. He received his B.S. with highest honors in Biological Chemistry from the University of Michigan and his Ph.D. in Chemistry from the University of California, Berkeley.

James L. Freddo, M.D. joined us in July 2006 as Chief Medical Officer and was named Senior Vice President, Drug Development and Chief Medical Officer in July 2008. Prior to joining Anadys, Dr. Freddo was Vice President, Clinical Site Head and Development Site Head, Pfizer Global Research and Development, La Jolla. Previously at Pfizer, he was Executive Director, Site Therapeutic Area Leader, Clinical Development, Oncology. While at Pfizer, Dr. Freddo led the team responsible for the registration of Sutent^® (sunitinib malate), a drug approved by the FDA in January 2006 for treating advanced kidney cancer and gastrointestinal stromal tumors. Prior to Pfizer, Dr. Freddo held a variety of senior management positions at Wyeth-Ayerst Research from December 1996 until June 2002, including Senior Director, Oncology, Senior Director, Infectious Diseases, and Senior Director, Transplantation Immunology. Dr. Freddo currently serves as a member of the Board of Directors of InfuSystem Holdings, Inc., a healthcare services company. He holds a B.S. degree in Medical Technology from the State University of New York at Stony Brook, and a M.D. degree from the University of North Carolina, where he also completed his fellowship training.

Elizabeth E. Reed, J.D joined us in October 2001 and was named Senior Vice President, Legal Affairs and General Counsel in August 2009. Ms. Reed has also served as our Corporate Secretary since January 2002. Previously, Ms. Reed served as our Vice President, Legal Affairs from December 2006 to August 2009, as our Senior Director, Legal Affairs from December 2002 to December 2006 and as our Director of Legal Affairs from October 2001 to December 2002. Prior to joining us, Ms. Reed was associated with the law firms of Cooley Godward LLP and Brobeck, Phleger & Harrison LLP. Ms. Reed is a member of the State Bar of California and received her B.S. in Business Administration with an emphasis in finance from the Haas School of Business at the University of California, Berkeley and holds a J.D., cum laude, from Harvard Law School.

Peter T. Slover joined us in April 2004 and was named Vice President, Finance and Operations in July 2009. Mr. Slover joined us as Manager of Financial Reporting and served in this position through December 2005. From January 2006 to July 2006, Mr. Slover served as the Company’s Senior Manager, Financial Reporting and Internal Controls, from August 2006 to December 2006 as our Associate Controller, from January 2007 to December 2008 as our Controller and from January 2009 to July 2009 as our Senior Director, Finance and Corporate Controller. Prior to joining the Company, Mr. Slover began his career as an auditor at KPMG LLP where he spent seven years in public accounting. Mr. Slover is a licensed Certified Public Accountant in the State of California. Mr. Slover received a B.S. degree in Business Administration from Shippensburg University.

Company Website

We file annual, quarterly, current reports, proxy statements and other information with the Securities and Exchange Commission. Our primary website can be found at http://www.anadyspharma.com. We make available free of charge at this website (under the “Investors — SEC Filings” caption) all of our reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, including our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K and amendments to those reports. These reports are made available on the website as soon as reasonably practicable after their filing with, or furnishing to, the Securities and Exchange Commission. Furthermore, we also make available on our website free of charge, and in print to any shareholder who requests it, the Committee Charters for our Audit, Compensation, and Corporate Governance and Nominating Committees, as well as the Code of Business Conduct and Ethics that applies to all directors, officers and employees of the Company. Amendments to these documents or waivers related to the Code of Business Conduct and Ethics will be made available on our website as soon as reasonably practicable after their execution.

The Company was incorporated in Delaware in September 1992 as ScripTech Pharmaceuticals, Inc., and in 1994 we changed our name to Scriptgen Pharmaceuticals, Inc. In May 2000, following the addition of a substantially new management team and the infusion of new capital, product candidates and technologies, we changed our name to Anadys Pharmaceuticals, Inc.


Item 1A.		Risk Factors

You should consider carefully the following information about the risks described below, together with the other information contained in this Annual Report and in our other public filings before making any investment decisions regarding our stock. If any of the following risks actually occurs, our business, financial condition, results of operations and future growth prospects would likely be materially and adversely affected. In these circumstances, the market price of our common stock would likely decline, and you may lose all or part of the money you paid to buy our common stock.

Risks Related to Our Business

Any significant set-back regarding, or the failure of, ANA598 will have a large negative impact on our business and stock price.

Currently, we are actively pursuing only the development of ANA598. As a result, our development portfolio entails a highly concentrated risk of failure. If the timing or results of clinical trials and non clinical studies of ANA598 do not meet our, your, analysts’ or others’ expectations, the market price of our common stock could decline significantly. Any significant set-back regarding, or the failure of, ANA598 will have a significant negative impact on us and our stock price.

We may be unable to enter into future strategic transactions, and in particular transactions around ANA598 or ANA773, on terms acceptable to us, or at all.

Our near and long-term viability will depend in part on our ability to successfully establish strategic transactions with pharmaceutical and biotechnology companies. Since we do not currently possess the resources necessary to independently fully develop and commercialize ANA598 or ANA773, we either will need to develop or acquire these resources on our own, which will require substantial funding, time and effort, or will need to enter into collaborative agreements to assist in the development and commercialization of these potential products. If we fail to establish collaborations or licensing arrangements on acceptable terms, we may need to delay or terminate one or more of our programs. Even if we successfully establish new collaborations, these relationships may never result in the successful development or commercialization of any product candidates or the generation of sales or royalty revenue.

More specifically, we elected to initiate the Phase II study of ANA598 prior to further exploring interest in a possible transaction around ANA598. In addition, we plan to seek outlicensing opportunities as a way to potentially continue advancing the development of ANA773. There is no guarantee that we will enter into a future transaction around ANA598 or ANA773 on favorable terms, or at all, or that discussions will initiate or progress on our desired timelines. Completing transactions of this nature is difficult and time-consuming. Potentially interested parties may decline to re-engage or may terminate discussions based upon their assessment of our competitive, financial, regulatory or intellectual property position or for any other reason. Furthermore, we may choose to defer consummating a transaction relating to ANA598 until additional data is obtained. If we do not actively pursue a transaction around ANA598 until we have additional data, we and our stockholders will bear the risk that ANA598 will fail prior to any future transaction.

We will need additional funding and may be unable to raise capital when needed, which would force us to delay, reduce or eliminate our development programs.

Our December 31, 2009 cash, cash equivalents and marketable securities balance was $20.5 million. We believe that this balance will be sufficient to satisfy our anticipated operational cash needs for at least the next 12 months. However, we will need to seek additional funding in order to conduct future development activities. There is no guarantee that additional funding will be available to us on acceptable terms, or at all. If funds are not available, we may be required to delay, reduce the scope of or eliminate one or more of our development programs.

In addition, we will need to raise additional capital if we choose to conduct certain activities, including:

	•		fund our development programs;

	•		acquire rights to products or product candidates, technologies or businesses;

	•		establish and maintain manufacturing, sales and marketing operations; and

	•		commercialize our product candidates, if any, that receive regulatory approval.

Our future funding requirements will depend on, and could increase significantly as a result of many factors, including:

	•		the progress of our clinical trials;

	•		the progress of our nonclinical development activities;

	•		our ability to establish and maintain strategic alliances;

	•		the costs involved in enforcing or defending patent claims and other intellectual property rights;

	•		the pace and timing of development activities conducted under joint development arrangements we may establish;

	•		the cost and timing of regulatory approvals;

	•		the costs of establishing or expanding manufacturing, sales and distribution capabilities;

	•		the costs related to development and manufacture of pre-clinical, clinical and validation lots for regulatory and commercialization of drug supply;

	•		the commercialization of ANA598, ANA773 and any additional products; and

	•		the extent to which we acquire or invest in other products technologies and businesses.

We do not anticipate that we will generate significant revenues from operations for at least several years, if ever. Until we can generate significant revenues from operations, we expect to satisfy our future cash needs through public or private equity offerings, debt financings, strategic alliances or other transactions, project financing and grant funding, as well as through interest income earned on cash balances. We cannot be certain that additional funding will be available to us on acceptable terms, or at all. If funds are not available, we may be required to delay, reduce the scope of or eliminate one or more of our research or development programs or our commercialization efforts.

Raising additional funds by issuing securities or through debt or project financing or strategic alliances and licensing arrangements may cause dilution to existing stockholders, restrict our operations or require us to relinquish proprietary rights.

We may seek to raise additional funds through public or private equity offerings, debt financings, project financings or strategic alliances and licensing arrangements. We cannot be certain that additional funding will be available on acceptable terms, or at all. To the extent that we raise additional capital by issuing equity securities, our stockholders’ ownership will be diluted. Other financing activities may also have an equity component, which also may lead to dilution. Any debt or project financing we enter into may involve covenants that restrict our operations. These restrictive covenants may include limitations on borrowing, specific restrictions on the use of our assets as well as prohibitions on our ability to create liens, pay dividends, redeem capital stocks or make investments. In addition, if we raise additional funds through strategic alliances and licensing arrangements, it may be necessary to relinquish potentially valuable rights to our potential products or proprietary technologies, or grant licenses on terms that are not favorable to us. For example, we might be forced to relinquish all or a portion of our sales and marketing rights with respect to potential products or license intellectual property that enables licensees to develop competing products.

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

Our existing organizational structure was formed in May 2000. Since then, most of our resources have been dedicated to the development of our proprietary drug discovery technologies, research and development and preclinical and early-stage clinical testing of compounds. Our current product candidates are at only the very early stages of clinical trials. ANA598, ANA773 and any other compounds that we may develop, may never be approved for commercial sales. These compounds will require extensive and costly development, preclinical testing and clinical trials prior to seeking regulatory approval for commercial sales. 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 losses to continue for at least several years, and we are unable to predict the extent of future losses and when we will become profitable in our business operations, if ever.

We have incurred net losses since our incorporation in 1992, and through December 31, 2009 we have an accumulated deficit of $283.3 million. Our losses are attributable in large part to the significant research and development costs required to identify and validate potential product candidates and conduct preclinical studies and clinical trials. To date, we have generated limited revenues, consisting of one-time or limited payments associated with past collaborations or grants, and we do not anticipate generating product revenues for at least several years, if ever. We would need to increase our operating expenses over at least the next several years in order to fund the development costs of our product candidates and further our development activities. As a result, over time, 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 in our business operations, if ever. Even if we do achieve profitability in our business operations, we may not be able to sustain or increase such profitability on an ongoing basis.

The technologies on which we rely are unproven and may not result in the development of commercially viable products.

Our current product candidates, ANA598 and ANA773, were selected based on the presumption that intervention at their respective targets, HCV polymerase and TLR7, offers a therapeutic benefit. There can be no assurance that intervention at either target will offer sufficient benefit and acceptable toxicity to warrant continued development and approval. ANA773 relies on the biology of a specific receptor, or protein, named Toll-Like Receptor-7, or TLR7. However, the interaction between small molecules and TLR7 represents a relatively new mechanism of action for the treatment of disease, including HCV and cancer, and there is no guarantee that an acceptable balance between therapeutic benefit and risk will be achieved with TLR7 agonists in HCV infected patients or in cancer patients. For example, in June 2006 we suspended dosing of ANA975, a TLR7 agonist prodrug, in our then on-going ANA975 clinical trial due to information from 13-week toxicology studies in animals that showed intense immune stimulation. We subsequently conducted additional pre-clinical studies and were unable to identify an acceptable balance between therapeutic benefit and risk using a daily dosing schedule over 13-weeks. Accordingly, we subsequently discontinued the development of ANA975 as a therapy for HCV infection. The science underlying ANA598 is also new and unproven, as no products acting at the HCV polymerase have been approved for marketing. ANA598 and ANA773 are at only the early stage of clinical investigation. The process of successfully discovering product candidates is expensive, time-consuming and unpredictable, and the historical rate of failure for drug candidates is extremely high. If our approaches to drug discovery and development are not successful, we will not be able to establish or maintain a clinical development portfolio or generate product revenue.

Because the results of preclinical studies and early clinical trials are not necessarily predictive of future results, we can provide no assurances that ANA598 or ANA773 will have favorable results in future clinical trials, or receive regulatory approval.

Positive results from preclinical studies or early clinical trials should not be relied upon as evidence that later or larger-scale clinical trials will succeed. There is typically an extremely high rate of attrition from the failure of drug candidates proceeding through clinical trials. There is no guarantee that viral load declines seen in early patient trials will be replicated in future trials of longer duration and/or larger patient populations. For example, short-term viral load data from our ANA598 Phase Ib study may not translate into long-term benefit due to the potential emergence of resistant variants or other factors. In particular, there is a perception by some within the scientific community that the administration of non-nucleosides is more likely to result in resistance than the administration of other types of direct acting antivirals in development for HCV (including protease inhibitors and nucleoside polymerase inhibitors) due to the lower genetic barrier of resistance to non-nucleosides relative to these other types of compounds; however, we and others within the scientific community believe that this concern is not likely to be a significant issue when non-nucleosides are dosed in combination with other agents. However, the outcome of this debate will not be known until data from longer term trials of non-nucleosides dosed in combination with other agents become available. Similarly, there is no guarantee that favorable safety and tolerability seen in short term studies will be replicated in studies of longer duration and/or in larger subject populations. For example, in a 14 day healthy volunteer study conducted in 2009, three of the 24 subjects who received ANA598 discontinued from the study due to the onset of a skin rash during the study. Furthermore, if future toxicology studies have unexpected results, the clinical development of the compound at issue could be suspended, delayed and/or terminated. If ANA598, or any other product candidate, fails to demonstrate sufficient safety and efficacy in any clinical trial or shows unexpected findings in future toxicology studies, we would experience potentially significant delays in, or be required to abandon, development of ANA598. If we delay or abandon our development efforts related to ANA598, we may not be able to generate sufficient revenues to become profitable, and our reputation in the industry and in the investment community would likely be significantly damaged, each of which would cause our stock price to decrease significantly.

We intend to develop ANA598 as a component of combination treatments, which presents additional challenges to the drug development process.

We are developing ANA598 as a potential component of future combination treatments. We may face additional challenges with this approach, as opposed to developing product candidates for monotherapy. For example, any negative properties of our product candidates may be exacerbated when combined with other agents and/or have unexpected effects in humans. Furthermore, the optimal development of our product candidates may entail explorations of combinations with other agents, which could require us to establish agreements or alliances with other companies or third parties. There is no guarantee that we will be able to enter into such alliances or agreements on terms that we view as favorable, or at all. An important element of development for an agent such as ANA598 will be to test the agent in combination with one or more other direct antivirals. In order for us to pursue this development strategy, we will need to engage the interest of other biopharmaceutical or pharmaceutical companies, since we do not have another direct antiviral to combine with ANA598. Our ability to engage this interest will be impacted by other companies’ internal HCV portfolio dynamics, with such dynamics influencing the companies’ perceived need to combine with an agent such as ANA598. For those companies

that have a perceived need to combine with an agent such as ANA598, we will be dependent on their perception of the profile of ANA598 and their desire to test ANA598 in combination with their agents. If they do not view the profile of ANA598 as favorably as we do, or if they establish other criteria for combination that we have not yet satisfied with ANA598, we could experience difficulties or delays in pursuing such combination trials. If we are unable to optimize the development of ANA598, our business prospects could be harmed, causing our stock price to suffer.

There is no guarantee that in future studies of ANA598, in which ANA598 may be dosed for longer duration in combination with other agents, that we will be able to identify safe and tolerable doses that result in clinical benefit, as measured by clearance of virus and durability of that clearance.

Although we are currently conducting a Phase II study in which ANA598 is being dosed for 12 weeks with current standard of care, it is presently unknown what duration of dosing of ANA598 will be most appropriate when used as a component of combination therapy, and further studies of longer duration may need to be explored. In addition, although we have presented in vitro data showing that combinations of ANA598 with current standard of care and with certain direct antiviral agents appear to be synergistic, these results may not be replicated in clinical trials. Also, it is possible that ANA598 will not be additive or synergistic with other potential components of future treatment regimens. Furthermore, it is possible that tolerability will be worse over longer durations of treatment than was seen for the same dose at a shorter duration of treatment. For example, in a 14 day healthy volunteer study conducted in 2009, three of the 24 subjects who received ANA598 discontinued from the study due to the onset of a skin rash characterized as mild to moderate with itching during the study, at comparable dose levels that were well tolerated over three days in patients. Similarly, if the tolerability of doses of ANA598 required for long-term treatment as part of future combinations is unacceptable or unfavorable relative to competitive product candidates, then the prospects for developing ANA598 as a treatment for chronic hepatitis C will be diminished, causing our stock price to decrease significantly.

The FDA could impose additional requirements on the development of ANA598 which could result in unexpected cost increases and/or delays to our development timelines.

The development of ANA598 in the United States is subject to ongoing regulation by the FDA. There is no guarantee that the FDA will not impose additional requirements on our development program for ANA598, including requirements associated with patient enrollment, manufacturing processes of our clinical trials materials or other development activities related to ANA598, which could result in increased costs to us or a delay in our desired timelines.

Fast track designation does not guarantee approval, or expedited approval, of ANA598 and there is no guarantee that ANA598 will maintain fast track designation.

In December 2008, we announced that the FDA granted fast track designation to ANA598 for the treatment of chronic HCV infection. Under the FDA Modernization Act of 1997, fast track designation is designed to facilitate the development and expedite the review of new drugs that are intended to treat serious or life-threatening conditions. Compounds selected must demonstrate the potential to address an unmet medical need for such a condition. Mechanisms intended to facilitate development include opportunities for frequent dialogue with FDA reviewers and for timely review of submitted protocols. However, the designation does not guarantee approval or expedited approval of any application for the product. Furthermore, the FDA may revoke fast track designation from a product candidate at any time if it determines that the criteria are no longer met.

During 2009 we completed a Phase I clinical trial of ANA773 for HCV and intend to explore partnership opportunities as a way to potentially continue the development of ANA773. There is no guarantee that we will be able to obtain a partnership around ANA773 or that the development of the program will be continued.

During 2009 we completed a Phase I trial of ANA773 in HCV infected patients. While we are encouraged by the data obtained to date, particularly at the higher doses at which we were able to confirm a dose response for ANA773 in HCV infected patients, further schedule exploration will likely be advisable before proceeding into larger scale studies. In connection with the restructuring we implemented in the middle of 2009 and our desire to focus our resources on our ANA598 program, we have decided to suspend further development of ANA773 while we look for a partner to potentially fund further development of the program. There is no guarantee that we will be able to obtain a partnership around ANA773 or that the development of the program will be able to be continued. If the program is continued, if we or a licensee are unable to achieve viral load reduction at levels comparable to injectable interferon but with a cleaner side effect profile, the prospects for developing ANA773 as a competitive HCV product will be diminished. Furthermore, the Phase I clinical trial was conducted in the Netherlands and not under a U.S. investigational new drug

application, or IND. If, in the future, we or a licensee want to proceed with the development of ANA773 for HCV in the United States, approval from the FDA under a U.S. IND will be required. There is no assurance that the FDA will agree that ANA773 should be tested as an investigational treatment for HCV. Currently, there is no evidence that a TLR7 agonist can confer long-term benefit as a therapy for HCV at an acceptable safety risk, and there is no assurance that the FDA will view the data from our Phase I study in the Netherlands as sufficiently compelling to allow clinical investigation. If the FDA does not view the data from our Phase I study in the Netherlands as sufficiently compelling, it may not allow studies under a U.S. IND, in which case development and commercialization of ANA773 for HCV in the United States would be precluded.

In 2007 we terminated our ANA975 development program due to challenges seen in animal toxicology studies. To the extent that the ANA975 toxicology observations are mechanism related, our ANA773 programs for cancer and hepatitis C and ability to out-license this product candidate could be negatively impacted, causing our stock price to decline.

ANA975 is an oral prodrug of isatoribine, a TLR7 agonist. In 2007 we discontinued the development of ANA975 as a treatment for HCV infection due to intense immune stimulation in animals. To the extent that any of the ANA975 toxicology observations are mechanism related, rather than compound specific, we, or a potential future collaborator, will need to determine whether the level of immune stimulation induced by TLR7 agonists can be modulated to achieve a potential therapeutic benefit with an acceptable safety profile. Although results from our ANA773 13-week animal toxicology study indicated that with every-other-day dosing of ANA773, immune stimulation of a magnitude believed to confer therapeutic potential can be achieved without adverse toxicology findings, there is no guarantee that this favorable toxicology profile will persist in future toxicology studies of longer duration, or that we will not see adverse safety findings in humans. If we are unable to modulate the immunomodulatory effect with a dose and schedule that provides therapeutic benefit without causing unacceptable adverse events, then the future development of ANA773 may not be viable or attractive to a potential licensee, which could materially and adversely affect our business and cause our stock price to decline.

Delays in the commencement of clinical testing of our current and potential product candidates could result in increased costs to us and delay our ability to generate revenues.

Our potential drug products will require additional nonclinical testing and extensive clinical trials prior to submission of any regulatory application for commercial sales. Previously, we have conducted only early-stage clinical trials on our own. As a result, we have very limited experience conducting clinical trials. In part because of this limited experience, we cannot be certain that planned clinical trials will begin or be completed 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.

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

	•		demonstrating sufficient safety and efficacy 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 or producing drug meeting our quality standards for a product candidate;

	•		obtaining approval of an IND application or proposed trial design from the FDA; and

	•		obtaining institutional review board approval to conduct a clinical trial at a prospective site.

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 and nature 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, the number of other products under development competing for the same patients in trials and the eligibility criteria for the clinical trial.

Delays in the completion of, or the termination of, clinical testing of our current and potential product candidates could result in increased costs to us and delay or prevent us from generating revenues.

Once a clinical trial has begun, it may be delayed, suspended or terminated by us, potential future collaborators, the FDA, or other regulatory authorities due to a number of factors, including:

	•		ongoing discussions with the FDA or other regulatory authorities regarding the scope or design of our clinical trials;

	•		failure to conduct clinical trials in accordance with regulatory requirements;

	•		lower than anticipated enrollment or retention rate of patients in clinical trials;

	•		inspection of the clinical trial operations or trial sites by the FDA or other regulatory authorities resulting in the imposition of a clinical hold;

	•		lack of adequate funding to continue clinical trials;

	•		negative results of clinical trials;

	•		negative or potentially problematic results of ongoing and concurrent non-clinical toxicology studies;

	•		requests by the FDA for supplemental information on, or clarification of, the results of clinical trials conducted in other countries;

	•		insufficient supply or deficient quality of drug candidates or other materials necessary for the conduct of our clinical trials; or

	•		serious adverse events or other undesirable drug-related side effects experienced by participants.

Many of the factors that may lead to a delay, suspension or termination of clinical testing of a current or potential product candidate may also ultimately lead to denial of regulatory approval of a current or potential product candidate. If we experience delays in the completion of, or termination of, clinical testing, our financial results and the commercial prospects for our product candidates may be harmed, and our ability to generate product revenues will be delayed.

Even if we successfully complete clinical trials of ANA598 or any future product candidate, there are no assurances that we will be able to submit, or obtain FDA approval of, a new drug application.

There can be no assurance that if our clinical trials of ANA598 or any other potential product candidate are successfully completed, we will be able to submit a new drug application, or NDA, to the FDA or that any NDA we submit will be approved by the FDA in a timely manner, if at all. If we are unable to submit a NDA with respect to ANA598 or any future 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 may require additional clinical trials, even when drug candidates performed well or achieved favorable results in large-scale Phase III clinical trials. If we fail to commercialize ANA598 or any future product candidate, we may be unable to generate sufficient revenues to attain profitability, and our reputation in the industry and in the investment community would likely be damaged, each of which would cause our stock price to decrease.

If we successfully develop products but those products do not achieve and maintain market acceptance, our business will not be profitable.

Even if ANA598 or any future 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 and third-party payors and our 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;

	•		availability of alternative treatments;

	•		pricing and cost effectiveness;

	•		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 establish or maintain an attractive price for ANA598 when used in combination with other agents.

If ANA598 or any future product candidate does not provide additional clinical benefit when included within a treatment regimen, that product likely will not be accepted favorably by the market. Similarly, if ANA773 does not provide additional clinical benefit when included within a treatment regimen, that product will likewise not be accepted favorably by the market. If any products we or our collaborators may develop do not achieve market acceptance, then we will not generate sufficient revenue to achieve or maintain profitability.

In addition, even if our products achieve market acceptance, we may not be able to maintain that market acceptance over time if:

	•		new products or technologies are introduced that are more favorably received than our products, are more cost effective or render our products obsolete; or

	•		complications, such as long-term toxicities and viral resistance, arise with respect to use of our products.

We depend on outside parties to conduct our clinical trials, which may result in costs and delays that prevent us from obtaining regulatory approval or successfully commercializing product candidates.

We engage clinical investigators and medical institutions to enroll patients in planned clinical trials and contract research organizations to perform data collection and analysis and other aspects of our preclinical studies and clinical trials. As a result, we depend on these clinical investigators, medical institutions and contract research organizations to properly perform the studies and trials. If these parties do not successfully carry out their contractual duties or obligations or meet expected deadlines, or if the quality 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. We may not be able to enter into replacement arrangements without undue delays or excessive expenditures. If there are delays in testing or regulatory approvals as a result of the failure to perform by third-parties, our drug development costs will increase and we may not be able to obtain regulatory approval for or successfully commercialize our product candidates. In addition, we may not be able to maintain any of these existing relationships, or establish new ones on acceptable terms, if at all.

We do not have internal manufacturing capabilities, and if we fail to develop and maintain supply relationships with future collaborators or other outside manufacturers, we may be unable to develop or commercialize any of our products.

Our ability to develop and commercialize products will depend in part on our ability to manufacture, or arrange for collaborators or other parties to manufacture, our products at a competitive cost, in accordance with regulatory requirements and in sufficient quantities for clinical testing and eventual commercialization. Our current manufacturing agreements reflect a much smaller scale than would be required for commercialization. If we are unable to enter into or maintain commercial-scale manufacturing agreements with future collaborators or capable contract manufacturers on acceptable terms the development and commercialization of our products could be delayed, which would adversely affect our ability to generate revenues and would increase our expenses.

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 not be able to generate product revenue.

We do not currently have the capabilities for the sales, marketing and distribution of pharmaceutical products. In order to commercialize any products, we would have to build our sales, marketing, distribution, managerial and other non-technical capabilities or make arrangements with third parties to perform these services. The establishment and development of our own sales force to market any products we may develop in the United States will be expensive and time-consuming and could delay any product launch, and we cannot be certain that we would be able to successfully develop this capacity. If we are unable to establish our sales and marketing capability or any other non-technical capabilities necessary to commercialize any product we may develop, we will need to contract with third parties to market and sell any products we may develop in the United States. We will also need to develop a plan to market and sell any products we may develop outside the United States. If we are unable to establish adequate sales, marketing and distribution capabilities, whether independently or with third parties, we may not be able to generate product revenue and may not become profitable.

If we are unable to retain key management and scientific staff, we may be unable to successfully develop or commercialize our product candidates.

We are a small company and have approximately 30 employees. Our success depends on our continued ability to retain and motivate highly qualified management and scientific personnel. In particular, our programs depend on our ability to retain highly skilled clinical and preclinical personnel in the field of HCV, as well as biologists and chemists.

We may not be able to retain qualified management and scientific personnel in the future due to the intense competition for qualified personnel among biotechnology and pharmaceutical businesses, particularly in the San Diego, California area. If we are not able to retain the necessary personnel to accomplish our business objectives, we may experience constraints that will impede significantly the achievement of our development objectives. In addition, all of our employees are “at will” employees, which means that any employee may quit at any time and we may terminate any employee at any time. Currently we do not have employment agreements with any employees or members of senior management that provide any guarantee of continued employment by us. We do not currently carry “key person” insurance covering members of senior management other than Steve Worland, Ph.D., our President and Chief Executive Officer. The insurance covering Dr. Worland is in the amount of $1.5 million. If we lose the services of Dr. Worland, or James L. Freddo, M.D., our Senior Vice President, Drug Development and Chief Medical Officer, or other members of our senior management team or key personnel, we may not be able to find suitable replacements, and our business may be harmed as a result.

Earthquake or wildfire damage to our facilities could delay our research and development efforts and adversely affect our business.

Our headquarters and research and development facilities in San Diego, California, are located in a seismic zone, and there is the possibility of an earthquake, which could be disruptive to our operations and result in delays in our research and development efforts. In addition, San Diego has experienced several severe wildfires during the past several years which have destroyed or damaged many businesses and residences in the San Diego area. In the event of an earthquake or a severe wildfire, if our facilities or the equipment in our facilities are significantly damaged or destroyed for any reason, or we are otherwise required to shut down our operations, we may not be able to rebuild or relocate our facility or replace any damaged equipment, or otherwise recommence our business operations, in a timely manner and our business, financial condition and results of operations could be materially and adversely affected.

Our securities available-for-sale held in the form of marketable securities are subject to market, interest and credit risk that may reduce their value.

A portion of our securities available-for-sale is invested in marketable securities. Our cash position may be adversely affected by changes in the value of these securities. In particular, the value of these holdings may be adversely affected by increases in interest rates, downgrades by rating agencies on the issuers of corporate bonds included in the portfolio and by other factors which may result in other than temporary declines in value of the investments. Each of these events may cause us to record charges to reduce the carrying value of our investment portfolio and may adversely affect our cash position.

Risks Related to Our Industry

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 commercial success depends on obtaining and maintaining patent protection and trade secret protection of our product candidates, proprietary technologies and their uses, as well as successfully defending these patents against third-party challenges. We will only be able to protect our product candidates, proprietary technologies and their uses from unauthorized use by third parties to the extent that valid and enforceable patents or effectively-protected trade secrets cover them.

Due to evolving legal standards relating to the patentability, validity and enforceability of patents covering pharmaceutical inventions and the scope of claims made under these patents, our ability to obtain and enforce patents is uncertain and involves complex legal and factual questions. Accordingly, rights under any issued patents may not provide us with sufficient protection for ANA598 or ANA773 or provide sufficient protection to afford us a commercial advantage against competitive products or processes. In addition, we cannot guarantee that any patents will issue from any pending or future patent applications owned by or licensed to us.

Even with respect to patents that have issued or will issue, we cannot guarantee that the claims of these patents are, or will be valid, enforceable or will provide us with any significant protection against competitive products or otherwise be commercially valuable to us. For example:

	•		we might not have been the first to make, conceive, or reduce to practice the inventions covered by all or any of our pending patent applications and issued patents;

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

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

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

	•		our issued or acquired patents may not provide a basis for commercially viable products, may not provide us with any competitive advantages, or may be challenged by third parties;

	•		our issued patents may not be valid or enforceable;

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

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

Patent applications in the United States are maintained in confidence for up to 18 months or longer after their filing. Consequently, we cannot be certain that we were the first to invent, or the first to file patent applications on our product candidates. In the event that a third party has also filed a U.S. patent application relating to our product candidates or a similar invention, we may have to participate in interference proceedings declared by the U.S. Patent Office to determine priority of invention in the United States. The costs of these proceedings could be substantial and it is possible that our efforts would be unsuccessful, resulting in a material adverse effect on our U.S. patent position. Furthermore, we may not have identified all U.S. and foreign patents or published applications that affect our business either by blocking our ability to commercialize our drugs or by covering similar technologies that affect our drug market.

In addition, some countries, including many in Europe, do not grant patent claims directed to methods of treating humans, and in these countries patent protection may not be available at all to protect our drug candidates. Even if patents issue, we cannot guarantee that the claims of those patents will be valid and enforceable or provide us with any significant protection against competitive products, or otherwise be commercially valuable to us. We may be particularly affected by this because we expect that ANA598, if approved, will be marketed in foreign countries with high incidences of HCV infection.

Other companies may obtain patents and/or regulatory approvals to use the same drugs to treat diseases other than HCV or cancer. As a result, we may not be able to enforce our patents effectively because we may not be able to prevent healthcare providers from prescribing, administering or using another company’s product that contains the same active substance as our products when treating patients infected with HCV or who have cancer.

If we fail to obtain and maintain patent protection and trade secret protection of ANA598 or ANA773, proprietary technologies and their uses, the competition we face would increase, reducing our potential revenues and adversely affecting our ability to attain or maintain profitability.

If we are sued for infringing intellectual property rights of others, it will be costly and time-consuming, and an unfavorable outcome in that litigation would have a material adverse effect on our business.

Our commercial success also depends upon our ability to develop, manufacture, market and sell our product candidates and use our proprietary technologies without infringing the proprietary rights of third parties. We may be exposed to future litigation by third parties based on claims that our product candidates, technologies or activities infringe the intellectual property rights of others. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in HCV and cancer. These could materially affect our ability to develop our drug candidates or sell our products. Because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our product candidates

or technologies may infringe. There also may be existing patents, of which we are not aware, that our product candidates or technologies may inadvertently infringe. Further, there may be issued patents and pending patent applications in fields relevant to our business, of which we may become aware from time to time, that we believe we do not infringe or that we believe are invalid or relate to immaterial portions of our overall drug discovery and development efforts. We cannot assure you that third parties holding any of these patents or patent applications will not assert infringement claims against us for damages or seeking to enjoin our activities. We also cannot assure you that, in the event of litigation, we will be able to successfully assert any belief we may have as to non-infringement, invalidity or immateriality, or that any infringement claims will be resolved in our favor.

There is a substantial amount of litigation involving patent and other intellectual property rights in the biotechnology and biopharmaceutical industries generally. Any litigation or claims against us, with or without merit, may cause us to incur substantial costs, could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. In addition, intellectual property litigation or claims could result in substantial damages and force us to do one or more of the following if a court decides that we infringe on another party’s patent or other intellectual property rights:

	•		cease selling, incorporating or using any of our product candidates or technologies that incorporate the challenged intellectual property;

	•		obtain a license from the holder of the infringed intellectual property right, which license may be costly or may not be available on reasonable terms, it at all; or

	•		redesign our processes or technologies so that they do not infringe, which could be costly and time consuming and may not be possible.

If we find during clinical evaluation that our drug candidates for the treatment of HCV or cancer should be used in combination with a product covered by a patent held by another company or institution, and that a labeling instruction is required in product packaging recommending that combination, we could be accused of, or held liable for, inducing infringement of the third-party patents covering the product recommended for co-administration with our product. In that case, we may be required to obtain a license from the other company or institution to use the required or desired package labeling, which may not be available on reasonable terms, or at all.

If we fail to obtain any required licenses or make any necessary changes to our technologies, we may be unable to develop or commercialize some or all of our product candidates.

We may be involved in lawsuits or proceedings to protect or enforce our patent rights, trade secrets or know-how, which could be expensive and time-consuming.

The defense and prosecution of intellectual property suits and related legal and administrative proceedings can be both costly and time-consuming. Litigation and interference proceedings could result in substantial expense to us and significant diversion of effort by our technical and management personnel. Further, the outcome of patent litigation is subject to uncertainties that cannot be adequately quantified in advance, including the demeanor and credibility of witnesses and the identity of the adverse party. This is especially true in biotechnology related patent cases that may turn on the testimony of experts as to technical facts upon which experts may reasonably disagree and which may be difficult to comprehend by a judge or jury. An adverse determination in an interference proceeding or litigation with respect to ANA598 or ANA773, to which we may become a party could subject us to significant liabilities to third parties or require us to seek licenses from third parties. If required, the necessary licenses may not be available on acceptable terms, or at all. Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from commercializing ANA598 or ANA773, which could have a material and adverse effect on our results of operations.

Furthermore, because of the substantial amount of pre-trial document and witness discovery required in connection with intellectual property litigation, there is risk that some of our confidential information could be compromised by disclosure during this type of litigation. In addition, during the course of this kind of litigation, there could be public announcements of the results of hearings, motions or other interim proceedings or developments. If securities analysts or investors perceive these results to be negative, it could have a substantial adverse effect on the trading price of our common stock.

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 also rely on trade secrets to protect our technology, especially where 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 also 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.

Many competitors have significantly more resources and experience, which may harm our commercial opportunity.

The biotechnology and pharmaceutical industries are subject to intense competition and rapid and significant technological change. We have many potential competitors, including major drug and chemical companies, specialized biotechnology firms, academic institutions, government agencies and private and public research institutions. Many of our competitors have significantly greater financial resources, experience and expertise in:

	•		research and development;

	•		preclinical testing;

	•		clinical trials;

	•		regulatory approvals;

	•		manufacturing; and

	•		sales and marketing of approved products.

Smaller or early-stage companies and research institutions may also prove to be significant competitors, particularly through collaborative arrangements with large and established pharmaceutical or other companies. We will also face competition from these parties in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient registration for clinical trials, and acquiring and in-licensing technologies and products complementary to our programs or potentially advantageous to our business. If any of our competitors succeed in obtaining approval from the FDA or other regulatory authorities for their products sooner than we do or for products that are more effective or less costly than ours, our commercial opportunity could be significantly reduced.

If our competitors develop treatments for HCV or cancer that are approved faster, marketed better or demonstrated to be more effective than ANA598, ANA773, or any other products that we may develop, our commercial opportunity will be reduced or eliminated.

We believe that a significant number of drugs are currently under development and may become available in the future for the treatment of HCV and certain cancers. Potential competitors may develop treatments for HCV or certain cancers that are more effective or less costly than our product candidates or that would make our product candidates obsolete or non-competitive. Some of these products may use therapeutic approaches that compete directly with ANA598 or ANA773. In addition, less expensive generic forms of currently marketed drugs could lead to additional competition upon patent expiration or invalidations.

ANA598, a non-nucleoside polymerase inhibitor, was selected as a development candidate in June 2007. If approved, ANA598 would likely be used in combination with the current standard of care and/or other direct antiviral agents such as protease inhibitors and polymerase inhibitors. Any product currently approved or approved in the future for the treatment of HCV infection could decrease or eliminate the commercial opportunity of ANA598. Other non-nucleoside inhibitors would likely be the most direct competitors for ANA598. To our knowledge, non-nucleoside polymerase inhibitor programs are currently under clinical evaluation by Pfizer, Gilead, Merck, Abbott, Boehringer Ingelheim and Vertex. Further, a number of companies have non-nucleoside polymerase inhibitor research and pre-clinical development programs.

Other potential competitors are products currently approved for the treatment of HCV infection: Peg- Intron (pegylated interferon-alpha-2b), Rebetol (ribavirin), and Intron-A (interferon-alpha-2b), which are marketed by Merck, Pegasys (pegylated interferon-alpha-2a), Copegus (ribavirin USP), and Roferon- A (interferon-alpha-2a), which are marketed by Roche. Additional compounds in late state clinical trials for HCV include Zalbin/Joulferon (albinterferon alfa-2b), in development by Human Genome Sciences and Novartis, telaprevir, in development by Vertex Pharmaceuticals, Janssen Pharmaceutica (Johnson & Johnson) and Mitsubishi Tanabe Pharma, boceprevir, MK-7009 and narlaprevir, in development by Merck, ITMN-191, in development by Intermune and Roche, TMC-435350, in development by Johnson & Johnson (Tibotec) and Medivir, BI-201335 in development by Boehringer Ingelheim, and RG7128 in development by Roche and Pharmasset.

ANA773 is also subject to competition in the treatment of HCV from all of the HCV products and compounds in development listed above as potential competitors of ANA598 and most specifically from the products and development candidates that act as an immunomodulator or have an immunomodulatory component, including Peg-Intron (pegylated interferon-alpha-2b), Rebetol (ribavirin), Intron-A (interferonalpha- 2b), Pegasys (pegylated interferon-alpha-2a), Copegus (ribavirin USP), and Roferon-A (interferon-alpha- 2a), each of which are products currently approved for the treatment of HCV. IMO-2055, a TLR9 agonist in development by Idera, is also being studied in early stage clinical trials in HCV patients. Other agents in development as potential replacements to pegylated interferon-alfa include Zalbin/Joulferon (albinterferon alfa-2b), in development by Human Genome Sciences and Novartis and Locteron, in development by Biolex Therapeutics, both of which are longer-acting versions of interferon alfa. Also, in development as potential improvements to existing interferons are PEG-interferon lambda, in development by Zymogenetics and Bristol Myers-Squibb, and omega interferon in development by Intarcia Therapeutics.

Any product currently approved or approved in the future for the treatment of cancer could decrease or eliminate the commercial opportunity of ANA773 in the oncology markets. Programs that most directly compete with the ANA773 oncology program at this time are other TLR agonists under evaluation for oncology indications, IMO-2055, in development by Idera and Merck KGaA and a cancer program in development by Dynavax.

If we cannot establish pricing of our product candidates acceptable to the government, insurance companies, managed care organizations and other payors, any product sales will be severely hindered.

The continuing efforts of the government, insurance companies, managed care organizations and other payors of health care costs to contain or reduce costs of health care may adversely affect:

	•		our ability to set a price we believe is fair for any products we or our collaborators may develop;

	•		our ability to generate adequate revenues and gross margins; and

	•		the availability of capital.

In certain foreign markets, the pricing of prescription pharmaceuticals is subject to government control. In the United States, given recent federal and state government initiatives directed at lowering the total cost of health care, the U.S. Congress and state legislatures will likely continue to focus on health care reform, the cost of prescription pharmaceuticals and on the reform of the Medicare and Medicaid systems. The trend toward managed health care in the United States, which could significantly influence the purchase of health care services and products, as well as legislative proposals to reform health care, control pharmaceutical prices or reduce government insurance programs, may result in lower prices for our product candidates. While we cannot predict whether any legislative or regulatory proposals affecting our business will be adopted, the announcement or adoption of these proposals could have a material and adverse effect on our potential revenues and gross margins.

If we cannot arrange for reimbursement policies favorable to our product candidates, their sales will be severely hindered.

Our ability to commercialize ANA598 or any other product candidate successfully will depend in part on the extent to which governmental authorities, private health insurers and other organizations establish appropriate reimbursement levels for the cost of ANA598 or any other product and related treatments. Third party payors are increasingly challenging the prices charged for medical products and services, including treatments for HCV. Also, the trend toward managed health care in the United States as well as legislative proposals to reform health care, control pharmaceutical prices or reduce government insurance programs, may also result in exclusion of our product candidates from reimbursement programs. 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 product revenue and generate significant profits and could impact our ability to raise capital.

Product liability claims may damage our reputation and, if insurance proves inadequate, the product liability claims may harm our results of operations.

We face an inherent risk of product liability exposure for claimed injuries related to the testing of our product candidates in human clinical trials, and will face an even greater risk if we or our potential future collaborators sell our product candidates commercially. If we cannot successfully defend ourselves against product liability claims, we will incur substantial liabilities. Regardless of merit or eventual outcome, product liability claims may result in:

	•		decreased demand for our product candidates;

	•		injury to our reputation;

	•		withdrawal of clinical trial participants;

	•		the inability to establish new collaborations with potential collaborators;

	•		substantial costs of related litigation;

	•		substantial monetary awards to patients; and

	•		the inability to commercialize our product candidates.

We currently have product liability insurance that covers our clinical trials and plan to increase and expand this coverage as we commence larger scale trials. We also intend to expand our insurance coverage to include the sale of commercial products if marketing approval is obtained for any of our product candidates. However, insurance coverage is increasingly expensive. We may not be able to maintain insurance coverage at a reasonable cost and we may not be able to obtain insurance coverage that will be adequate to satisfy any liability that may arise.

Any claims relating to our improper handling, storage or disposal of biological, hazardous and radioactive materials could be time-consuming and costly.

Our research and development involves the controlled use of hazardous materials, including chemicals that cause cancer, volatile solvents, including ethylacetate and acetonitrile, radioactive materials and biological materials including plasma from patients infected with HCV or other infectious diseases that have the potential to transmit disease. Our operations also produce hazardous waste products. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these 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 required to suspend or modify our operations. Although we believe that our safety procedures for handling and disposing of these materials comply with legally prescribed standards, we cannot completely eliminate the risk of accidental contamination or injury from these materials. In the event of contamination or injury, we could be held liable for damages or penalized with fines in an amount exceeding our resources, and our clinical trials could be suspended. In addition, we may have to incur significant costs to comply with future environmental laws and regulations.

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. Any system failure, accident or security breach that causes interruptions in our operations could result in a material disruption of our development 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 development 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.

Risks Related to Our Common Stock

Future sales of our common stock may cause our stock price to decline.

Our current stockholders hold a substantial number of shares of our common stock that they are able to sell in the public market. Significant portions of these shares are held by a small number of stockholders. Sales by our current stockholders of a substantial number of shares or the expectation that such sale may occur, could significantly reduce the market price of our common stock.

Our stock price may be volatile.

The market price of our common stock may fluctuate significantly in response to a number of factors, most of which we cannot control, including:

	•		changes in the regulatory status of our product candidates, including the status and results of our clinical trials of ANA598 and ANA773;

	•		significant contracts, new technologies, acquisitions, commercial relationships, joint ventures or capital commitments;

	•		disputes or other developments relating to proprietary rights, including patents, trade secrets, litigation matters, and our ability to patent or otherwise protect our product candidates and technologies;

	•		conditions or trends in the pharmaceutical and biotechnology industries;

	•		fluctuations in stock market prices and trading volumes of similar companies, of our competitors or of the markets generally;

	•		variations in our quarterly operating results;

	•		changes in securities analysts’ estimates of our financial performance;

	•		failure to meet or exceed securities analysts’ or investors’ expectations of our quarterly financial results, clinical results or our achievement of milestones;

	•		sales of large blocks of our common stock, or the expectation that such sales may occur, including sales by our executive officers, directors and significant stockholders;

	•		additions or departures of key personnel;

	•		discussion of our business, products, financial performance, prospects or our stock price by the financial and scientific press and online investor communities such as chat rooms;

	•		regulatory developments in the United States and foreign countries;

	•		economic and political factors, including wars, terrorism and political unrest; and

	•		technological advances by our competitors.

Our quarterly results may fluctuate significantly, resulting in fluctuations in our stock price.

We expect our results of operations to be subject to quarterly fluctuations. The level of our revenues, if any, and results of operations at any given time, will be based primarily on the following factors:

•

the status of development of ANA598, ANA773 and our other product candidates, including results of preclinical studies and clinical trials and changes in regulatory status;

	•		our execution of collaborative, licensing or other arrangements, including arrangements involving ANA773, and the timing and accounting treatment of payments we make or receive under these arrangements;

	•		whether or not we achieve specified research or commercialization milestones under any agreement that we enter into with collaborators and the timely payment by commercial collaborators of any amounts payable to us;

	•		variations in the level of expenses related to our product candidates or potential product candidates during any given period; and

	•		the effect of competing technological and market developments.

These factors, some of which are not within our control, may cause the price of our stock to fluctuate substantially. In particular, if our quarterly operating results fail to meet or exceed the expectations of securities analysts or investors, our stock price could drop suddenly and significantly. We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.

Our largest stockholders may take actions that are contrary to your interests, including selling their stock.

A small number of our stockholders hold a significant amount of our outstanding stock. These stockholders may support competing transactions and have interests that are different from yours. In addition, the average number of shares of our stock that trade each day is generally low. As a result, sales of a large number of shares of our stock by these large stockholders or other stockholders within a short period of time could adversely affect our stock price.

Anti-takeover provisions in our organizational documents and Delaware law may discourage or prevent a change in control, even if an acquisition would be beneficial to our stockholders, which could affect our stock price adversely and prevent attempts by our stockholders to replace or remove our current management.

Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may delay or prevent a change in control, discourage bids at a premium over the market price of our common stock and adversely affect the market price of our common stock and the voting and other rights of the holders of our common stock. These provisions include:

	•		dividing our board of directors into three classes serving staggered three-year terms;

	•		prohibiting our stockholders from calling a special meeting of stockholders;

	•		permitting the issuance of additional shares of our common stock or preferred stock without stockholder approval;

	•		prohibiting our stockholders from making certain changes to our amended and restated certificate of incorporation or amended and restated bylaws except with 66 2/3% stockholder approval; and

	•		requiring advance notice for raising matters of business or making nominations at stockholders’ meetings.

We are also subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for five years unless the holder’s acquisition of our stock was approved in advance by our board of directors. Although we believe these provisions collectively provide for an opportunity to receive higher bids by requiring potential acquirers to negotiate with our board of directors, they would apply even if the offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.

We have never paid cash dividends on our capital stock and we do not anticipate paying dividends in the foreseeable future.

We have paid no cash dividends on any of our classes of capital stock to date, and we currently intend to retain our future earnings, if any, to fund the development and growth of our business. In addition, the terms of any future debt or credit facility may preclude us from paying any dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of potential gain for the foreseeable future.

Item 1B. Unresolved Staff Comments

Not Applicable.

Item 2. Properties

Our headquarters and research and development facility is located in approximately 14,000 square feet of office and laboratory space in San Diego, California. We occupy this facility under a lease, which expires on January 31, 2011.

Item 3. Legal Proceedings

We are currently not a party to any material legal proceedings.

Item 4. Reserved

Reserved.

Part II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities

Market Information

Our common stock is traded on the Nasdaq Global Market under the symbol ANDS. The following table sets forth the high and low sales prices for our common stock for the periods indicated, as reported on the Nasdaq Global Market.


2009	High		Low
First Quarter	$	8.43	$	1.61
Second Quarter		6.90		1.68
Third Quarter		3.32		1.44
Fourth Quarter		3.02		1.79


2008	High		Low
First Quarter	$	1.77	$	1.36
Second Quarter		3.13		1.50
Third Quarter		2.98		2.10
Fourth Quarter		2.70		1.50

Holders

As of February 17, 2010, there were approximately 5,400 holders of our common stock.

Dividend Policy

We have never declared or paid any cash dividends on our capital stock. We currently intend to retain future earnings, if any, for development of our business and therefore do not anticipate that we will declare or pay cash dividends on our capital stock in the foreseeable future.

Performance Measurement Comparison⁽¹⁾

The following graph shows a comparison of the five year total cumulative returns of an investment of $100 in cash on December 31, 2004 in (i) our common stock (ii) the Nasdaq Composite Index and (iii) the Nasdaq Biotechnology Index. All values assume reinvestment of the full amount of all dividends (to date, we have not declared any dividends).

Comparison of cumulative total return on investment since December 31, 2004:



	December 31, 2004		December 31, 2005		December 31, 2006		December 31, 2007		December 31, 2008		December 31, 2009
Anadys Pharmaceuticals, Inc.	$	100.00	$	117.49	$	65.69	$	21.50	$	20.96	$	28.17
NASDAQ Composite Index		100.00		101.37		111.03		121.92		72.49		104.31
NASDAQ Biotechnology Index		100.00		102.84		103.89		108.65		94.93		109.77


(1)		This section is not “soliciting material,” is not deemed “filed” with the SEC and is not to be incorporated by reference in any filing of the Company under the 1933 Act or the 1934 Act whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

Item 6. Selected Financial Data

The selected financial data set forth below with respect to our consolidated statements of operations for each of the three years in the period ended December 31, 2009 and, with respect to our consolidated balance sheets, at December 31, 2009 and 2008 are derived from our consolidated financial statements that have been audited by Ernst & Young LLP, an independent registered public accounting firm, which are included elsewhere in this Annual Report on Form 10-K. The statement of operations data for the years ended December 31, 2006 and 2005 and the balance sheet data as of December 31, 2007, 2006 and 2005 are derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K. The information set forth below is not necessarily indicative of the results of future operations and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K.


	For the years ended December 31,
	2009			2008			2007			2006			2005
	(In thousands, except net loss per share)
Consolidated Statements of Operations Data:
Revenues	$	—		$	—		$	24,118		$	5,420		$	4,887
Operating expenses:
Research and development⁽¹⁾		19,494			25,993			28,192			25,419			20,901
General and administrative⁽¹⁾		8,243			8,109			8,692			11,308			7,705

Total operating expenses⁽¹⁾		27,737			34,102			36,884			36,727			28,606

Loss from operations		(27,737	)		(34,102	)		(12,766	)		(31,307	)		(23,719	)

Other income (expense):
Interest income		478			1,482			3,611			4,727			2,103
Interest expense		—			—			—			(69	)		(189	)
Loss from valuation of common stock warrant liability		(151	)		—			—			—			—
Other, net		132			218			(17	)		(111	)		(118	)

Total other income (expense), net		459			1,700			3,594			4,547			1,796

Net loss	$	(27,278	)	$	(32,402	)	$	(9,172	)	$	(26,760	)	$	(21,923	)

Net loss per share, basic and diluted:	$	(0.81	)	$	(1.13	)	$	(0.32	)	$	(0.94	)	$	(0.89	)

Shares used in calculating net loss per share, basic and diluted:		33,775			28,750			28,646			28,512			24,756


⁽¹⁾		As a result of the adoption of ASC 718 on January 1, 2006, there is a lack of comparability in our research and development expenses and our general and administrative expenses for the periods presented prior to January 1, 2006. Please reference Note 10 in our consolidated financial statements for additional information related to the impact of ASC 718 on our research and development expenses and our general and administrative expenses.


	As of December 31,
	2009			2008			2007			2006			2005
							(In thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and securities available-for-sale	$	20,490		$	27,936		$	56,495		$	82,149		$	104,851
Working capital		13,769			24,325			52,084			75,054			98,682
Total assets		21,735			31,674			61,526			89,401			116,976
Long-term debt, net of current portion		—			—			—			—			682
Accumulated deficit		(283,332	)		(256,054	)		(223,652	)		(214,480	)		(187,720	)
Total stockholders’ equity		14,429			25,825			55,679			60,325			78,936

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

This discussion and analysis should be read in conjunction with our financial statements and notes thereto included in this Annual Report on Form 10-K (this Annual Report). Operating results are not necessarily indicative of results that may occur in future periods.

This Annual Report contains forward-looking statements. These forward-looking statements involve a number of risks and uncertainties. Such forward-looking statements include statements about our development plans and programs, clinical trials, strategies, objectives, and other statements that are not historical facts, including statements which may be preceded by the words “intend,” “will,” “plan,” “expect,” “anticipate,” “estimate,” “aim,” “seek,” “believe,” “hope” or similar words. For such statements, we claim the protection of the Private Securities Litigation Reform Act of 1995. Readers of this Annual Report are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. We undertake no obligation to update publicly or revise any forward-looking statements. Actual events or results may differ materially from our expectations. Important factors that could cause actual results to differ materially from those stated or implied by our forward-looking statements include, but are not limited to, the risk factors identified in our periodic reports filed with the Securities and Exchange Commission (SEC), including those set forth in “Item 1A. Risk Factors” in this Annual Report.

Overview

Anadys Pharmaceuticals, Inc. is a biopharmaceutical company dedicated to improving patient care by developing novel medicines for the treatment of hepatitis C. We believe hepatitis C represents a large and significant unmet medical need. Our objective is to contribute to an improved treatment outcome for patients with this serious disease. We are currently focusing our efforts on the development of ANA598, a small-molecule, non-nucleoside inhibitor of the NS5B polymerase for the treatment of hepatitis C. We are currently conducting a Phase II study of ANA598 in combination with pegylated interferon alpha and ribavirin, which is the current standard of care (SOC) for the treatment of hepatitis C. This study is being conducted in patients infected with hepatitis C virus (HCV).

On June 3, 2009, we initiated a strategic restructuring to focus our operations on the development of ANA598, in particular the Phase II study of ANA598 in combination with interferon and ribavirin. The strategic restructuring resulted in a reduction in our workforce of approximately 40%, with most of the employees having departed by the end of June 2009 and several others departing at later dates prior to the end of 2009. We incurred a cash charge of approximately $1.3 million for the year ended December 31, 2009, which is included in operating expenses, for cash severance, benefits and outplacement services in connection with the workforce reduction. In addition, we incurred a noncash charge of $0.4 million associated with the modification of stock options for individuals included in the strategic restructuring.

We also have investigated ANA773, an oral, small-molecule inducer of endogenous interferons that acts via the Toll-like receptor 7, or TLR7, pathway in a Phase I trial in hepatitis C. In 2009 we concluded a Phase I clinical trial of ANA773 in HCV patients.

We have also investigated ANA773 for the treatment of cancer. In 2009 we elected to stop enrollment of new patients in the ongoing Phase I oncology trial to focus our resources on ANA598. We plan for currently enrolled patients to continue to receive ANA773 until disease progression is observed and to conclude the trial once all patients reach this point.

We have incurred significant operating losses since our inception and, as of December 31, 2009, our accumulated deficit was $283.3 million. We expect to incur substantial losses for at least the next several years as we:

	•		continue the development of ANA598 for the treatment of HCV;

	•		develop methods for and scale-up manufacturing of ANA598 for clinical trials and potential commercialization;

	•		commercialize any product candidates that receive regulatory approval; and

	•		potentially in-license technology and acquire or invest in businesses, products or technologies that are synergistic with our own.

Research and Development

During 2009 and 2008, research and development expenses consisted primarily of costs associated with clinical development of the Company’s product candidates. During 2007, research and development expenses consisted primarily of costs associated with the discovery, preclinical and clinical development of our product candidates. Research and development expenses may include external costs such as fees paid to clinical research organizations, clinical trial investigators, contract research organizations, drug substance and drug product manufacturers and consultants. Research and development expenses may also include internal costs such as compensation, supplies, materials, an allocated portion of facilities costs, an allocated portion of information systems support personnel and depreciation.

At this time, due to the risks inherent in the clinical trial process and given the early-stage of development of our product candidates, we are unable to estimate with any certainty the costs we will incur in the continued development of our product candidates for commercialization. Clinical development timelines, likelihood of success and total costs vary widely. However, we expect our research and development costs to be substantial and to increase as we advance our product candidates through clinical development.

The following summarizes our research and development expenses for the years ended December 31, 2009, 2008 and 2007 (in thousands):


	For the years ended December 31,
	2009		2008		2007
ANA598	$	10,355	$	11,044	$	8,390
ANA773		3,103		8,177		6,136
ANA380		—		—		700
ANA975, net of reimbursement		—		117		560
Discovery stage programs		—		—		1,936
Infrastructure, support personnel and other		4,052		5,384		7,194
Severance related to reduction in force		630		—		813
Non-cash employee and non-employee share-based compensation		1,354		1,271		2,463

Total research and development expense	$	19,494	$	25,993	$	28,192

Effective July 1, 2008, we began allocating costs for ANA773 between our HCV and oncology program. For the year ended December 31, 2009, ANA773 HCV related costs were $2.3 million and ANA773 oncology related costs were $0.8 million. For the six months ended December 31, 2008, ANA773 HCV related costs were $3.1 million and ANA773 oncology related costs were $0.9 million.

General and Administrative

General and administrative expenses consist primarily of salaries and benefits for executive, finance, investor relations, business development, human resources and legal personnel. In addition, general and administrative expenses include insurance costs, professional services and an allocated portion of facilities costs and information systems support personnel.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles (GAAP). The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses and related disclosure of contingent assets and liabilities. We review our estimates on an on-going basis and make adjustments to the consolidated financials statements as considered necessary. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. While all of our significant accounting policies are described in Note 1 to our consolidated financial statements included in this Annual Report, we believe the following accounting policies involve the judgments and estimates used in the preparation of our consolidated financial statements:

Drug Development Costs. Drug development costs include costs associated with the development of our product candidates including non-clinical activities, toxicology studies, manufacturing of non-clinical and clinical materials and clinical trials. We review and accrue drug development costs based on work performed. We estimate work performed utilizing factors such as subject enrollment, estimated timeline for completion of studies and other factors. These costs and estimates vary based on the type, scope and length of non-clinical and clinical studies as well as other factors. Drug development cost accruals are subject to revisions as studies, projects and trials progress to completion. Expense is adjusted for revisions in the period in which the facts that give rise to the revision become known.

Common Stock Warrant Liability. We account for common stock warrants which may potentially be settled with cash as a liability. The common stock warrants have been recorded at their fair value at issuance and will continue to be recorded at fair value each subsequent balance sheet date until such time that they are exercised or are otherwise modified to remove the provisions that require this treatment, at which time the warrants will be adjusted to fair value and reclassified from liabilities to stockholders’ equity. Any change in value between reporting periods will be recorded as other income (expense) at each reporting date. The fair value of the warrants is estimated using the Black-Scholes pricing model.

Share-Based Compensation. Share-based compensation cost is estimated at the grant date based on the award’s fair-value as calculated by a Black-Scholes pricing model and the portion that is expected to vest is recognized as expense evenly over the requisite service period. The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, the risk-free interest rate, the expected term of the awards and expected forfeitures. If any of the assumptions used in the model change significantly, share-based compensation expense may differ materially in the future from that recorded in the current period.

Results of Operations

Comparison of the Years Ended December 31, 2009, 2008 and 2007

Revenue. During 2009 and 2008, we did not recognize any revenue. We recorded revenue of $24.1 million for the year ended December 31, 2007. The $24.1 million decrease from 2007 to 2008 was primarily attributed to the recognition in 2007 of previously deferred revenue upon the termination of our License and Co-Development Agreement with Novartis.

Research and Development Expenses. Research and development expenses were $19.5 million, $26.0 million and $28.2 million for the years ended December 31, 2009, 2008 and 2007, respectively. The $6.5 million decrease from 2008 to 2009 was primarily due to $6.4 million in cost savings associated with our strategic restructuring initiated in June 2009 of which, $5.1 million was due to reduced ANA773 development costs and $1.3 million of which was due to reduced infrastructure and support personnel costs. These decreases were partially offset by severance costs of $0.6 million. During 2009, we incurred the following external development costs associated with our ANA598 program: $1.2 million associated with our completed Phase Ib clinical trial in HCV patients, $1.0 million associated with our completed long-term chronic toxicology studies of ANA598, $0.8 million associated with our completed 14-day healthy volunteer study and $2.0 million for our on-going Phase II clinical trial in HCV patients. During 2009, we incurred the following external development costs associated with our ANA773 program: $1.4 million associated with our completed Phase I clinical trial for HCV and $0.3 million associated with our on-going Phase I clinical trial for oncology. As we have elected to suspend the development of ANA773 for HCV and oncology, we do not anticipate incurring significant costs related to this program in future periods. Our non-cash share-based compensation expense associated with share-based payments granted to our research and development employees was $1.4 million for the year ended December 31, 2009 compared to $1.3 million for the year ended December 31, 2008. Included in our non-cash share-based compensation expense for the year-ended December 31, 2009 is $0.3 million associated with the modification of stock options for individuals included in our strategic restructuring.

The $2.2 million decrease in research and development expenses from 2007 to 2008 was primarily due to cost savings derived from our completed 2007 strategic restructuring which included the halting of early stage discovery efforts and the termination of our collaborations with both Novartis and LG Life Sciences. These decreases were partially offset by an increase in development costs for ANA598 and ANA773. In 2008, we incurred development costs associated with our ANA598 program related to our completed Phase Ia clinical trial in healthy volunteers, our on-going Phase Ib clinical trial in HCV patients, the initiation of long-term chronic toxicology studies of ANA598 and the manufacturing of clinical and non-clinical materials. 2008 development costs for ANA773 include costs associated with the manufacturing of non-clinical and clinical materials, our completed 13-week GLP toxicology studies, our then on-going Phase I clinical trial for HCV and our then on-going Phase I clinical trial for oncology. Our non-cash share-based compensation expense associated with share-based payments granted to our research and development employees was $1.3 million and $2.5 million for the years ended December 31, 2008 and 2007, respectively. The decrease in our non-cash share-based compensation expense was primarily associated with the cancellation of outstanding stock options for personnel included in our 2007 workforce reduction, as well as a reduction in the weighted average fair value assigned to stock options granted in 2008 compared to 2007.

General and Administrative Expenses. General and administrative expenses were $8.2 million, $8.1 million and $8.7 million for the years ended December 31, 2009, 2008 and 2007, respectively. The $0.1 million increase from 2008 to 2009 was primarily attributable to severance costs of $0.7 million, which were partially offset by a reduction in allocated facility costs associated with the relocation of our corporate headquarters to a smaller facility. The $0.6 million decrease from 2007 to 2008 was primarily the result of cost savings derived from our completed 2007 strategic restructuring. Non-cash share-based compensation expense associated with share-based payments granted to our general and administrative employees and non-employee directors for the years ended December 31, 2009, 2008 and 2007 was $1.4 million, $1.5 million and $1.7 million, respectively. Included in our non-cash share-based compensation expense for the year-ended December 31, 2009 is $0.1 million associated with the modification of stock options for individuals included in our 2009 strategic restructuring.

Interest Income. Interest income was $0.5 million, $1.5 million and $3.6 million for the years ended December 31, 2009, 2008 and 2007, respectively. The $1.0 million decrease in our interest income from 2008 to 2009 was the result of a lower average cash, cash equivalents and securities available-for-sale balance and lower interest rates during 2009 compared to 2008. Our average balance of cash, cash equivalents and securities available-for-sale, which were invested in interest bearing securities, was $22.9 million in 2009 compared to $40.6 million in 2008. The decrease in our average cash balance from 2008 to 2009 was driven by our use of cash, cash equivalents and securities to fund our on-going operations partially offset by proceeds received from the equity financing during June 2009. The $2.1 million decrease in our interest income from 2007 to 2008 was the result of a lower average cash, cash equivalents and securities available-for-sale balance and lower interest rates during 2008 compared to 2007. Our average balance of cash, cash equivalents and securities available-for-sale, which were invested in interest bearing securities, was $40.6 million in 2008 compared to $67.7 million in 2007. The decrease in our average cash balance from 2007 to 2008 was driven by our use of cash, cash equivalents and securities to fund our on-going operations.

Common Stock Warrant Liability. Non-operating expense associated with the increase in common stock warrant liability was $0.2 million for the year ended December 31, 2009. This represents the increase in the fair value of the warrants from June 3, 2009 to December 31, 2009. The fair value was calculated using the Black Scholes pricing model and is remeasured at each reporting period. Potential future increases in our stock price will result in losses being recognized in our statement of operations in future periods. Conversely, potential future declines in our stock price will result in gains being recognized in our statement of operations in future periods.

Liquidity and Capital Resources

Overview

Our December 31, 2009 cash, cash equivalents and marketable securities balance was $20.5 million. Our cash, cash equivalents and available-for sale securities decreased by $7.4 million from December 31, 2008 to December 31, 2009. The decrease in cash, cash equivalents and securities available-for-sale is the result of year-to-date cash utilization to fund our operations, partially offset by net proceeds of $16.0 million received from our completed equity financing during June 2009. We believe that our existing cash, cash equivalents and securities available-for-sale will be sufficient to meet our projected operating requirements for at least the next twelve months.

On June 3, 2009, the Company sold 8.4 million shares of common stock and warrants to purchase 2.9 million shares of common stock to institutional investors for net proceeds of approximately $16.0 million. The proceeds from this equity financing are being utilized to fund operating activities and to continue to advance ANA598 for the treatment of HCV.

Excluding the net proceeds from our equity financing completed during June 2009, we used $23.4 million in cash to fund operations during the year ended December 31, 2009 compared to $28.6 million during the year ended December 31, 2008. The decease in our operating cash burn can be attributed to the following factors: our strategic restructuring, initiated in June 2009, to focus our operations on the development of ANA598, our decision to suspend the development of ANA773 for HCV and oncology and the relocation of our corporate headquarters to a smaller facility in July 2009. We anticipate the strategic restructuring completed in 2009 will generate annual cash expense savings of approximately $4.0 million to $5.0 million. We anticipate the relocation of our operations to a smaller building to achieve an annual facility expense reduction of approximately $1.8 million.

Future Cash Requirements

Over time we expect our development expenses to be substantial and to increase as we continue the advancement of our development programs. The lengthy process of completing clinical trials and seeking regulatory approval for our product candidates requires the expenditure of substantial resources. Any failure by us or delay in completing clinical trials, or in obtaining regulatory approvals, could cause our research and development expenses to increase and, in turn, have a material adverse effect on our results of operations.

Our future capital uses and requirements depend on numerous forward-looking factors. These factors may include but are not limited to the following:

	•		the progress of our clinical trials;

	•		the progress of our nonclinical development activities;

	•		our ability to establish and maintain strategic alliances;

	•		the costs involved in enforcing or defending patent claims and other intellectual property rights;

	•		the costs and timing of regulatory approvals;

	•		the costs of establishing or expanding manufacturing, sales and distribution capabilities;

	•		the costs related to development and manufacture of non-clinical, clinical and validation lots for regulatory and commercialization of drug supply;

	•		the success of the commercialization of ANA598, ANA773 or any other product candidates we may develop; and

	•		the extent to which we acquire or invest in other products, technologies and businesses.

Investment Portfolio

As of December 31, 2009, we have $20.1 million of securities available-for-sale consisting of money market funds, commercial paper, municipal bonds, U.S. treasury notes, U.S. government sponsored enterprise securities and corporate debt securities with maturities that range from one day to 12 months with an overall average months to maturity of 5.1 months. We have the ability to liquidate these marketable securities without restriction or penalty.

As of December 31, 2009, we performed a review of all of the securities in our portfolio with an unrealized loss position, to determine if any other-than-temporary impairments were required to be recorded. Factors considered in our assessment included but were not limited to the following: our ability and intent to hold the security until maturity; the number of months until the security’s maturity, the number of quarters that each security was in an unrealized loss position, ratings assigned to each security by independent rating agencies, the magnitude of the unrealized loss compared to the face value of the security and other market conditions. No other-than-temporary impairments were identified as of December 31, 2009 related to securities currently in our portfolio. We also noted that none of the securities as of December 31, 2009 have been in an unrealized loss position for greater than one year. As of December 31, 2009 we do not own any asset-backed securities or auction rate securities.

Cash Flows from Operating Activities and Investing Activities

Our consolidated statements of cash flows are summarized as follows (in thousands):


	For the years ended December 31,
	2009			2008			2007
Net cash used in operating activities	$	(24,229	)	$	(28,288	)	$	(25,658	)

Cash provided by (used in) investing activities
Purchase of securities available-for-sale	$	(24,657	)	$	(8,806	)	$	(15,131	)
Proceeds from sale of securities available-for-sale		26,484			12,463			13,170
Purchase of property and equipment		(88	)		(213	)		(356	)
Proceeds from disposal of property and equipment		111			392			—

Net cash provided by (used in) investing activities	$	1,850		$	3,836		$	(2,317	)

We expect to continue to utilize cash and marketable securities to fund our operating activities as we continue to advance our wholly owned product candidate ANA598. We are not currently party to any development collaborations and therefore cash to fund future operations will most likely have to be obtained from one of the following sources: our current investment portfolio, the sale of equity securities, new strategic alliance agreements or other transactions, project financing or debt financing.

Cash Flows from Financing Activities

Our consolidated statements of cash flows are summarized as follows (in thousands):


	For the years ended December 31,
	2009		2008		2007
Cash provided by financing activities
Proceeds from exercise of stock options and employee stock purchase plan	$	385	$	259	$	257
Proceeds from equity financing, net of issuance costs		16,015		—		—

Net cash provided by financing activities	$	16,400	$	259	$	257

Aggregate Contractual Obligations

The following summarizes our contractual obligations as of December 31, 2009 (in thousands):


			Less
			than 1		2011 to		2013 to
Contractual Obligations	Total		Year		2012		2014		Thereafter
Operating leases	$	388	$	358	$	30	$	—	$	—
Minimum royalty commitment		700		100		200		200		200

	$	1,088	$	458	$	230	$	200	$	200

We also enter into agreements with clinical sites and contract research organizations that conduct our clinical trials. We generally make payments to these entities based upon the number of subjects enrolled and the length of their participation in the trials. To date, the majority of our clinical costs have been related to the costs of subjects entering our clinical trials as well as the manufacturing of compounds to be used in our clinical trials. Costs associated with clinical trials will continue to vary as the trials go through their natural phases of enrollment and follow-up. The costs will also be influenced by the pace of the development activities, timing of the development activities and regulatory requirements associated with the conduct of our clinical trials. At this time, due to the risks inherent in the clinical trial process and given the early stage of development of our product development programs, we are unable to estimate with any certainty the total costs we will incur in the continued development of our product candidates for potential commercialization. Due to these same factors, we are unable to determine the anticipated completion dates for our current product development programs. Clinical development timelines, probability of success and development costs vary widely. As we continue our development programs, we anticipate that we will make determinations as to how much funding to direct to each program on an ongoing basis in response to the scientific and clinical success of each product candidate, as well as an ongoing assessment of the product candidate’s commercial potential. In addition, we cannot forecast with any degree of certainty whether any of our product candidates will be subject to future partnering, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements. As a result, we cannot be certain when, or if, and to what extent we will receive cash inflows from the commercialization of our product candidates.

Fair Value Inputs

Fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or liability. See Notes 2 and 3 to the audited consolidated financial statements, which are included elsewhere in this Annual Report.

We value our marketable securities by using quoted market prices, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. The types of securities valued based on quoted market prices in active markets include money market securities. We do not adjust the quoted price for such securities. The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency

include commercial paper, municipal bonds, U.S. treasury notes, U.S. government sponsored enterprise securities and corporate debt securities. The price for each security at the measurement date is sourced from an independent pricing vendor. Periodically, management assesses the reasonableness of these sourced prices by comparing them to the prices provided by our portfolio managers to derive the fair value of these financial instruments. Historically, we have not experienced significant deviation between the prices from the independent pricing vendor and our portfolio managers. Management assesses the inputs of the pricing in order to categorize the financial instruments into the appropriate hierarchy levels. The fair value of the common stock warrants, which may potentially be settled with cash and are therefore treated as a liability, is estimated using the Black-Scholes pricing model.

Off-Balance Sheet Arrangements

As of December 31, 2009, 2008 and 2007, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships. We do not have relationships or transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term marketable securities. Due to the nature of our short-term investments, we believe that we are not subject to any material market risk exposure. We do not have any foreign currency or other derivative financial instruments.

Item 8. Financial Statements and Supplementary Data

The consolidated financial statements and related financial information required to be filed are indexed on page F-1 of this Annual Report on Form 10-K and are incorporated herein.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not Applicable.

Item 9A. Controls and Procedures

Management’s Report on Internal Control Over Financial Reporting

Evaluation of Disclosure Controls and Procedures: Our President and Chief Executive Officer and Vice President, Finance and Operations performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-l5(e) and l5d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this Annual Report. Based on that evaluation, our Chief Executive Officer and Vice President, Finance and Operations concluded that our disclosure controls and procedures were effective as of December 31, 2009 in providing them with material information related to the Company in a timely manner, as required to be disclosed in the reports the Company files under the Exchange Act.

Management’s Annual Report on Internal Control over Financial Reporting: Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f).

Under the supervision and with the participation of our management, including our President and Chief Executive Officer and Vice President, Finance and Operations, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control — Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2009.

The effectiveness of our internal control over financial reporting as of December 31, 2009 has been audited by Ernst & Young LLP, an independent registered public accounting firm.

Changes in Internal Control Over Financial Reporting: There was no significant change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of Anadys Pharmaceuticals, Inc.

We have audited Anadys Pharmaceuticals, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Anadys Pharmaceuticals, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Anadys Pharmaceuticals, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Anadys Pharmaceuticals, Inc. as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2009 of Anadys Pharmaceuticals, Inc. and our report dated March 1, 2010 expressed an unqualified opinion thereon.



	/s/ Ernst & Young LLP

San Diego, California
March 1, 2010

Item 9B. Other Information

Not applicable.

Part III

Certain information required by Part III of Form 10-K is omitted from this report because we expect to file a definitive proxy statement for our 2010 Annual Meeting of Stockholders (the Proxy Statement) within 120 days after the end of our fiscal year pursuant to Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended, and the information included in the Proxy Statement is incorporated herein by reference to the extent provided below.


Item 10.		Directors, Executive Officers and Corporate Governance

The information required by Item 10 of Form 10-K is incorporated by reference to the information under the headings “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Audit Committee” and “Shareholder Communications with the Board of Directors” in our Proxy Statement.

Certain information required by Item 10 of Form 10-K regarding our executive officers is set forth in Item 1 of Part I of this Annual Report under the caption “Executive Officers of the Registrant.”

We have adopted a Code of Business Conduct and Ethics, which applies to all our directors, officers and employees, including our President and Chief Executive Officer and Vice President, Finance and Operations and all of our finance team. The Code of Business Conduct and Ethics is posted on our website, http://www.anadyspharma.com (under the “Investors — Corporate Governance” caption). In addition, we will provide to any person without charge, upon request, addressed to the Corporate Secretary at Anadys Pharmaceuticals, Inc., 5871 Oberlin Drive, Suite 200, San Diego, CA 92121, a copy of our Code of Business Conduct and Ethics. We intend to satisfy the disclosure requirement regarding any amendment to, or waiver of, a provision of the Code of Business Conduct and Ethics for our President and Chief Executive Officer and Vice President, Finance and Operations or persons performing similar functions, by posting such information on our website.


Item 11.		Executive Compensation

The information required by Item 11 of Form 10-K is incorporated by reference to the information under the heading “Compensation of Executive Officers” and “Compensation of Directors” in our Proxy Statement.


Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The following table summarizes our outstanding securities and securities available for future issuance under our equity compensation plans as of December 31, 2009. Security holders of the Company have approved the 2002 Equity Incentive Plan, 2004 Equity Incentive Plan (2004 Plan), 2004 Non-Employee Directors’ Stock Option Plan and 2004 Employee Stock Purchase Plan.

In connection with the hiring of certain executive officers during 2006, the Compensation Committee of our Board of Directors approved inducement grants of non-qualified stock options. These option awards were granted without security holder approval pursuant to NASDAQ Marketplace Rule 4350(i)(1)(A)(iv). Although these options were granted outside the 2004 Plan, they are subject to substantially identical terms and conditions as those contained in the 2004 Plan.

(c)

Number of securities

remaining available for

(a)

(b)

future issuance under equity

Number of securities to

Weighted-average

compensation plans

be issued upon exercise

exercise price of

(excluding securities

Plan Category

of outstanding options

outstanding options

reflected in column (a))

Equity compensation plans approved by security holders

6,817,036

3.60

1,977,430

Equity compensation plans not approved by security holders

342,975

3.00

—

Total

7,160,011

1,977,430

The additional information required by Item 12 of Form 10-K related to security ownership of certain beneficial owners and management is incorporated herein by reference to the information under the heading “Security Ownership of Certain Beneficial Owners and Management” in our Proxy Statement.


Item 13.		Certain Relationships and Related Transactions, and Director Independence

The information required by Item 13 of Form 10-K related to transactions with related persons, promoters and certain control persons, if any, is incorporated herein by reference to the information under the heading “Certain Transactions” in our Proxy Statement. The information required by Item 13 of Form 10-K relating to director independence is incorporated herein by reference to the information under the heading “Election of Directors” in our Proxy Statement.


Item 14.		Principal Accounting Fees and Services

The information required by Item 14 of Form 10-K is incorporated herein by reference to the information under the heading “Ratification of Selection of Independent Registered Accounting Firm” in our Proxy Statement.

Part IV

Item 15. Exhibits and Financial Statement Schedules

(a) The following financial statements, financial statements schedules and exhibits are filed as part of this report or incorporated herein by reference:

	(1)		Financial Statements. See index to consolidated financial statements on page F-1.

	(2)		Financial Statement Schedules. All financial statements schedules for which provision is made in Regulation S-X are omitted because they are not required under the related instructions, are inapplicable, or the required information is given in the financial statements, including the notes thereto.

	(3)		Exhibits.


Exhibit
Number	Exhibit Description	Incorporated by Reference or Attached Hereto
3.1	Form of Amended and Restated Certificate of Incorporation of the Registrant	Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on May 14, 2004.

3.2	Amended and Restated Bylaws of the Registrant	Incorporated by reference to the Registrant’s Current Report on Form 8-K (SEC File No. 000-50632) filed on December 5, 2007.

4.1	Form of Specimen Common Stock Certificate	Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.

4.2	Form of Warrant	Incorporated by reference to the Registrant’s Current Report on Form 8-K (SEC File No. 000-50632) filed on June 4, 2009.

10.1#	2002 Equity Incentive Plan	Incorporated by reference to Exhibit 10.3 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on November 14, 2003.

10.2#	Form of Stock Option Agreement under 2002 Equity Incentive Plan	Incorporated by reference to Exhibit 10.4 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on November 14, 2003.

10.3#	2004 Equity Incentive Plan	Incorporated by reference to Exhibit 10.5 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.

10.4#	Form of Stock Option Agreement under 2004 Equity Incentive Plan	Incorporated by reference to Exhibit 10.6 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.

10.5#	Form of Amendment to Stock Option Agreement Under 2004 Equity Incentive Plan, applicable to Non-Employee Director grants	Incorporated by reference to Exhibit 10.5 in the Registrant’s Annual Report on Form 10-K (SEC File No. 000-50632) filed on March 3, 2009.

10.6#	2004 Employee Stock Purchase Plan	Incorporated by reference to Exhibit 10.7 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.

10.7#	Form of Offering Document under the 2004 Employee Stock Purchase Plan	Incorporated by reference to Exhibit 10.8 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.

10.8#	Form of Indemnification Agreement by and between the Registrant and each of its directors and officers	Incorporated by reference to Exhibit 10.11 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on November 14, 2003.


Exhibit
Number	Exhibit Description	Incorporated by Reference or Attached Hereto
10.9#	Form of Stock Option Agreement Under 2004 Non-Employee Directors’ Stock Option Plan	Incorporated by reference to Exhibit 10.10 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.

10.10#	Terms of Employment dated February 1, 2001 by and between the Registrant and Steve Worland, Ph.D.	Incorporated by reference to Exhibit 10.27 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on November 14, 2003.

10.11#	Terms of Employment dated October 2, 2001 by and between the Registrant and Elizabeth E. Reed	Incorporated by reference to Exhibit 10.30 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.

10.12#	Form of Inducement Stock Option Agreement	Incorporated by reference to Exhibit 10.42 in the Registrant’s Current Report on Form 8-K (SEC File No. 000-50632) filed on September 25, 2006.

10.13#	Terms of Employment dated September 11, 2006 by and between the Registrant and James T. Glover	Incorporated by reference to Exhibit 10.43 in the Registrant’s Current Report on Form 8-K (SEC File No. 000-50632) filed on September 25, 2006.

10.14#	Amended and Restated Severance and Change in Control Agreement dated March 3, 2008 by and between the Registrant and Stephen T. Worland, Ph.D.	Incorporated by reference to Exhibit 10.16 in the Registrant’s Annual Report on Form 10-K (SEC File No. 000-50632) filed on March 5, 2008.

10.15#	Amended and Restated Severance and Change in Control Agreement dated March 3, 2008 by and between the Registrant and James L. Freddo, M.D.	Incorporated by reference to Exhibit 10.18 in the Registrant’s Annual Report on Form 10-K (SEC File No. 000-50632) filed on March 5, 2008.

10.16#	Amended and Restated Severance and Change in Control Agreement dated March 3, 2008 by and between the Registrant and Elizabeth E. Reed	Incorporated by reference to Exhibit 10.19 in the Registrant’s Annual Report on Form 10-K (SEC File No. 000-50632) filed on March 5, 2008.

10.17#	Terms of Employment dated June 21, 2006 by and between the registrant and James L. Freddo, M.D.	Incorporated by reference to Exhibit 10.21 in the Registrant’s Annual Report on Form 10-K (SEC File No. 000-50632) filed on March 5, 2008.

10.18#	Terms of Employment dated March 6, 2001 by and between the Registrant and Mary-Yaroshevsky-Glanville	Incorporated by reference to Exhibit 10.22 in the Registrant’s Annual Report on Form 10-K (SEC File No. 000-50632) filed on March 5, 2008.

10.19#	Amended and Restated 2004 Non-Employee Directors’ Stock Option Plan	Incorporated by reference to Exhibit 10.24 in the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on May 1, 2008.

10.20	Sub-lease agreement dated June 18, 2009 by and between the Registrant and Phenomix Corporation	Incorporated by reference to Exhibit 10.24 in the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on July 31, 2009.

10.21#	Severance Agreement and General Release dated June 30, 2009 by and between the Registrant and James T. Glover	Incorporated by reference to Exhibit 10.25 in the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on July 31, 2009.

10.22#	Terms of Employment dated July 1, 2009 for Peter T. Slover	Incorporated by reference to Exhibit 10.26 in the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on July 31, 2009.

10.23#	Severance and Change in Control Agreement dated July 1, 2009 by and between the Registrant and Peter T. Slover	Incorporated by reference to Exhibit 10.27 in the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on July 31, 2009.

10.24#	Severance Agreement and General Release dated September 30, 2009 by and between the Registrant and Mary Yaroshevsky-Glanville	Incorporated by reference to Exhibit 10.28 in the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on October 30, 2009.


Exhibit
Number	Exhibit Description	Incorporated by Reference or Attached Hereto
10.25#	Anadys Pharmaceuticals, Inc. Executive Officer Bonus Plan	Incorporated by reference to Exhibit 10.29 in the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on October 30, 2009.

21.1	List of Subsidiaries of the Registrant	Incorporated by reference to Exhibit 21.1 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on November 14, 2003.

23.1	Consent of Independent Registered Public Accounting Firm	Attached Hereto.

31.1	Certification of President and Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Act of 1934, as amended	Attached Hereto.

31.2	Certification of Vice President, Finance and Operations pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Act of 1934, as amended	Attached Hereto.

32.1	Certifications of President and Chief Executive Officer and Vice President, Finance and Operations pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Attached Hereto.


#		Indicates management contract or compensatory plan.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Diego, State of California, on the 1^st day of March, 2010.


	ANADYS PHARMACEUTICALS, INC.
	By:	/s/ STEPHEN T. WORLAND, PH.D.
		Stephen T. Worland, Ph.D.
		President and Chief Executive Officer

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Stephen T. Worland, Ph.D. and Peter T. Slover, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and any other documents in connection therewith, and to file the same, with all exhibits thereto, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them or their or his substitute or substituted, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Act of 1934, as amended, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.


Signature	Title	Date

/s/ STEPHEN T. WORLAND, PH.D.	President, Chief Executive Officer and Director	March 1, 2010
Stephen T. Worland, Ph.D.	(Principal Executive Officer)

/s/ PETER T. SLOVER	Vice President, Finance and Operations	March 1, 2010
Peter T. Slover	(Principal Financial and Accounting Officer)

/s/ GEORGE A. SCANGOS, PH.D.	Chairman of the Board	March 1, 2010
George A. Scangos, Ph.D.

/s/ MARK G. FOLETTA	Director	March 1, 2010
Mark G. Foletta

/s/ MARIOS FOTIADIS	Director	March 1, 2010
Marios Fotiadis

/s/ STEVEN H. HOLTZMAN	Director	March 1, 2010
Steven H. Holtzman

/s/ STELIOS PAPADOPOULOS, PH.D.	Director	March 1, 2010
Stelios Papadopoulos, Ph.D.

/s/ KLEANTHIS G. XANTHOPOULOS, PH.D.	Director	March 1, 2010
Kleanthis G. Xanthopoulos, Ph.D.

ANADYS PHARMACEUTICALS, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


		Page
Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets as of December 31, 2009 and 2008		F-3
Consolidated Statements of Operations for each of the years ended December 31, 2009, 2008 and 2007		F-4
Consolidated Statements of Stockholders’ Equity for each of the years ended December 31, 2009, 2008 and 2007		F-5
Consolidated Statements of Cash Flows for each of the years ended December 31, 2009, 2008 and 2007		F-6
Notes to Consolidated Financial Statements		F-7

F-1

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of Anadys Pharmaceuticals, Inc.

We have audited the accompanying consolidated balance sheets of Anadys Pharmaceuticals, Inc. as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Anadys Pharmaceuticals, Inc. at December 31, 2009 and 2008, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Anadys Pharmaceuticals, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2010 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

San Diego, California
March 1, 2010

F-2

ANADYS PHARMACEUTICALS, INC.

CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)


	December 31,			December 31,
	2009			2008
Assets
Current assets:

Cash and cash equivalents	$	4,497		$	10,476
Securities available-for-sale		15,993			17,460
Prepaid expenses and other current assets		559			2,202

Total current assets		21,049			30,138

Property and equipment, net		626			1,476
Other assets		60			60


Total assets	$	21,735		$	31,674


Liabilities and Stockholders’ Equity
Current liabilities:

Accounts payable	$	740		$	558
Accrued expenses		2,643			4,823
Common stock warrant liability		3,897			—
Current portion of deferred rent		—			348
Other current liabilities		—			84

Total current liabilities		7,280			5,813

Other long-term liabilities		26			36

Commitments and contingencies

Stockholders’ equity:

Preferred stock, $0.001 par value; 10,000,000 shares authorized at December 31, 2009 and December 31, 2008; no shares issued and outstanding at December 31, 2009 and December 31, 2008		—			—
Common stock, $0.001 par value; 90,000,000 shares authorized at December 31, 2009 and December 31, 2008; 37,341,957 and 28,816,763 shares issued and outstanding at December 31, 2009 and December 31, 2008, respectively		37			29
Additional paid-in capital		297,687			282,297
Accumulated other comprehensive gain (loss)		37			(447	)
Accumulated deficit		(283,332	)		(256,054	)

Total stockholders’ equity		14,429			25,825


Total liabilities and stockholders’ equity	$	21,735		$	31,674

See accompanying notes to consolidated financial statements.

F-3

ANADYS PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except net loss per share)


	For the Years Ended December 31,
	2009			2008			2007
Revenues:

Collaborative agreements	$	—		$	—		$	24,118

Total revenues		—			—			24,118

Operating Expenses:

Research and development		19,494			25,993			28,192
General and administrative		8,243			8,109			8,692


Total operating expenses		27,737			34,102			36,884


Loss from operations		(27,737	)		(34,102	)		(12,766	)

Other income (expense):

Interest income		478			1,482			3,611
Loss from valuation of common stock warrant liability		(151	)		—			—
Other, net		132			218			(17	)


Total other income (expense), net		459			1,700			3,594


Net loss	$	(27,278	)	$	(32,402	)	$	(9,172	)


Net loss per share, basic and diluted	$	(0.81	)	$	(1.13	)	$	(0.32	)


Shares used in calculating net loss per share, basic and diluted		33,775			28,750			28,646

See accompanying notes to consolidated financial statements.

F-4

ANADYS PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share data)


												Accumulated
												other
									Additional			comprehensive						Total
	Preferred stock				Common stock				paid-in			gain			Accumulated			stockholders’
	Shares		Amount		Shares		Amount		capital			(loss)			deficit			equity
Balance at December 31, 2006		—	$	—		28,596,198	$	29	$	274,798		$	(22	)	$	(214,480	)	$	60,325
Issuance of common stock pursuant to the exercise of stock options and warrants		—		—		30,192		—		89			—			—			89
Issuance of common stock pursuant to the employee stock purchase plan		—		—		70,558		—		168			—			—			168
Compensation related to stock options and warrants issued to non-employees		—		—		—		—		101			—			—			101
Share-based compensation expense including forfeitures		—		—		—		—		4,065			—			—			4,065
Comprehensive loss:
Unrealized gain on short-term investments		—		—		—		—		—			103			—			103
Net loss		—		—		—		—		—			—			(9,172	)		(9,172	)

Comprehensive loss		—		—		—		—		—			—			—			(9,069	)

Balance at December 31, 2007		—	$	—		28,696,948	$	29	$	279,221		$	81		$	(223,652	)	$	55,679
Issuance of common stock pursuant to the exercise of stock options and warrants		—		—		36,567		—		106			—			—			106
Issuance of common stock pursuant to the employee stock purchase plan		—		—		83,248		—		153			—			—			153
Compensation related to stock options and warrants issued to non-employees		—		—		—		—		66			—			—			66
Share-based compensation expense including forfeitures		—		—		—		—		2,751			—			—			2,751
Comprehensive loss:
Unrealized loss on short-term investments		—		—		—		—		—			(528	)		—			(528	)
Net loss		—		—		—		—		—			—			(32,402	)		(32,402	)

Comprehensive loss		—		—		—		—		—			—			—			(32,930	)

Balance at December 31, 2008		—	$	—		28,816,763	$	29	$	282,297		$	(447	)	$	(256,054	)	$	25,825
Issuance of common stock pursuant to the exercise of stock options		—		—		84,465		—		232			—			—			232
Issuance of common stock pursuant to the employee stock purchase plan		—		—		82,729		—		153			—			—			153
Issuance of common stock associated with equity financing, net of issuance costs		—		—		8,358,000		8		16,007			—			—			16,015
Fair value of common stock warrants issued in connection with equity financing		—		—		—		—		(3,746	)		—			—			(3,746	)
Compensation related to stock options and warrants issued to non-employees		—		—		—		—		125			—			—			125
Share-based compensation expense including forfeitures		—		—		—		—		2,619			—			—			2,619
Comprehensive loss:
Unrealized gain on short-term investments		—		—		—		—		—			484			—			484
Net loss		—		—		—		—		—			—			(27,278	)		(27,278	)

Comprehensive loss		—		—		—		—		—			—			—			(26,794	)

Balance at December 31, 2009		—	$	—		37,341,957	$	37	$	297,687		$	37		$	(283,332	)	$	14,429

See accompanying notes to consolidated financial statements.

F-5

ANADYS PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)


	For the years ended December 31,
	2009			2008			2007
Cash Flows from Operating Activities:
Net loss	$	(27,278	)	$	(32,402	)	$	(9,172	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		853			1,141			1,431
Share-based compensation		2,619			2,751			4,065
Amortization of premium/discount on securities available-for-sale		155			157			—
(Gain) loss on the sale of available-for-sale securities		(31	)		24			—
Compensation related to stock option issuances to non-employees		96			16			52
Loss on valuation of common stock warrant liability		151			—			—
Rent expense related to warrants issued in connection with operating lease of the Company’s former facility		29			50			49
(Gain) loss from disposal of property and equipment		(26	)		(149	)		27
Changes in operating assets and liabilities:
Accounts receivable		—			—			1,175
Prepaid expenses and other current assets		1,643			(1,198	)		(63	)
Other assets		—			1,320			7
Accounts payable		182			(526	)		290
Accrued expenses		(2,180	)		1,057			449
Deferred rent		(348	)		(584	)		(466	)
Deferred revenue		—			—			(23,567	)
Other liabilities		(94	)		55			65


Net cash used in operating activities		(24,229	)		(28,288	)		(25,658	)

Cash Flows from Investing Activities:
Purchase of securities available-for-sale		(24,657	)		(8,806	)		(15,131	)
Proceeds from sale and maturity of securities available-for-sale		26,484			12,463			13,170
Purchase of property and equipment		(88	)		(213	)		(356	)
Proceeds from the sale of property and equipment		111			392			—


Net cash provided by (used in) investing activities		1,850			3,836			(2,317	)

Cash Flows from Financing Activities:
Proceeds from exercise of stock options and employee stock purchase plan		385			259			257
Proceeds from equity financing, net of issuance costs		16,015			—			—


Net cash provided by financing activities		16,400			259			257

Net decrease in cash and cash equivalents		(5,979	)		(24,193	)		(27,718	)
Cash and cash equivalents at beginning of year		10,476			34,669			62,387


Cash and cash equivalents at end of year	$	4,497		$	10,476		$	34,669


Supplemental Disclosure of Non-Cash Investing and Financing Activities:
Fair value of common stock warrant liability	$	3,746		$	—		$	—

Unrealized gain (loss) on securities available-for-sale	$	484		$	(528	)	$	103

See accompanying notes to consolidated financial statements.

F-6

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Summary of Significant Accounting Policies

Organization and Business

Anadys Pharmaceuticals, Inc. (Anadys or the Company) is a biopharmaceutical company dedicated to improving patient care by developing novel medicines for the treatment of hepatitis C. The Company believes hepatitis C represents a large and significant unmet medical need. The Company’s objective is to contribute to an improved treatment outcome for patients with this serious disease.

The Company is currently focusing its efforts on the development of ANA598, a small-molecule, non-nucleoside inhibitor of the NS5B polymerase for the treatment of hepatitis C. The Company has also investigated ANA773, an oral, small-molecule inducer of endogenous interferons that acts via the Toll-like receptor 7, or TLR7, pathway in a Phase I trial in hepatitis C and in a separate Phase I trial for treatment of patients with advanced cancer.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Anadys Pharmaceuticals Europe GmbH and Anadys Development Limited. All significant intercompany accounts and transactions have been eliminated. In 2003, the Company discontinued its Anadys Pharmaceuticals Europe GmbH operations and intends to dissolve that entity. Anadys Development Limited was established in 2005 to serve as a legal representative of the Company for conducting clinical trials in Europe. As of and for the year ended December 31, 2009, neither Anadys Pharmaceuticals Europe GmbH nor Anadys Development Limited had active operations.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual amounts could differ from those estimates.

Cash and Cash Equivalents

Cash and cash equivalents are comprised of highly liquid investments with an original maturity of less than three months when purchased and are readily convertible without prior notice or penalty to known amounts of cash.

Securities Available-for-Sale

Investments with an original maturity of more than three months when purchased have been classified by management as securities available-for-sale. Such investments are carried at fair value, with unrealized gains and losses included as a component of accumulated other comprehensive gain (loss) in stockholders’ equity. Realized gains and losses and declines in value judged to be other-than-temporary (of which there have been none to date) on available-for-sale securities are included in interest income. The cost of securities sold is based on the specific-identification method. The Company views its available-for-sale securities as available for use in current operations. Accordingly, the Company has classified all investments as short-term, even though the stated maturity date may be one year or more beyond the current balance sheet date.

Fair Value of Financial Instruments

The carrying amount of cash, cash equivalents, securities available-for-sale, accounts payable and accrued expenses are considered to be representative of their respective fair value because of the short-term nature of those items.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to a significant concentration of credit risk consist primarily of cash, cash equivalents and securities available-for-sale. The Company maintains deposits in federally insured financial institutions in excess of federally insured limits. Management, however, believes the Company is not exposed to significant credit risk due to the financial position of the depository institutions in which those deposits are held. Additionally, the Company has established guidelines regarding diversification of its investments and their maturities, which are designed to maintain safety and liquidity.

F-7

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

During 2007, the Company derived a majority of its revenues from a License and Co-Development Agreement with Novartis International Pharmaceutical Ltd. (Novartis) which was terminated during 2007.

Property and Equipment

Property and equipment are stated at cost and depreciated over the estimated useful lives of the assets (ranging from three to five years) using the straight-line method. Leasehold improvements are amortized over the estimated useful life of the asset or the lease term, whichever is shorter.

Impairment of Long-Lived Assets

If indicators of impairment exist, the Company assesses the recoverability of the affected long-lived assets by determining whether the carrying value of such assets can be recovered through undiscounted future operating cash flows. If impairment is indicated, the Company measures the amount of such impairment by comparing the fair value of the asset to the carrying value of the asset and records the impairment as a reduction in the carrying value of the related asset and a charge to operating results. The Company has not recognized any impairment loss for the period ended December 31, 2009.

Research and Development

During 2009 and 2008, research and development expenses consisted primarily of costs associated with clinical development of the Company’s product candidates. During 2007, research and development expenses consisted primarily of costs associated with the discovery, preclinical and clinical development of the Company’s product candidates. Research and development expenses may include external costs such as fees paid to clinical research organizations, clinical trial investigators, contract research organizations, drug substance and drug product manufacturers and consultants. Research and development expenses may also include internal costs such as compensation, supplies, materials, an allocated portion of facilities costs, an allocated portion of information systems support personnel and depreciation.

Under the Company’s former License and Co-Development Agreement with Novartis, which was terminated during 2007, reimbursements of development costs for ANA975 from Novartis were recorded as an offset to research and development expense.

Accumulated Other Comprehensive Gain (Loss)

All components of comprehensive gain (loss), including net income (loss), are reported in the financial statements in the period in which they are recognized. Comprehensive income (loss) is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. Net income (loss) and other comprehensive income (loss), including unrealized gains and losses on investments and foreign currency translation adjustments, are reported, net of their related tax effect, to arrive at comprehensive income (loss).

Deferred Rent

Rent expense is recorded on a straight-line basis over the term of the lease. The difference between rent expense recorded and amounts paid under the lease agreement is recorded as deferred rent in the accompanying consolidated balance sheet. During 2004, the Company entered into a sub-lease agreement to lease the Company’s former corporate headquarters and research and development facility located in San Diego, California. This lease expired on August 1, 2009. In accordance with the sub-lease agreement, the Company was allocated a $1.6 million tenant improvement allowance as an incentive to move into the facility. The Company recorded this incentive as an increase to both property and equipment and deferred rent and these amounts were being amortized on a straight-line basis over the life of the lease of 62 months. As of December 31, 2008, the Company had $0.2 million of unamortized deferred rent associated with the lease incentive. As of December 31, 2009 there was no unamortized deferred rent associated with the lease incentive. On June 18, 2009, the Company entered into a new sublease agreement to lease its current corporate headquarters and research and development facility located in San Diego, California. There is no deferred rent associated with this lease.

Share-Based Compensation

Share-based compensation expense for options granted to employees and non-employee directors is estimated at the grant date based on the award’s fair value as calculated using a Black-Scholes pricing model and the portion that is ultimately expected to vest is recognized as expense on a straight-line basis over the requisite service period. The Company accounts for compensation expense for options granted to non-employees based on the fair value of the options issued using the Black-Scholes pricing model and is periodically re-measured as the underlying options vest. The Company records share-based compensation as components of either research and development expense or general and administrative expense.

F-8

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Net Loss Per Share

Basic loss per share (EPS) is calculated by dividing the net loss by the weighted-average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted EPS is computed by dividing the net loss by the weighted-average number of common stock equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, common stock subject to repurchase by the Company, preferred stock, options and warrants are considered to be common stock equivalents and are only included in the calculation of diluted earnings per share when their effect is dilutive.

Common stock equivalents from stock options and warrants of approximately 10.1 million, 6.6 million and 5.6 million were excluded from the calculation of net loss per share for the years ended December 31, 2009, 2008 and 2007, respectively, because the effect would be antidilutive.

Subsequent Events

The Company evaluated all events or transactions that occurred after the balance sheet date of December 31, 2009 through the date it issued these financial statements. No subsequent events were identified requiring additional disclosure in the notes to these financial statements.

Adoption of Recent Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (FASB) created the Accounting Standards Codification (ASC), which is codified as ASC 105. Effective September 15, 2009, the Company adopted the provisions of ASC 105. The ASC was established as the single source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in preparation of financial statements in conformity with U.S. GAAP. The adoption of ASC 105 did not have a material impact on the Company’s consolidated financial statements.

Effective June 15, 2009, the Company adopted the provisions of ASC 855, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. The adoption of ASC 855 did not have a material impact on the Company’s consolidated financial statements.

Effective June 15, 2009, the Company adopted the provisions of ASC 825, which extends the disclosure requirements regarding the fair value of financial instruments to interim financial statements of publicly traded companies. The adoption of ASC 825 did not have a material effect on the Company’s consolidated financial statements.

Effective June 15, 2009, the Company adopted the provisions of ASC 320, which extends the disclosure requirements regarding debt and equity securities to interim financial statements of publicly traded companies as well as provides new disclosure requirements. The adoption of ASC 320 did not have a material effect on the Company’s consolidated financial statements.

In December 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force (EITF) on ASC 808. ASC 808 requires collaborators to present the results of activities for which they act as the principal on a gross basis and report any payments received from (made to) other collaborators based on other applicable U.S. GAAP or, in the absence of other applicable U.S. GAAP, based on analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election. Further, ASC 808 clarified that the determination of whether transactions within a collaborative arrangement are part of a vendor-customer (or analogous) relationship subject to ASC 605. ASC 808 was effective for us beginning on January 1, 2009. The adoption of ASC 808 did not have a material effect on the Company’s consolidated financial statements.

F-9

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. Securities Available-for-Sale

Securities available-for-sale consisted of the following as of December 31, 2009 and 2008, respectively (in thousands):


	December 31, 2009
	Amortized		Unrealized					Market
	Cost		Gain		Loss			Value
Commercial paper	$	2,199	$	—	$	—		$	2,199
Municipal bonds		1,026		—		—			1,026
U.S. treasury notes		2,048		—		(1	)		2,047
U.S. government sponsored enterprise securities		9,127		8		(5	)		9,130
Corporate debt securities		1,556		35		—			1,591

	$	15,956	$	43	$	(6	)	$	15,993


	December 31, 2008
	Amortized		Unrealized					Market
	Cost		Gain		Loss			Value
U.S. Government sponsored enterprise securities	$	6,604	$	72	$	—		$	6,676
Corporate debt securities		11,304		64		(584	)		10,784

	$	17,908	$	136	$	(584	)	$	17,460

The amortized cost and estimated fair value of the Company securities available-for-sale by contractual maturity as of December 31, 2009 and 2008 are shown below (in thousands):


	December 31, 2009
	Amortized		Unrealized					Market
	Cost		Gain		Loss			Value
Within one year	$	15,956	$	43	$	(6	)	$	15,993
After one year		—		—		—			—

	$	15,956	$	43	$	(6	)	$	15,993


	December 31, 2008
	Amortized		Unrealized					Market
	Cost		Gain		Loss			Value
Within one year	$	15,641	$	106	$	(580	)	$	15,167
After one year through two years		2,267		30		(4	)		2,293

	$	17,908	$	136	$	(584	)	$	17,460

Included in the Company’s securities portfolio as of December 31, 2008 was an American General Finance Corporation, a subsidiary of American International Group, Inc. (AIG), corporate bond which had an unrealized loss position of $0.6 million. This security matured on August 15, 2009 at par value.

As of December 31, 2009, the Company performed a review of all of the securities in its portfolio with an unrealized loss position to determine if any other-than-temporary impairments were required to be recorded. Factors considered in the Company’s assessment included, but were not limited to the following: the Company’s ability and intent to hold the security until maturity; the number of months until the security’s maturity, the number of quarters that each security has been in an unrealized loss position, ratings assigned to each security by independent rating agencies, the magnitude of the unrealized loss compared to the face value of the security and other market conditions. No other-than-temporary impairments were identified as of December 31, 2009 related to securities currently in the Company’s portfolio. The Company also noted that none of the securities as of December 31, 2009 have been in an unrealized loss position for greater than one year.

3. Fair Value Measurements

As of December 31, 2009, the Company has $20.1 million of marketable securities consisting of money market funds, commercial paper, municipal bonds, U.S. treasury notes, U.S. government sponsored enterprise securities and corporate debt securities with maturities that range from one day to 12 months with an overall average time to maturity of 5.1 months. The Company has the ability to liquidate these investments without restriction or penalty.

F-10

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions. These inputs are classified into the following hierarchy:

Level 1 Inputs — Quoted prices for identical instruments in active markets.

Level 2 Inputs — Quoted prices for similar instruments in active markets; and quoted prices for identical or similar instruments in markets that are not active.

Level 3 Inputs — Unobservable inputs based on the Company’s assessment that market participants would use in pricing the instruments.

The Company determines fair value for marketable securities with Level 1 inputs through quoted market prices. The Company determines fair value for marketable securities with Level 2 inputs through broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. The Company determines fair value for the common stock warrants with Level 3 inputs through a Black-Scholes pricing model.

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2009 (in thousands):


			Fair Value Measurements at Reporting Date Using
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	December 31,		Assets		Inputs		Inputs
	2009		(Level 1)		(Level 2)		(Level 3)
Description
Assets:
Money market funds	$	2,101	$	2,101	$	—	$	—
Commercial paper		3,199		—		3,199		—
Municipal bonds		1,026		—		1,026		—
U.S. treasury notes		2,047		—		2,047		—
U.S. government sponsored enterprise securities		9,130		—		9,130		—
Corporate debt securities		2,599		—		2,599		—

Total financial assets	$	20,102	$	2,101	$	18,001	$	—


Liabilities:
Common stock warrants	$	3,897	$	—	$	—	$	3,897

Total financial liabilities	$	3,897	$	—	$	—	$	3,897

As of December 31, 2009, the Company has a $3.9 million common stock warrant liability. This liability is associated with warrants to purchase 2.9 million shares of common stock, issued in connection with the Company’s common stock offering, which closed in June 2009. See additional information related to the forms of these warrants at Note 5.

The Company initially assessed the fair value of the warrants on June 3, 2009, the date of their issuance, at $3.7 million. The Company reassesses the fair value of the warrants at each reporting date utilizing a Black-Scholes pricing model. As of June 3, 2009, inputs used in the Black Scholes pricing model included a dividend yield of 0%, expected volatility of 88.79%, risk-free interest rate of 2.54% and expected life of approximately five years. As of December 31, 2009, inputs used in the Black-Scholes pricing model included a dividend yield of 0%, expected volatility of 93.82%, risk-free interest rate of 2.69% and expected life of approximately 4.4 years. As a result of this calculation, the Company recorded a loss of $0.2 million for the year ended December 31, 2009. The loss is reflected in the Company’s consolidated statement of operations as a component of other income (expense), net.

F-11

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table is a roll forward of the fair value of the common stock warrants, as to which fair value is determined by Level 3 inputs (in thousands):


	As of December 31,
	2009
Description
Beginning balance	$	—
Purchases, issuances, and settlements		3,746
Realized loss included in net loss		151

Ending balance	$	3,897

4. Property and Equipment

Property and equipment consist of the following (in thousands):


	As of December 31,
	2009			2008
Furniture and fixtures	$	41		$	69
Equipment		3,914			5,412
Computers and software		1,399			1,798
Leasehold improvements		30			1,833

		5,384			9,112
Less accumulated depreciation and amortization		(4,758	)		(7,636	)

	$	626		$	1,476

Depreciation and amortization expense relating to property and equipment for the years ended December 31, 2009, 2008 and 2007 was $0.9 million, $1.1 million and $1.4 million, respectively.

5. Equity Financing

On June 3, 2009, the Company sold 8.4 million shares of common stock and warrants to purchase 2.9 million shares of common stock to institutional investors for gross proceeds of approximately $17.5 million. The shares of common stock and the warrants were sold in units, with each unit consisting of one share of common stock and a warrant to purchase 0.35 of a share of common stock, at a purchase price of $2.09375 per unit. Each warrant has an exercise price of $2.75 per share, is exercisable 6 months after issuance and will expire five years from the date of issuance. The Company agreed to pay the Placement Agent, Cowen & Company, LLC, a fee equal to 6% of the gross proceeds from the offering of common stock and common stock warrants in the offering, and to reimburse it for legal and other expenses, not to exceed $100,000. The net proceeds related to this transaction were approximately $16.0 million.

The warrants included in this transaction contain a “fundamental change” provision, which may in certain circumstances allow the common stock warrants to be redeemed for cash at an amount equal to the Black-Scholes Value, as defined in the warrants. In addition, the warrants include a “failure to timely deliver shares” provision, which may require the Company to pay cash to the warrant holder in certain circumstances as defined in the warrants. Accordingly, the common stock warrants are recorded as a liability and then marked to market each period through earnings in other income (expense). See a discussion on the fair value of the common stock warrants at Note 3.

6. Restructuring

On June 3, 2009, the Company initiated a strategic restructuring to focus its operations on the development of ANA598, in particular a Phase II study of ANA598 in combination with interferon and ribavirin. The strategic restructuring resulted in a reduction in the Company’s workforce of approximately 40%, with most of the employees having departed by the end of June 2009 and several others departing at later dates prior to the end of 2009. The Company incurred a cash charge of $1.3 million for the year ended December 31, 2009, which is included in operating expenses, for cash severance, benefits and outplacement services in connection with the workforce reduction. In addition, the Company incurred a noncash charge of $0.4 million associated with the modification of stock options for individuals included in the strategic restructuring.

F-12

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following is a rollforward of the Company’s restructuring liability (in thousands):


	As of December 31,
	2009
Description
Beginning balance	$	—
Additions		1,283
Severance payments		(1,231	)

Ending balance	$	52

The Company expects that the restructuring liability of $0.1 million at December 31, 2009 to be utilized during 2010.

7. Other Balance Sheet Captions


	As of December 31,
	2009		2008
Prepaid expenses and other current assets consist of the following (in thousands):
Tenant deposit on former facility	$	—	$	1,260
Prepaid insurance		208		193
Interest receivable		138		278
Other prepaid expenses		213		471

	$	559	$	2,202

The tenant deposit on the Company’s former facility was collected in September 2009.


	As of December 31,
	2009		2008
Other assets consist of the following (in thousands):
Note receivable	$	30	$	60
Tenant deposit on current facility		30		—

	$	60	$	60


	As of December 31,
	2009		2008
Accrued expenses consist of the following (in thousands):
Accrued personnel costs	$	320	$	344
Accrued employee bonus		988		1,347
Accrued drug development		508		2,110
Accrued legal and patent costs		243		198
Accrued facility costs		20		124
Accrued severance costs		52		—
Other accrued expenses		512		700

	$	2,643	$	4,823

8. Commitments and Contingencies

On June 18, 2009, the Company entered into a Sublease Agreement with Phenomix Corporation for the lease of approximately 14,000 square feet of office and laboratory space in which the Company is conducting its ongoing operations. Each month during the approximate 19.5 month term of the lease which commenced on July 9, 2009, the Company is required to remit base rent of $0.03 million. The lease also provides for additional payments, including a $0.03 million security deposit, common area maintenance charges, taxes, maintenance and utilities. This leased space, located in San Diego, California, replaced the Company’s former headquarters and research and development facility in which the Company occupied approximately 40,000 square feet under a lease that expired on August 1, 2009. Gross rent expense for the years ended December 31, 2009, 2008 and 2007 was approximately $1.4 million, $2.1 million and $2.0 million, respectively.

Future minimum lease payments under equipment and facility leases are as follows as of December 31, 2009 (in thousands):


2010	$	358
2011		30

	$	388

F-13

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. Collaboration and License Agreements

Novartis International Pharmaceutical Ltd.

During 2007, the Company and Novartis decided to discontinue the development of ANA975. As a result, during 2007 the Company recognized $21.0 million of previously deferred revenue. No revenue was recognized under the Novartis collaboration in 2008 or 2009.

During the years ended December 31, 2008, and 2007, the Company recorded $0.05 million and $0.5 million as offsets to research and development expense, which represent Novartis’ share of ANA975 expenses incurred by the Company. The Company did not record an offset to research and development expense during the year ended December 31, 2009.

10. Stockholders’ Equity

Warrants

As of December 31, 2009, the Company had outstanding warrants to purchase 2.9 million shares of common stock with an average exercise price of $2.78. These warrants expire at various times between December 17, 2012 and June 3, 2014. See additional information related to the warrants at Note 5.

Stock Options

In 2002, the Company adopted the 2002 Equity Incentive Plan (the 2002 Plan). In connection with the adoption of the 2002 Plan, the Company’s 1994 Stock Option Plan and 1998 Equity Incentive Plan (collectively, the “Prior Plans”) were amended and restated into the 2002 Plan. All options that were previously granted under the Prior Plans became governed by the 2002 Plan and the Prior Plans no longer existed as individual plans. The 2002 Plan provided for the issuance of incentive stock options to officers and other employees of the Company and non-qualified stock options, awards of stock and direct stock purchase opportunities to directors, officers, employees and consultants of the Company.

During March 2004 upon the effectiveness of the Company’s initial public offering (IPO), the 2004 Equity Incentive Plan (the 2004 Plan) was adopted. The initial share reserve under the 2004 Plan was equal to the number of shares of common stock reserved under the 2002 Plan that remained available for future stock awards upon the effectiveness of the IPO. Options granted under the 2002 Plan continue to be governed by the provisions of the 2002 Plan. On October 30, 2009, the Company registered an additional 1,000,000 shares for issuance under the 2004 Plan in accordance with the provisions of the 2004 Plan. The total number of shares which remain available for grant under the 2004 Plan is 609,295 shares at December 31, 2009. The options are exercisable at various dates and will expire no more than ten years from their date of grant, or in the case of certain non-qualified options, ten years from the date of grant. The exercise price of each option shall be determined by the Board of Directors although generally options have an exercise price equal to the fair market value of the Company’s stock on the date of the option grant. In the case of incentive stock options, the exercise price shall not be less than 100% of the fair market value of the Company’s common stock at the time the option is granted. For holders of more than 10% of the Company’s total combined voting power of all classes of stock, incentive stock options may not be granted at less than 110% of the fair market value of the Company’s common stock at the date of grant and for a term not to exceed five years.

Upon the effectiveness of the initial public offering, the 2004 Non-Employee Directors’ Stock Option Plan (the NEDSOP Plan) was adopted. On October 30, 2009, the Company registered an additional 186,549 shares for issuance under the NEDSOP Plan in accordance with the provisions of the NEDSOP Plan. The total number of shares which remain available for grant under the NEDSOP Plan is 325,512 shares at December 31, 2009. The options are exercisable at various dates and will expire no more than ten years from their date of grant. The exercise price of each option shall be determined by the Board of Directors although generally options have an exercise price equal to the fair market value of the Company’s stock on the date of the option grant.

In connection with the hiring of certain executive officers during 2006, the Compensation Committee of the Company’s Board of Directors approved inducement grants of non-qualified stock options to purchase shares of Anadys’ Common Stock. The total number of shares which remain outstanding under the inducement grants is 342,975 shares at December 31, 2009. These option awards were granted without stockholder approval pursuant to NASDAQ Marketplace Rule 4350(i)(1)(A)(iv). Although these options were granted outside the 2004 Plan, they are subject to substantially identical terms and conditions as those contained in the 2004 Plan.

F-14

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes information about stock options outstanding under the 2002 Plan, 2004 Plan, the NEDSOP Plan and inducement grants as of December 31, 2009:


Options Outstanding								Options Exercisable
				Weighted		Weighted				Weighted
Range of				Average		Average				Average
Exercise		Number		Remaining		Exercise		Number		Exercise
Price		Outstanding		Contractual Life		Price		Exercisable		Price
$	1.48-$2.24		1,826,018		8.24	$	2.00		561,712	$	1.93
$	2.25-$2.42		1,814,223		8.09	$	2.36		757,453	$	2.30
$	2.68-$3.00		1,508,828		4.13	$	2.92		1,401,613	$	2.93
$	3.46-$8.16		1,797,514		5.26	$	5.98		1,678,639	$	6.09
$	8.37-$15.61		213,428		4.70	$	11.48		211,868	$	11.45

			7,160,011						4,611,285

A summary of the Company’s stock option activity and related information is as follows:


				Weighted		Weighted-Average		Aggregate Intrinsic
	Options			Average		Remaining		Value
	Outstanding			Exercise Price		Contractual Term		(in thousands)
Balance at December 31, 2006		5,047,180		$	5.77
Granted		2,005,875			2.59
Exercised		(30,192	)		2.95
Cancelled		(1,475,036	)		6.52

Balance at December 31, 2007		5,547,827		$	4.44
Granted		1,508,493			2.07
Exercised		(36,567	)		2.90
Cancelled		(474,387	)		5.47

Balance at December 31, 2008		6,545,366		$	3.83
Granted		1,359,736			2.34
Exercised		(84,465	)		2.74
Cancelled		(660,626	)		4.34

Balance at December 31, 2009		7,160,011		$	3.57		6.48	$	364

Exercisable at December 31, 2009		4,611,285		$	4.25		5.06	$	144

The total intrinsic value of options exercised during the year ended December 31, 2009 was $0.2 million determined as of the date of exercise. There was no material intrinsic value for options exercised during the year ended December 31, 2008. The total intrinsic value of options exercised during the year ended December 31, 2007 was $0.05 million determined as of the date of exercise. The Company settles employee stock option exercises with newly issued common shares.

The Company granted 15,000 stock options to non-employees for the year ended December 31, 2009. The Company did not grant any stock options to non-employees for the years ended December 31, 2008 and 2007. Compensation expense related to non-employee stock option grants was $0.1 million, $0.01 million and $0.05 million for the years ended December 31, 2009, 2008 and 2007, respectively.

Share-Based Compensation

The Company is required to record share-based compensation as components of either research and development expense or general and administrative expense. The Company has reported the following amounts of share-based compensation expense in the consolidated Statements of Operations (in thousands, except per share data):


	For the years ended December 31,
	2009		2008		2007
Research and development expense	$	1,354	$	1,271	$	2,463
General and administrative expense		1,361		1,492		1,650

Total share-based compensation expense	$	2,715	$	2,763	$	4,113


Net share-based compensation expense, per common share basic and diluted	$	0.08	$	0.10	$	0.14

F-15

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Included in the research and development expense and general and administrative expense for the year ended December 31, 2009 is $0.3 million and $0.1 million, respectively, of share-based compensation expense related to the modification of stock options for employees included in the June 2009 reduction in workforce.

As of December 31, 2009, there was an additional $3.1 million of total unrecognized compensation cost related to unvested share-based awards granted under the Company’s stock option plans. This unrecognized compensation cost is expected to be recognized over a weighted-average period of 2.54 years.

The fair value of options granted to employees and directors was estimated at the date of grant using a Black-Scholes pricing model with the weighted-average assumptions stated below.


	For the years ended December 31,
	2009			2008			2007
Risk-free interest rate		2.20	%		2.45	%		4.20	%
Dividend yield		0	%		0	%		0	%
Volatility factors of the expected market price of the Company’s common stock		80	%		71	%		70	%
Weighted-average expected life of option (years)		5.94			5.76			5.60

The estimated weighted-average fair value of stock options granted during 2009, 2008 and 2007 was $1.62, $1.31 and $1.67, respectively.

Dividend Yield—The Company has never declared or paid dividends on common stock and has no plans to do so in the foreseeable future.

Expected Volatility—Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated or is expected to fluctuate during a period. The Company considered the historical volatility from its IPO through the dates of grants, in combination with the historical volatility of peer companies and business and economic considerations in order to estimate the expected volatility, due to the Company’s short history as a public company.

Risk-Free Interest Rate—This is the U.S. Treasury rate for the week of each option grant during the quarter having a term that most closely resembles the expected life of the option.

Expected Life of the Option Term—This is the period of time that the options granted are expected to remain unexercised. Options granted during the year have a maximum contractual term of ten years. The Company estimates the expected life of the option term based on actual past behavior for similar options with further consideration given to the class of employees to whom the options were granted.

Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company assesses the forfeiture rate on an annual basis and revises the rate when deemed necessary.

Employee Stock Purchase Plan

Under the Company’s 2004 Employee Stock Purchase Plan (Purchase Plan), employees may purchase common stock every six months (up to but not exceeding 12% of each employee’s wages) over the offering period at 85% of the fair market value of the common stock at certain specified dates. The offering period may not exceed 24 months. This purchase discount is significant enough to be considered compensatory. As a result, the Company recorded $0.2 million, $0.2 million and $0.04 million in share-based compensation related to the Purchase Plan for the years ended December 31, 2009, 2008 and 2007, respectively.

F-16

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2008 and 2007, 82,729 shares, 83,248 shares and 70,558 shares of common stock were issued under the Purchase Plan, respectively. The weighted-average fair value of employee stock Purchase Plan purchases was $1.85, $1.84 and $2.38 per share for 2009, 2008 and 2007, respectively.

Shares Reserved for Issuance

Shares of common stock reserved for future issuance as of December 31, 2009 are as follows:


	December 31, 2009
Warrants		2,944,234
Employee Stock Purchase Plan		1,041,054

Stock options under the Company’s Plans:
Granted and outstanding		7,160,011
Reserved for future issuance		936,376

		8,096,387

11. Income Taxes

As of December 31, 2009 and 2008, the Company has not recorded any uncertain tax benefits.

Significant components of the Company’s deferred tax assets are shown below. A valuation allowance of $91.0 million and $80.5 million has been established to offset the deferred tax assets, as realization of such assets has not met the more likely than not threshold, as of December 31, 2009 and 2008, respectively.


	As of December 31,
	2009			2008
	(in thousands)
Deferred tax assets:
Net operating loss carryforwards	$	52,972		$	46,681
Research and development credits		5,574			4,663
Non-qualified stock options		4,914			3,844
Capitalized research and development expense		27,415			25,058
Accruals		98			248
Other		33			30

Total deferred tax assets		91,006			80,524
Valuation allowance for deferred tax assets		(90,991	)		(80,524	)

Net deferred taxes	$	15		$	—

Deferred tax liabilities:
Unrealized gain (loss) on securities available-for-sale		(15	)		—

Total deferred tax liabilities		(15	)		—


Net deferred taxes	$	—		$	—

As of December 31, 2009 the Company had federal and state tax net operating loss (NOL) carryforwards of approximately $133.5 million and $109.5 million, respectively. Approximately $4.1 million of the federal loss carryforwards will begin expiring in 2010 and approximately $5.8 million of the state loss carryforwards will begin expiring in 2011, unless previously utilized. The Company also has federal and state research tax credit (R&D credit) carryforwards of approximately $2.2 million and $5.2 million respectively. The federal research credits will begin expiring in 2027 unless previously utilized. The state research credits do not expire.

Utilization of the NOL and R&D credit carryforwards may be subject to a substantial annual limitation under Section 382 of the Internal Revenue Code of 1986, and similar state provisions due to ownership change limitations that have occurred previously or that could occur in the future. These ownership changes may limit the amount of NOL and R&D credit carryforwards and other deferred tax assets that can be utilized to offset future taxable income and tax, respectively. In general, an ownership change, as defined by Section 382, results from transactions increasing ownership of certain shareholders or public groups in the stock of the corporation by

F-17

ANADYS PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

more than 50 percentage points over a three-year period. During 2007, the Company completed an analysis of Section 382 and has determined that, as of December 31, 2009 and 2008, approximately $14.8 million and $16.0 million, respectively, of the deferred tax assets related to NOL and credit carryforwards will expire unused and, accordingly, the Company has removed such assets from its deferred tax assets with a corresponding reduction to its valuation allowance. During 2009, the Company completed an initial analysis of Section 382 and, based on this analysis, the Company believes that an ownership change, as defined in Section 382, has occurred during 2009 and, therefore, its NOL and R&D credit carryforwards and other deferred tax assets will be subject to annual limitations in future periods. As of the date of the filing of this Annual Report on Form 10-K, a final determination of the annual limitations has not been determined and, therefore, the Company’s deferred tax assets related to its NOLs and R&D credit carryforwards have not been reduced for the limitations associated with the change in ownership which occurred during 2009. There may be additional limitations imposed on the Company’s ability to fully utilize its remaining deferred tax assets due to future ownership changes. Any amounts that are determined by the Company to expire prior to their utilization due to such limitations will be removed from deferred tax assets with a corresponding reduction of the valuation allowance. In addition, future changes in the unrecognized tax benefit will have no impact on the effective tax rate due to the existence of the valuation allowance.

The Company’s practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of December 31, 2009, the Company did not record any interest or penalties.

The provision for income taxes on earnings subject to income taxes differs from the statutory federal rate at December 31, 2009, 2008 and 2007, due to the following (in thousands):


	2009			2008			2007
Federal income taxes at 35%	$	(9,547	)	$	(11,341	)	$	(3,210	)
State income taxes, net of federal benefit		(1,566	)		(1,748	)		(383	)
Tax effect on non-deductible expenses and credits		(980	)		(567	)		(792	)
Increase in valuation allowance		10,467			12,940			(11,033	)
Expiration of net operating loss carryforwards		1,426			703			—
Other		200			13			2
Adjustment for Section 382 limitation		—			—			15,416

	$	—		$	—		$	—

The tax years 1993 to 2009 remain open to examination by the major taxing jurisdictions to which the Company is subject, as tax authorities may have the right to examine prior periods where net operating losses or tax credits were generated and carried forward.

12. Savings Plan

The Company has a retirement savings plan for all employees, subject to certain age requirements, pursuant to Section 401(k) of the Internal Revenue Code. The Company matches 25% of employee contributions up to 6% of eligible compensation. Employer contributions were $0.1 million for each of the years ended December 31, 2009, 2008 and 2007.

13. Unaudited Quarterly Results of Operations

The following quarterly financial data, in the opinion of management, reflects all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of results for the periods presented.


	First			Second			Third			Fourth
Fiscal year 2009	Quarter			Quarter			Quarter			Quarter
				(in thousands, except net loss per share)
Revenues	$	—		$	—		$	—		$	—
Net loss		(8,759	)		(6,530	)		(7,732	)		(4,257	)
Net loss per share, basic and diluted		(0.30	)		(0.21	)		(0.21	)		(0.11	)


	First			Second			Third			Fourth
Fiscal year 2008	Quarter			Quarter			Quarter			Quarter
				(in thousands, except net loss per share)
Revenues	$	—		$	—		$	—		$	—
Net loss		(7,444	)		(7,092	)		(9,349	)		(8,517	)
Net loss per share, basic and diluted		(0.26	)		(0.25	)		(0.32	)		(0.30	)

F-18

Position

Steve Worland, Ph.D.

President and Chief Executive Officer

James L. Freddo, M.D.

Senior Vice President, Drug Development and Chief Medical Officer

Elizabeth E. Reed, J.D.

Senior Vice President, Legal Affairs and General Counsel

Peter T. Slover, CPA

Vice President, Finance and Operations