Alexza Pharmaceuticals Inc. - FORM 10-Q

Attached files

file	filename
EX-10.4 - EX-10.4 - Alexza Pharmaceuticals Inc.	f56407exv10w4.htm
EX-31.1 - EX-31.1 - Alexza Pharmaceuticals Inc.	f56407exv31w1.htm
EX-32.1 - EX-32.1 - Alexza Pharmaceuticals Inc.	f56407exv32w1.htm
EX-10.2 - EX-10.2 - Alexza Pharmaceuticals Inc.	f56407exv10w2.htm
EX-10.5 - EX-10.5 - Alexza Pharmaceuticals Inc.	f56407exv10w5.htm
EX-31.2 - EX-31.2 - Alexza Pharmaceuticals Inc.	f56407exv31w2.htm
EX-10.1 - EX-10.1 - Alexza Pharmaceuticals Inc.	f56407exv10w1.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q


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

For the quarterly period ended June 30, 2010


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

For the transition period from to

Commission File Number 000-51820

ALEXZA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)


Delaware		77-0567768

(State or other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)

2091 Stierlin Court Mountain View, California		94043

(Address of principal executive offices)		(Zip Code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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

Large accelerated filer o

Accelerated filer 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 Exchange Act). Yes o No þ

Total number of shares of common stock outstanding as of July 22, 2010: 52,924,536.

ALEXZA PHARMACEUTICALS, INC.
TABLE OF CONTENTS


		page
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009		3
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009 and the period from December 19, 2000 (inception) to June 30, 2010		4
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009 and the period from December 19, 2000 (inception) to June 30, 2010		5
	Notes to Condensed Consolidated Financial Statements		7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		20

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		30

Item 4.	Controls and Procedures		31


PART II. OTHER INFORMATION

Item 1A.	Risk Factors		32

Item 1.	Legal Proceedings		50

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

Item 3.	Defaults Upon Senior Securities		50

Item 5.	Other Information		50

Item 6.	Exhibits		51

SIGNATURES			52
EX-10.1
EX-10.2
EX-10.4
EX-10.5
EX-31.1
EX-31.2
EX-32.1

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ALEXZA PHARMACEUTICALS, INC.
(a development stage company)
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)


	June 30,			December 31,
	2010			2009⁽¹⁾
ASSETS
Current assets:
Cash and cash equivalents	$	14,222		$	13,450
Marketable securities		27,445			6,466
Other receivables		—			1,406
Prepaid expenses and other current assets		736			804

Total current assets		42,403			22,126

Property and equipment, net		24,366			23,598
Restricted cash		400			400
Other assets		4,126			50

Total assets	$	71,295		$	46,174


LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	2,879		$	2,705
Accrued clinical trial expenses		208			303
Other accrued expenses		3,523			3,481
Deferred revenue		1,000			—
Other current liabilities		—			3,750
Current portion of contingent consideration liability		10,453			13,202
Current portion of financing obligations		3,350			2,515

Total current liabilities		21,413			25,956

Deferred rent		15,730			15,708
Deferred revenue		39,000			—
Noncurrent portion of contingent consideration liability		8,056			11,636
Noncurrent portion of financing obligations		15,748			—

Stockholders’ deficit:
Preferred stock		—			—
Common stock		5			5
Additional paid-in-capital		262,263			257,493
Other comprehensive income		8			(1	)
Deficit accumulated during development stage		(290,928	)		(264,623	)

Total stockholders’ deficit		(28,652	)		(7,126	)

Total liabilities and stockholders’ deficit	$	71,295		$	46,174


(1)		The condensed consolidated balance sheet at December 31, 2009 has been derived from audited consolidated financial statements at that date.

See accompanying notes to the financial statements.

ALEXZA PHARMACEUTICALS, INC.
(a development stage company)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)


													Period from
													December 19, 2000
	Three Months Ended						Six Months Ended						(inception) to
	June 30,						June 30,						June 30,
	2010			2009			2010			2009			2010
Revenue	$	—		$	—		$	—		$	9,514		$	16,945

Operating expenses:
Research and development		8,290			12,005			15,854			22,970			260,315
General and administrative		3,812			4,205			8,864			8,069			86,974
Restructuring charges		—			625			—			2,153			2,037
Acquired in-process research and development		—			—			—			—			3,916

Total operating expenses		12,102			16,835			24,718			33,192			353,242

Loss from operations		(12,102	)		(16,835	)		(24,718	)		(23,678	)		(336,297	)

Loss on change in fair value of contingent consideration liability		(449	)		—			(1,171	)		—			(9,154	)
Interest and other income/ (expense), net		28			(9	)		9			88			13,907
Interest expense		(370	)		(125	)		(425	)		(283	)		(4,473	)

Net loss		(12,893	)		(16,969	)		(26,305	)		(23,873	)		(336,017	)

Consideration paid in excess of noncontrolling interest		—			—			—			—			(61,566	)

Net loss attributed to noncontrolling interest in Symphony Allegro, Inc.		—			7,229			—			12,419			45,089


Net loss attributable to Alexza common stockholders	$	(12,893	)	$	(9,740	)	$	(26,305	)	$	(11,454	)	$	(352,494	)


Net loss per share attributable to Alexza common stockholders	$	(0.24	)	$	(0.29	)	$	(0.50	)	$	(0.35	)


Shares used to compute basic and diluted net loss per share attributable to Alexza common stockholders		52,798			33,136			52,661			33,052

See accompanying notes to the financial statements.

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


							Period from
							December 19, 2000
	Six Months Ended						(inception) to
	June 30,						June 30,
	2010			2009			2010
Cash flows from operating activities:
Net loss	$	(26,305	)	$	(23,873	)	$	(336,017	)

Adjustments to reconcile net loss attributable to Alexza common stockholders to net cash provided by (used in) operating activities:
Share-based compensation		3,286			3,679			22,221
Extinguishment of officer note receivable		—			—			2,300
Change in fair value of contingent liability		1,171			—			9,154
Issuance of common stock for intellectual property		—			—			92
Charge for acquired in-process research and development		—			—			3,916
Amortization of assembled workforce		—			—			222
Amortization of debt discount and deferred interest		8			22			399
Amortization of premium (discount) on available-for-sale securities		27			32			(574	)
Depreciation and amortization		2,311			2,456			23,920
(Gain)/loss on disposal of property and equipment		(5	)		42			121
Changes in operating assets and liabilities:
Other receivables		1,406			—			—
Prepaid expenses and other current assets		68			496			(730	)
Other assets		1,031			—			(1,594	)
Accounts payable		174			(1,042	)		2,750
Accrued clinical and other accrued liabilities		(53	)		(1,586	)		31
Deferred revenues		40,000			(9,514	)		40,000
Other liabilities		22			(761	)		19,120

Net cash provided by (used in) operating activities		23,141			(30,049	)		(214,669	)


Cash flows from investing activities:
Purchases of available-for-sale securities		(29,958	)		(5,425	)		(368,130	)
Maturities of available-for-sale securities		8,961			12,001			341,268
Purchases of available-for-sale securities held by Symphony Allegro, Inc.		—			—			(49,975	)
Maturities of available-for-sale securities held by Symphony Allegro, Inc.		—			11,926			45,093
(Increase)/decrease in restricted cash		—			—			(400	)
Purchases of property and equipment		(6,824	)		(693	)		(48,170	)
Proceeds from disposal of property and equipment		—			—			28
Cash paid for merger		—			—			(250	)

Net cash provided by (used in) investing activities		(27,821	)		17,809			(80,536	)

See accompanying notes to the financial statements.

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


							Period from
							December 19, 2000
	Six Months Ended						(inception) to
	June 30,						June 30,
	2010			2009			2010
Cash flows from financing activities:
Proceeds from issuance of common stock and warrants, net of offering costs		—			—			139,722
Proceeds from exercise of stock options and stock purchase rights under the Employee Stock Purchase Plan		563			350			5,999
Repurchases of common stock		—			—			(8	)
Proceeds from issuance of convertible preferred stock		—			—			104,681
Proceeds from repayment of stockholder note receivable		—			—			29
Proceeds from purchase of noncontrolling interest in Symphony Allegro, Inc		—			—			4,882
Proceeds from purchase of noncontrolling interest by preferred shareholders in Symphony Allegro, Inc, net of fees		—			—			47,171
Payments of contingent payments to Symphony Allegro Holdings, LLC.		(7,500	)		—			(7,500	)
Proceeds from financing obligations		14,806			—			33,738
Payments of financing obligations		(2,417	)		(2,379	)		(19,287	)

Net cash provided by (used in) financing activities		5,452			(2,029	)		309,427


Net increase (decrease) in cash and cash equivalents		772			(14,269	)		14,222
Cash and cash equivalents at beginning of period		13,450			26,036			—

Cash and cash equivalents at end of period	$	14,222		$	11,767		$	14,222

See accompanying notes to the financial statements.

ALEXZA PHARMACEUTICALS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. The Company and Basis of Presentation

Business

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

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

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required for complete financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s interim consolidated financial information. The results for the three month and six months ended June 30, 2010 are not necessarily indicative of the results to be expected for the year ending December 31, 2010 or for any other interim period or any other future year.

The accompanying unaudited condensed consolidated financial statements and notes to condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2009 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 9, 2010.

Basis of Consolidation

The unaudited condensed consolidated financial statements include the accounts of Alexza and its wholly-owned subsidiaries, Addicere Therapeutics, Inc., Alexza Singapore Pte. Ltd., Alexza Singapore Manufacturing Pte. Ltd., Alexza UK Limited, and Symphony Allegro, Inc. (“Allegro”). On August 26, 2009, Alexza acquired all of the outstanding equity of Allegro (see Note 12). Prior to August 26, 2009, Alexza consolidated the financial results of Allegro, as Allegro was deemed a variable interest entity and Alexza was deemed the primary beneficiary. All significant intercompany balances and transactions have been eliminated.

Significant Risks and Uncertainties

The Company has incurred significant losses from operations since its inception and expects losses to continue for the foreseeable future. The Company has financed its operations primarily through the sale of equity securities, licensing collaborations, capital lease and debt financing and government grants. The Company will need to raise additional capital to fund its operations, to develop its product candidates, and to develop its manufacturing capabilities, and such funding may not be available or may be on terms that are not favorable to the Company.

Recently Adopted Accounting Standards

The Financial Accounting Standards Board (“FASB”) ratified ASU 2010-06, which modified the disclosure requirements regarding fair value accounting. The Company adopted the provisions of ASU 2010-06 during the six months ended June 30, 2010, see Note 3. The adoption of this guidance did not have an impact on the Company’s financial position, results of operations or cash flows.

Recently Issued Accounting Standards

The FASB ratified ASU 2010-13, which eliminates the residual method of allocation, and instead requires companies to use the relative selling price method when allocating revenue in a multiple deliverable arrangement. When applying the relative selling price method, the selling price for each deliverable shall be determined using vendor specific objective evidence of selling price, if it exists, otherwise using third-party evidence of selling price. If neither vendor specific objective evidence nor third-party evidence of selling price exists for a deliverable, companies shall use their best estimate of the selling price for that deliverable when applying the relative selling price method. ASU 2010-13 shall be effective in fiscal years beginning on or after June 15, 2010, with earlier application permitted. Companies may elect to adopt this guidance prospectively for all revenue arrangements entered into or materially modified after the date of adoption, or retrospectively for all periods presented. The Company is currently evaluating the potential impact, if any, of the adoption of this guidance on its financial position, results of operations and cash flows.

In March 2010, the FASB issued new guidance on the use of the milestone method of recognizing revenue for research and development arrangements under which consideration to be received by the vendor is contingent upon the achievement of certain milestones. The update provides guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. A vendor can recognize consideration in its entirety as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. Additional disclosures describing the consideration arrangement and the entity’s accounting policy for recognition of such milestone payments are also required. The new guidance is effective for fiscal years, and interim periods within such fiscal years, beginning on or after June 15, 2010, with early adoption permitted. The guidance may be applied prospectively to milestones achieved during the period of adoption or retrospectively for all prior periods. The Company is currently evaluating the potential impact, if any, of the adoption of this guidance on its financial position, results of operations and cash flows.

2. Equity Financing Facility

On May 26, 2010, the Company obtained a committed equity financing facility under which the Company may sell up to the lesser of $25 million of its common stock or 10,581,724 shares of its common stock to Azimuth Opportunity, Ltd. (“Azimuth”) over a 24-month period pursuant to the terms of a Common Stock Purchase Agreement (the “Purchase Agreement”). The Company is not obligated to utilize any of the facility.

The Company will determine, at its sole discretion, the timing, the dollar amount and the price per share of each draw under this facility, subject to certain conditions. When and if the Company elects to use the facility by delivery of a draw down notice to Azimuth, the Company will issue shares to Azimuth at a discount of between 5.00% and 6.75% to the volume weighted average price of the Company’s common stock over a preceding period of trading days (a “Draw Down Period”). The Purchase Agreement also provides that from time to time, at the Company’s sole discretion, it may grant Azimuth the right to purchase additional shares of the Company’s common stock during each Draw Down Period for an amount of shares specified by the Company based on the trading price of its common stock. Upon Azimuth’s exercise of an option, the Company will sell to Azimuth the shares subject to the option at a price equal to the greater of the daily volume weighted average price of the Company’s common stock on the day Azimuth notifies the Company of its election to exercise its option or the threshold price for the option determined by the Company, less a discount calculated in the same manner as it is calculated in the draw down notices.

Azimuth is not required to purchase any shares at a pre-discounted purchase price below $3.00 per share, and any shares sold under this facility will be sold pursuant to a shelf registration statement declared effective by the Securities and Exchange Commission on May 20, 2010. The Purchase Agreement will terminate on May 26, 2012. As of June 30, 2010, there have been no sales of common stock under the Purchase Agreement.

3. Fair Value Accounting

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. Three

levels of inputs, of which the first two are considered observable and the last unobservable, may be used to measure fair value. The three levels are:

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

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

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

The following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents, and marketable securities) by major security type and liability measured at fair value on a recurring basis as of June 30, 2010 and December 31, 2009 (in thousands):


June 30, 2010	Level 1		Level 2		Level 3		Total
Assets
Money market funds	$	9,233	$	—	$	—	$	9,233


Available for sale debt securities
Corporate debt securities	$	—	$	14,497	$	—	$	14,497
Government-sponsored enterprises		—		16,948		—		16,948

Total available for sale debt securities	$	—	$	31,445	$	—	$	31,445


Total assets	$	9,233	$	31,445	$	—	$	40,678


Liabilities
Contingent consideration liability	$	—	$	—	$	18,509	$	18,509

Total liabilities	$	—	$	—	$	18,509	$	18,509


December 31, 2009	Level 1		Level 2		Level 3		Total
Assets
Money market funds	$	10,421	$	—	$	—	$	10,421


Available for sale debt securities
Government-sponsored enterprises	$	—	$	5,217	$	—	$	5,217
Corporate debt securities		—		3,500		—		3,500

Total available for sale debt securities	$	—	$	8,717	$	—	$	8,717


Total assets	$	10,421	$	8,717	$	—	$	19,138


Liabilities
Contingent consideration liability	$	—	$	—	$	24,838	$	24,838

Total liabilities	$	—	$	—	$	24,838	$	24,838

Cash equivalents and marketable securities

The following table outlines the amortized cost, fair value and unrealized gain/(loss) for the Company’s financial assets by major security type as of June 30, 2010 and December 31, 2009 (in thousands):


	Amortized		Fair		Unrealized
June 30, 2010	Cost		Value		Gain/(Loss)
Money market funds	$	9,233	$	9,233	$	—
Corporate debt securities		14,494		14,497		3
Government-sponsored enterprises		16,943		16,948		5

Total	$	40,670	$	40,678	$	8


	Amortized		Fair		Unrealized
December 31, 2009	Cost		Value		Gain/(Loss)
Money market funds	$	10,421	$	10,421	$	—
Government-sponsored enterprises		5,218		5,217		(1	)
Corporate debt securities		3,500		3,500		—

Total	$	19,139	$	19,138	$	(1	)

The Company had no sales of marketable securities during the three or six months ended June 30, 2010 or 2009. As of June 30, 2010, all of the Company’s marketable securities have a maturity of less than one year.

When determining if there are any “other-than-temporary” impairments on its investments, the Company evaluates: (i) whether the investment has been in a continuous realized loss position for over 12 months; (ii) the duration to maturity of the Company’s investments; (iii) the Company’s intention to hold the investments to maturity and if it is not more likely than not that the Company will be required to sell the investment before recovery of the amortized cost bases; (iv) the credit rating of each investment; and (v) the type of investments made. Through June 30, 2010, the Company has not recognized any “other-than-temporary” losses on its investments.

The Company’s available for sale debt securities are valued utilizing a multi-dimensional relational model. Inputs, listed in approximate order of priority for use when available, include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data.

Contingent Consideration Liability

In connection with the exercise of the Company’s option to purchase all of the outstanding equity of Allegro, the Company is obligated to make contingent cash payments to the former Allegro stockholders related to certain payments received by the Company from future partnering agreements pertaining to AZ-004/104 (Staccato loxapine) or AZ-002 (Staccato alprazolam) (see Note 12). The Company estimated the fair value of this contingent consideration liability using a probability-weighted discounted cash flow model. The Company derived multiple cash flow scenarios for each of the product candidates and applied a probability to each of the scenarios. These cash flows were then discounted at an 18% rate.

This fair value measurement is based on significant inputs not observed in the market and thus represents a Level 3 measurement. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s assumptions in measuring fair value.

The Company records any changes in the fair value of the contingent consideration liability in earnings in the period of the change. Certain events including, but not limited to, clinical trial results, U.S. Food and Drug Administration (“FDA”) approval or nonapproval of the Company’s submissions, such as the New Drug Application (“NDA”) for AZ-004 submitted by the Company in December 2009, the timing and terms of any strategic partnership agreement, and the commercial success of AZ-004, AZ-104 or AZ-002 could have a material impact on the fair value of the contingent consideration liability, and as a result, the Company’s results of operations and financial position.

In February 2010, Biovail Laboratories International SRL (“Biovail”) paid the Company an upfront $40 million payment for the rights to commercialize AZ-004 in the United States and Canada (See Note 12). The Company in turn paid $7.5 million of the upfront payment to the former Allegro stockholders under the terms of the exercise of the option to purchase all of the outstanding equity of Allegro.

The following table represents a reconciliation of the change in the fair value measurement of the contingent consideration liability for the three and six months ended June 30, 2010 (in thousands).


	Three		Six
	Months		Months
	Ended		Ended
	June 30,		June 30,
	2010		2010
Beginning balance	$	18,060	$	24,838
Payments made		—		(7,500	)
Adjustments to fair value measurement		449		1,171

Ending balance	$	18,509	$	18,509

4. Share-Based Compensation Plans

2005 Equity Incentive Plan

In December 2005, the Company’s Board of Directors adopted the 2005 Equity Incentive Plan (the “2005 Plan”). The 2005 Plan is an amendment and restatement of the Company’s previous stock option plans. Stock options issued under the 2005 Plan generally vest over four years, based on service time, or upon the accomplishment of certain milestones and have a maximum contractual term of 10 years. Restricted stock units granted to officer or non-officer employees generally vest over four years from the grant date or upon the accomplishment of certain milestones. Restricted stock units granted to non-employee directors generally vest one year after the date of grant. Prior to vesting, restricted stock units do not have dividend equivalent rights, do not have voting rights and the shares underlying the restricted units are not considered issued and outstanding. Shares are issued upon vesting of the restricted stock units.

The 2005 Plan provides for annual reserve increases on the first day of each year commencing on January 1, 2007 and ending on January 1, 2015. The annual reserve increases will be equal to the lesser of (i) 2% of the total number of shares of the Company’s common stock outstanding on December 31 of the preceding calendar year, or (ii) 1,000,000 shares of common stock. The Company’s Board of Directors has the authority to designate a smaller number of shares by which the authorized number of shares of common stock will be increased prior to the last day of any calendar year. On January 1, 2010 and 2009 an additional 1,000,000 and 656,417 shares of the Company’s common stock, respectively, were reserved for issuance under this provision.

2005 Non-Employee Directors’ Stock Option Plan

In December 2005, the Company’s Board of Directors adopted the 2005 Non-Employee Directors’ Stock Option Plan (the “Directors’ Plan”). The Directors’ Plan provides for the automatic grant of nonstatutory stock options to purchase shares of common stock to the Company’s non-employee directors, which vest over four years and have a term of 10 years. The Directors’ Plan provides for an annual reserve increase to be added on the first day of each fiscal year, commencing on January 1, 2007 and ending on January 1, 2015. The annual reserve increases will be equal to the number of shares subject to options granted during the preceding fiscal year less the number of shares that revert back to the share reserve during the preceding fiscal year. The Company’s Board of Directors has the authority to designate a smaller number of shares by which the authorized number of shares of common stock will be increased prior to the last day of any calendar year. On each of January 1, 2010 and 2009 an additional 37,500 shares of the Company’s common stock were reserved for issuance under this provision.

The following table sets forth the summary of option activity under the Company’s share-based compensation plans for the six months ended June 30, 2010:


	Outstanding Options
				Weighted
	Number of			Average
	Shares			Exercise Price
Outstanding at January 1, 2010		4,740,499		$	5.17
Options granted		252,771			2.84
Options exercised		(98,107	)		1.97
Options canceled		(469,666	)		8.32

Outstanding at June 30, 2010		4,425,497			4.78

The total intrinsic value of options exercised during the three and six months ended June 30, 2010 was $47,000 and $108,000, respectively, and $24,000 and $37,000 during the same periods in 2009, respectively.

The following table sets forth the summary of restricted stock unit activity under the Company’s equity incentive plans for the six months ended June 30, 2010:


				Weighted
				Average
	Number of			Grant-Date
	Shares			Fair Value
Outstanding at January 1, 2010		196,270		$	3.90
Granted		1,434,780			2.54
Released		(121,441	)		2.47
Forfeited		(18,520	)		3.55

Outstanding at June 30, 2010		1,491,089			2.68

As of June 30, 2010, 172,314 and 200,000 shares remained available for issuance under the 2005 Plan and the Directors’ Plan, respectively.

2005 Employee Stock Purchase Plan

In December 2005, the Company’s Board of Directors adopted the 2005 Employee Stock Purchase Plan (“ESPP”). The ESPP allows eligible employee participants to purchase shares of the Company’s common stock at a discount through payroll deductions. The ESPP consists of a fixed offering period, generally 24 months with four purchase periods within each offering period. Purchases are generally made on the last trading day of each October and April. Employees purchase shares at each purchase date at 85% of the market value of the Company’s common stock on their enrollment date or the end of the purchase period, whichever price is lower.

The ESPP provides for annual reserve increases on the first day of each fiscal year commencing on January 1, 2007 and ending on January 1, 2015. The annual reserve increases will be equal to the lesser of (i) 1% of the total number of shares of the Company’s common stock outstanding on December 31 of the preceding calendar year, or (ii) 250,000 shares of common stock. The Company’s Board of Directors has the authority to designate a smaller number of shares by which the authorized number of shares of common stock will be increased prior to the last day of any calendar year. An additional 250,000 shares were reserved for issuance on each of January 1, 2010 and 2009 under this provision. The Company issued 277,721 shares at a weighted average price of $1.33 under the ESPP during the three and six months ended June 30, 2010 and 216,401 shares at a weighted average price of $1.41 during the three and six months ended June 30, 2009. At June 30, 2010, 128,522 shares are available for issuance under the ESPP.

5. Share-Based Compensation

Employee Share-Based Awards

Compensation cost for employee share-based awards is based on the grant-date fair value and will be recognized over the vesting period of the applicable award on a straight-line basis. The Company issues employee share-based awards in the form of stock options and restricted stock units under the Company’s equity incentive plans, and stock purchase rights under the ESPP.

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

During the three and six months ended June 30, 2010, the weighted average fair value of the employee stock options granted was $2.17 and $1.92, respectively and $1.19 and $1.71 in the same periods in 2009, respectively. The weighted average fair value of restricted stock units issued was $3.44 and $2.54 in the three and six months ended June 30, 2010, respectively. The weighted average fair value of restricted stock units issued was $2.19 in the six months ended June 30, 2009. The Company did not issue restricted stock units in the three months ended June 30, 2009. The weighted average fair value of stock purchase rights granted under the ESPP was $2.10 and $2.10 during the three and six months ended June 30, 2010, respectively, and $2.69 and $2.91 during the same periods in 2009, respectively.

The estimated grant date fair values of the stock options and stock purchase rights were calculated using the Black-Scholes valuation model, and the following weighted average assumptions:


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2010			2009			2010			2009
Stock Option Plans
Expected term	5.0 years			5.0 years			5.0 years			5.0 years
Expected volatility		84	%		89	%		85	%		86	%
Risk-free interest rate		2.16	%		2.38	%		2.35	%		1.74	%
Dividend yield		0	%		0	%		0	%		0	%

Employee Stock Purchase Plan
Expected term	2.0 years			2.0 years			2.0 years			1.9 years
Expected volatility		78	%		74	%		78	%		72	%
Risk-free interest rate		1.67	%		2.32	%		1.67	%		2.64	%
Dividend yield		0	%		0	%		0	%		0	%

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

As of June 30, 2010, there were $3,760,000, $2,376,000 and $206,000 of total unrecognized compensation costs related to unvested stock option awards, unvested restricted stock units and stock purchase rights, respectively, which are expected to be recognized over a weighted average period of 1.6 years, 0.7 years and 0.8 years, respectively.

There was no share-based compensation capitalized at June 30, 2010.

6. Net Loss per Share Attributable to Alexza Common Stockholders

Historical basic and diluted net loss per share attributable to Alexza common stockholders is calculated by dividing the net loss attributable to Alexza common stockholders by the weighted-average number of common shares outstanding for the period. The following items were excluded in the net loss per share attributable to Alexza common stockholders calculation for the three and six months ended June 30, 2010 and 2009 because the inclusion of such items would have had an anti-dilutive effect:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2010		2009		2010		2009
Stock options		4,488,500		4,740,849		4,572,499		4,409,290
Restricted stock units		1,403,147		1,083,242		1,000,854		626,311
Warrants to purchase common stock		12,915,751		2,431,242		12,853,019		2,431,242

7. Restructuring Charges

In January 2009, the Company restructured its operations to focus its efforts on the continued rapid development of its AZ-004 (Staccato loxapine) product candidate. The restructuring included a workforce reduction of 50 employees, representing approximately 33% of the Company’s total workforce and was completed in the second quarter of 2009. The Company incurred restructuring expenses of $625,000 and $2,153,000 in the three and six months ended June 30, 2009 related to employee severance and other termination benefits, including a non-cash charge related to modifications to share-based awards. All expenses were incurred and paid in 2009 and no additional charges are expected related to this restructuring.

8. Comprehensive Loss Attributed to Alexza Common Stockholders

Comprehensive loss attributed to Alexza common stockholders is comprised of net loss and unrealized gains (losses) on marketable securities. Total comprehensive loss attributed to Alexza common stockholders for the three and six months ended June 30, 2010 and 2009 is as follows (in thousands):


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2010			2009			2010			2009
Net loss	$	(12,893	)	$	(16,969	)	$	(26,305	)	$	(23,873	)
Change in unrealized gain (loss) on marketable securities		1			(1	)		9			(33	)

Comprehensive loss		(12,892	)		(16,970	)		(26,296	)		(23,906	)
Comprehensive loss attributable to noncontrolling interest in Symphony Allegro Inc.		—			7,229			—			12,419

Comprehensive loss attributable to Alexza common stockholders	$	(12,892	)	$	(9,741	)	$	(26,296	)	$	(11,487	)

9. Other Accrued Expenses

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


	June 30,		December 31,
	2010		2009
Accrued compensation	$	2,369	$	2,174
Accrued professional fees		522		630
Other		632		677

Total	$	3,523	$	3,481

10. Debt Obligations

Equipment Financing Agreements

The Company has outstanding borrowings under financing agreements to finance equipment purchases. Borrowings under the agreements are to be repaid in 36 to 48 monthly installments of principal and interest. The interest rate, which is fixed for each draw, is based on the U.S. Treasury securities of comparable maturities and ranges from 9.2% to 10.6%. The equipment purchased under each of the equipment financing agreements is pledged as security. The Company believes the amortized book value represents the approximate fair value of the outstanding debt.

Due to a late payment made in October 2009, the Company may be in default of the terms of its equipment financing obligations. The Company does not believe it is in default; however, if the Company is in default, the lender would have the right to demand payment on all outstanding obligations. As a result, the Company has classified all of the outstanding equipment financing obligations as a current liability as of June 30, 2010. Subsequent to the late payment, the Company paid the installment that was at issue and has paid all subsequent installments in a timely manner.

Term Loan Agreements

Hercules Technology Growth Capital

In May 2010, the Company entered into a Loan and Security Agreement (“Loan Agreement”) with Hercules Technology Growth Capital, Inc. (“Hercules”). Under the terms of the Loan Agreement, the Company borrowed $15,000,000 at an interest rate of the higher of (i) 10.75% or (ii) 6.5% plus the prime rate as reported in the Wall Street Journal, with a maximum interest rate of 14% and issued to Hercules a secured term promissory note evidencing the loan. The Company will make interest only payments for the initial eight months, which will be extended an additional three months if the Company receives FDA approval for the AZ-004 NDA by February 1, 2011. Thereafter, the loan will be repaid in 33 equal monthly installments.

The Loan Agreement limits both the seniority and amount of future debt the Company may incur. The Company may be required to prepay the loan in the event of a change in control. In conjunction with the loan, the Company issued to Hercules a five-year warrant to purchase 376,394 shares of the Company’s common stock at a price of $2.69 per share. The warrant is immediately exercisable and expires five years from the effective date. The Company estimated the fair value of this warrant as of the issuance date to be $921,000, which was recorded as a debt discount to the loan and consequently a reduction to the carrying value of the loan. The fair value of the warrant was calculated using the Black-Scholes option valuation model, and was based on the contractual term of the warrant of five years, a risk-free interest rate of 2.31%, expected volatility of 84% and 0% expected dividend yield. The Company also recorded fees paid to Hercules as a debt discount, which further reduced the carrying value of the loan. The debt discount is being amortized to interest expense.

Autoliv ASP, Inc.

In June 2010, in return for transfer to the Company of all right, title and interest in a production line for the commercial manufacture of chemical heat packages completed or to be completed by Autoliv ASP, Inc (“Autoliv”) on behalf of the Company, the Company paid Autoliv $4,000,000 in cash and issued Autoliv a $4,000,000 unsecured promissory note. The note will bear interest beginning on January 1, 2011 at 8% per annum and will be paid in 48 consecutive and equal installments of $97,000 beginning on that date. (See Note 13)

Future scheduled principal payments under the equipment financing agreements and the term loans as of June 30, 2010 are as follows (in thousands):


	Equipment
	Financing		Loan
	Obligations		Agreements		Total
2010 — remaining 6 months	$	761	$	—	$	761
2011		427		4,993		5,420
2012		—		6,364		6,364
2013		—		6,528		6,528
2014		—		1,115		1,115
Thereafter		—		—		—

Total	$	1,188	$	19,000	$	20,188

11. Facility Leases

The Company leases two buildings in Mountain View, California, which the Company began to occupy in the fourth quarter of 2007. The Company recognizes rental expense on the facility on a straight line basis over the initial term of the lease. Differences between the straight line rent expense and rent payments are classified as deferred rent liability on the balance sheet. The lease for both facilities expires on March 31, 2018, and the Company has two options to extend the lease for five years each.

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

In May 2008, the Company entered into an agreement to sublease a portion of its Mountain View facility. The sublease agreement, as amended, expires on January 31, 2011, at which time it will convert to a month-to-month lease.

In January 2010, the Company entered into an agreement to sublease an additional portion of its Mountain View facility from March 1, 2010 through February 28, 2014. The sublessee has an option to extend the sublease agreement for 12 months and a second option to extend the sublease agreement an additional 37 months. If the sublessee exercises these options, the rent will be at fair market rates at the time the option is exercised. In the three months ended March 31, 2010, the Company recorded a charge of $1,144,000 to record the difference between the lease payments made by the Company and the cash receipts to be generated from the sublease over the life of the sublease.

12. License Agreements

Biovail Laboratories International SRL

In February 2010, the Company entered into a collaboration and license agreement (“License Agreement”) and a manufacture and supply agreement, (“Supply Agreement” and collectively, the “Collaboration”), with Biovail, for AZ-004 for the treatment of psychiatric and/or neurological indications and the symptoms associated with these indications, including the initial indication for the rapid treatment of agitation in schizophrenia and bipolar disorder patients. The Collaboration contemplates that the Company will be the exclusive supplier of AZ-004 for clinical and commercial uses and have responsibility for the NDA for AZ-004 for the initial indication, as well as responsibility for any additional development and regulatory activities required for use by these two patient populations in the outpatient setting. Biovail will be responsible for commercialization for the initial indication and, if it elects, development and commercialization of additional indications for AZ-004 in the U.S. and Canada.

Under the terms of the License Agreement, Biovail paid the Company an upfront fee of $40 million, and the Company may be eligible to receive up to an additional $90 million in milestone payments upon achievement of predetermined regulatory, clinical and commercial manufacturing milestones. The

Company may be subject to certain payment obligations to Biovail, up to $5 million, if it does not meet certain other milestones prior to a termination of the License Agreement. The Company is also eligible to receive tiered royalty payments of 10% to 25% on any net sales of AZ-004. The Company is responsible for conducting and funding all development and regulatory activities associated with AZ-004’s initial indication for the rapid treatment of agitation in patients with schizophrenia or bipolar disorder as well as for its possible use in the outpatient setting in these two patient populations. The Company’s obligation to fund the outpatient development efforts is limited to a specified amount. Biovail is responsible for certain Phase 4 development commitments and related costs and expenses. For additional indications, the Company has an obligation regarding certain efforts and related costs and expenses, up to a specified amount, and if it elects, Biovail is responsible for all other development commitments and related costs and expenses.

Under the terms of the Supply Agreement, the Company is the exclusive supplier of AZ-004 and has responsibility for the manufacture, packaging, labeling and supply for clinical and commercial uses. Biovail will purchase AZ-004 from the Company at predetermined transfer prices. The transfer prices depend on the volume of AZ-004 purchases, subject to certain adjustments.

Either party may terminate the Collaboration for the other party’s uncured material breach or bankruptcy. In addition, Biovail has the right to terminate the Collaboration (a) upon 90 days written notice for convenience; (b) upon 90 days written notice if the FDA does not approve the AZ-004 NDA for the initial indication for the rapid treatment of agitation in patients with schizophrenia or bipolar disorder; (c) immediately upon written notice for safety reasons or withdrawal of marketing approval; (d) upon 90 days written notice upon certain recalls of the product; or (e) immediately upon written notice within 60 days of termination of the Supply Agreement under certain circumstances. The Supply Agreement automatically terminates upon the termination of the License Agreement.

For revenue recognition purposes, the Company views the Collaboration with Biovail as a multiple element arrangement. Multiple element arrangements are analyzed to determine whether the various performance obligations, or elements, can be separated or whether they must be accounted for as a single unit of accounting. The Company evaluates whether the delivered elements under the arrangement have value on a stand-alone basis and whether objective and reliable evidence of fair value of the undelivered items exist. Deliverables that do not meet these criteria are not evaluated separately for the purpose of revenue recognition. For a single unit of accounting, payments received are recognized in a manner consistent with the final deliverable. The Company has concluded that there is not objective and reliable evidence of fair value of all of the undelivered elements, and thus the Company is accounting for such elements as a single unit of accounting. Further, the Company currently estimates that the final deliverable under the Collaboration will be the supply of clinical and commercial product to Biovail. The Company plans to recognize revenue associated with the upfront payment over the periods beginning with the first supply of commercial product to Biovail through May 2022. The Company has not commenced the delivery of clinical and commercial product to Biovail, thus no revenue was recognized during the three or six months ended June 30, 2010.

Symphony Allegro, Inc.

On December 1, 2006, the Company entered into a series of related agreements with Symphony Capital LLC (“Symphony Capital”), Symphony Allegro Holdings LLC (“Holdings”) and Allegro, providing for the financing of the clinical development of its AZ-002, Staccato alprazolam, and AZ-004/104, Staccato loxapine, product candidates (the “Programs”). Symphony Capital and other investors (collectively, the “Allegro Investors”) invested $50,000,000 in Holdings, which then invested the $50,000,000 in Allegro. Pursuant to the agreements, Allegro agreed to invest up to the full $50,000,000 to fund the clinical development of the Programs, and the Company licensed to Allegro certain intellectual property rights related to the Programs. The Company received an exclusive purchase option (the “Purchase Option”) that gave the Company the right, but not the obligation, to acquire all, but not less than all, of the outstanding equity of Allegro, thereby allowing the Company to reacquire all of the Programs.

In June 2009, the Company entered into an agreement with Holdings to amend the provisions of and to exercise the Purchase Option. The Company completed the acquisition of all of the outstanding equity of Allegro pursuant to the amended Purchase Option on August 26, 2009. In exchange for all of the outstanding equity of Allegro, the Company: (i) issued to the Allegro Investors 10,000,000 shares of common stock; (ii) issued to the Allegro Investors five-year warrants to purchase 5,000,000 shares of common stock at an exercise price of $2.26 per share and canceled the warrants to purchase 2,000,000

shares of common stock held by the Allegro Investors; and (iii) will pay Holdings certain percentages of cash payments that may be generated from future partnering transactions for the Programs.

Prior to the closing of the acquisition of all of the outstanding equity of Allegro pursuant to the amended Purchase Option, the Company had concluded that Allegro was by design a variable interest entity. The Company also concluded that it was most closely associated with Allegro and therefore consolidated Allegro’s financial results.

Upon closing of the acquisition of all of the outstanding equity of Allegro pursuant to the amended Purchase Option, the Company recorded the acquisition as a capital transaction that did not affect its net loss. However, because the acquisition was accounted for as a capital transaction, the excess consideration transferred over the carrying value of the noncontrolling interest in Allegro was treated as a deemed dividend for purposes of reporting net loss per share, increasing net loss attributable to Alexza stockholders by $61,566,000 during the three and nine months ended September 30, 2009. In addition, upon the closing, the Company ceased to charge net losses of Allegro against the noncontrolling interest.

Endo Pharmaceuticals, Inc.

On December 27, 2007, the Company entered into a license, development and supply agreement (the “Endo Agreement”), with Endo Pharmaceuticals, Inc. (“Endo”) for AZ-003 (Staccato fentanyl) and the fentanyl class of molecules for North America. Under the terms of the Endo Agreement, Endo paid the Company a $10,000,000 non-refundable upfront fee and Endo was obligated to pay potential additional milestone payments of up to $40,000,000 upon achievement of predetermined regulatory and clinical milestones. Endo was also obligated to pay royalties to the Company on net sales of the product, from which the Company would be required to pay for the cost of goods for the manufacture of the commercial version of the product. Under the terms of the Endo Agreement, the Company had primary responsibility for the development and costs of the Staccato Electronic Multiple Dose device and the exclusive right to manufacture the product for clinical development and commercial supply. Endo had the responsibility for future pre-clinical, clinical and regulatory development, and, if AZ-003 was approved for marketing, for commercializing the product in North America. The Company recorded the $10,000,000 upfront fee it received from Endo in January 2008 as deferred revenue. The Company was unable to allocate a fair value to each of the deliverables outlined in the Endo Agreement and therefore accounted for the deliverables as a single unit of accounting. The Company began to recognize the $10,000,000 upfront payment as revenue in the third quarter of 2008 over the estimated performance period of six years, resulting in revenues of $486,000 in 2008.

In January 2009, the Company and Endo mutually agreed to terminate the Endo Agreement, with all rights to AZ-003 reverting back to the Company. The Company’s obligations under the Endo Agreement were fulfilled upon the termination of the Endo Agreement, and the Company recognized the remaining deferred revenue of $9,514,000 during the three months ended March 31, 2009.

13. Autoliv Manufacturing and Supply Agreement

On November 2, 2007, the Company entered into a Manufacturing and Supply Agreement (the “Manufacture Agreement”) with Autoliv pursuant to which Autoliv agreed to manufacture, assemble and test heat packages that can be incorporated into the Company’s Staccato device (the “Chemical Heat Packages”).

In June 2010, the Company and Autoliv entered into an agreement to amend the terms of the Manufacture Agreement (the “Amendment”). Under the terms of the Amendment, Alexza paid Autoliv $4,000,000 and issued Autoliv a $4,000,000 unsecured promissory note in return for a production line for the commercial manufacture of Chemical Heat Packages. The note will bear interest beginning on January 1, 2011 at 8% per annum and will be paid in 48 consecutive and equal installments of $97,000 beginning on that date. At Alexza’s request, Autoliv will manufacture up to two additional production lines for the commercial manufacture of Chemical Heat Packages at a cost not to exceed $2.4 million for each additional line.

The provisions of the Amendment superseded (a) the obligation of the Company set forth in the Manufacture Agreement to reimburse Autoliv for certain expenses related to the equipment and tooling used in production and testing of the Chemical Heat Packages in an amount of up to $12 million upon the earliest of December 31, 2011, 60 days after the termination of the Manufacture Agreement or 60 days after

approval by the FDA of an NDA filed by the Company, and (b) the obligation of Autoliv to transfer possession and ownership of such equipment and tooling. Pursuant to the Amendment, the parties also agreed to revise the specified purchase price of Chemical Heat Packages supplied by Autoliv, which varies based on annual quantities ordered by the Company.

Subject to certain exceptions, Autoliv has agreed to manufacture, assemble and test the Chemical Heat Packages solely for the Company in conformance with the Company’s specifications. The Company will pay Autoliv a specified purchase price, which varies based on annual quantities ordered by the Company, per Chemical Heat Package delivered. The initial term of the Manufacture Agreement expires on December 31, 2012, at which time the Manufacture Agreement will automatically renew for successive five-year renewal terms unless the Company or Autoliv notifies the other party no less than 36 months prior to the end of the initial term or the then-current renewal term that such party wishes to terminate the Manufacture Agreement. The Manufacture Agreement provides that during the term of the Manufacture Agreement, Autoliv will be the Company’s exclusive supplier of the Chemical Heat Packages. In addition, the Manufacture Agreement grants Autoliv the right to negotiate for the right to supply commercially any second generation chemical heat package (a “Second Generation Product”) and provides that the Company will pay Autoliv certain royalty payments if the Company manufactures Second Generation Products itself or if the Company obtains Second Generation Products from a third party manufacturer. Upon the termination of the Manufacture Agreement, the Company will be required, on an ongoing basis, to pay Autoliv certain royalty payments related to the manufacture of the Chemical Heat Packages by the Company or third party manufacturers.

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

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential” and similar expressions intended to identify forward-looking statements. Examples of these statements include, but are not limited to, statements regarding: the prospects and anticipated timing of us receiving approval to market AZ-004, the implications of interim or final results of our clinical trials, the progress of our research programs, including clinical testing, the extent to which our issued and pending patents may protect our products and technology, the potential of such product candidates to lead to the development of commercial products, our anticipated timing for initiation or completion of our clinical trials for our product candidates, our future operating expenses, our future losses, our future expenditures and the sufficiency of our cash resources. Our actual results could differ materially from those discussed in our forward-looking statements for many reasons, including the risks faced by us and described in Part II, Item 1A of this Quarterly Report on Form 10-Q and our other filings with the Securities and Exchange Commission, or SEC. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

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

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

We are a pharmaceutical company focused on the research, development, and commercialization of novel proprietary products for the acute treatment of central nervous system conditions. All of our product candidates are based on our proprietary technology, the Staccato system. The Staccato system vaporizes an excipient-free drug to form a condensation aerosol that, when inhaled, allows for rapid systemic drug delivery. Because of the particle size of the aerosol, the drug is quickly absorbed through the deep lung into the bloodstream, providing speed of therapeutic onset that is comparable to intravenous, or IV, administration but with greater ease, patient comfort and convenience. In December 2009, we submitted our first New Drug Application, or NDA, to the U.S. Food and Drug Administration, or FDA, for our lead product candidate, AZ-004. In February 2010, the FDA accepted our filing and provided us a Prescription Drug User Fee Act, or PDUFA, goal date of October 11, 2010. In February 2010, we licensed the U.S. and Canadian commercialization rights to AZ-004 to Biovail Laboratories International SRL, or Biovail. We plan to seek additional commercial partners for AZ-004 outside of the United States and Canada.

In January 2009, we reduced, and in some cases suspended, the development of our other product candidates in order to concentrate our efforts and resources on the clinical, regulatory, manufacturing and commercial development of our lead product candidate. In the first half of 2010, we conducted a thorough review of our product pipeline, evaluating current and potential new Staccato-based product candidates. The result of this review yielded three categories of Staccato-based product candidates: (1) those product candidates where we believe we can add value through internal development, (2) those product candidates where we have developed the product idea, but where a development partner is required, and (3) product candidates based on new ideas, primarily focused on new chemical entities, where the Staccato technology can facilitate better or more effective delivery and pharmacology. In July 2010, we announced that we have selected AZ-007 (Staccato zaleplon) for the treatment of insomnia as the next product candidate to move forward into active development. In addition, we have created Addicere Therapeutics, Inc., as a wholly-owned subsidiary, to develop all applications of the Staccato technology for the pharmaceutical uses of nicotine. We are continuing to seek partners to support development of our product candidates.

Our clinical-stage product candidates in active development are:

	•		AZ-004 (Staccato loxapine). We are developing AZ-004 for the rapid treatment of agitation in patients with schizophrenia or bipolar disorder. In December 2009, we submitted our NDA to the FDA. In February 2010, the FDA accepted our filing and provided us a PDUFA goal date of October 11, 2010. We believe that the data generated from our clinical and non-clinical studies contained within our NDA submission adequately demonstrate the efficacy and safety of AZ-004 for the rapid treatment of agitation in patients with schizophrenia or bipolar disorder.

			In February 2010, we entered into a collaboration and license agreement, or license agreement, and a manufacture and supply agreement, collectively, the collaboration, with Biovail for AZ-004 (Staccato loxapine) for the treatment of psychiatric and/or neurological indications and the symptoms associated with these indications, including the initial indication of treating agitation in schizophrenia and bipolar disorder patients. The collaboration contemplates that we will be the exclusive supplier of AZ-004 for clinical and commercial uses and have responsibility for the NDA for AZ-004 for the initial indication of rapid treatment of agitation in patients with schizophrenia or bipolar disorder, as well as responsibility for any additional development and regulatory activities required for use in these two patient populations in the outpatient setting. Biovail will be responsible for commercialization for the initial indication and, if it elects, development and commercialization of additional indications for AZ-004 in the United States and Canada.

			Under the terms of the license agreement, Biovail paid us an upfront fee of $40 million, and we may be eligible to receive up to an additional $90 million in milestone payments upon achievement of predetermined regulatory, clinical and commercial manufacturing milestones. We may be subject to certain payment obligations to Biovail, up to $5 million, if we do not meet certain other milestones prior to a termination of the license agreement. We are also eligible to receive tiered royalty payments of 10% to 25% on any net sales of AZ-004. We are responsible for conducting and funding all development and regulatory activities associated with AZ-004’s initial indication for the rapid treatment of agitation in patients with schizophrenia or bipolar disorder as well as for its possible use in the outpatient setting in these two patient populations. Our obligation to fund the outpatient development efforts is limited to a specified amount, none of which is expected to be incurred in 2010. Biovail is responsible for certain Phase 4 development commitments and related costs and expenses. For additional indications, we have an obligation regarding certain efforts and related costs and expenses, up to a specified amount, and, if it elects, Biovail is responsible for all other development commitments and related costs and expenses.

			Under the terms of the manufacture and supply agreement, we are the exclusive supplier of AZ-004 and have responsibility for the manufacture, packaging, labeling and supply for clinical and commercial uses. Biovail will purchase AZ-004 from us at predetermined transfer prices. The transfer prices depend on the volume of AZ-004 purchases, subject to certain adjustments.

			Either party may terminate the collaboration for the other party’s uncured material breach or bankruptcy. In addition, Biovail has the right to terminate the collaboration (a) upon 90 days written notice for convenience; (b) upon 90 days written notice if the FDA does not approve the AZ-004 NDA for the initial indication for the rapid treatment of agitation in patients with schizophrenia or bipolar disorder; (c) immediately upon written notice for safety reasons or withdrawal of marketing approval; (d) upon 90 days written notice upon certain recalls of the product; or (e) immediately upon written notice within 60 days of termination of the manufacture and supply agreement under certain circumstances. The manufacture and supply agreement automatically terminates upon the termination of the license agreement.

	•		AZ-007 (Staccato zaleplon). We have completed Phase 1 testing for AZ-007. This product candidate is being developed for the treatment of insomnia in patients who have difficulty falling asleep, including patients who awake in the middle of the night and have difficulty falling back asleep. In the Phase 1 study, AZ-007 delivered an IV-like pharmacokinetic profile with a median time to peak drug concentration of 1.6 minutes. Pharmacodynamics, measured as sedation assessed on a 100 mm visual-analog scale, showed onset of effect as early as 2 minutes after dosing. In July 2010, we announced that we will move AZ-007 into active development, and we anticipate the commencement of Phase 2 clinical trials in the first half of 2011.

Our clinical-stage product candidates not in active development are:

	•		AZ-001 (Staccato prochlorperazine). During the third quarter of 2008, we conducted an end-of-Phase 2 meeting with the FDA for AZ-001. This product candidate is being developed for the treatment of patients suffering from acute migraine headaches. We believe we have a clear understanding of the development requirements for filing an NDA for this product candidate.

	•		AZ-104 (Staccato loxapine, low-dose). AZ-104, a lower-dose version of AZ-004, is being studied for the treatment of patients suffering from acute migraine headaches.

	•		AZ-002 (Staccato alprazolam). AZ-002 has completed a Phase 1 clinical trial in healthy subjects and a Phase 2a proof-of-concept clinical trial in panic disorder patients for the treatment of panic attacks, an indication we are not planning to pursue. However, given the safety profile, the successful and reproducible delivery of alprazolam, and the IV-like pharmacological effect demonstrated to date, we are assessing AZ-002 for other possible indications and renewed clinical development.

	•		AZ-003 (Staccato fentanyl). We have completed and announced positive results from a Phase 1 clinical trial of AZ-003 in opioid-naïve healthy subjects. This product candidate is being developed for the treatment of patients with acute pain, including patients with breakthrough cancer pain and postoperative patients with acute pain episodes.

On May 4, 2010, we entered into a Loan and Security Agreement, or Loan Agreement, with Hercules Technology Growth Capital, Inc., or Hercules. Under the terms of the Loan Agreement, we have borrowed $15,000,000 at an interest rate of the higher of (i) 10.75% or (ii) 6.5% plus the prime rate as reported in the Wall Street Journal, with a maximum interest rate of 14%, and issued to Hercules a secured term promissory note evidencing the loan. We will make interest only payments for the initial eight months, which will be extended for an additional thee months if we receive FDA approval for the AZ-004 NDA by February 1, 2011. Thereafter, the loan will be repaid in 33 equal monthly installments. The Loan Agreement limits both the seniority and amount of future debt we may incur. The Company may be required to repay the loan in the event of a change in control. In conjunction with the loan, we issued to Hercules a five-year warrant to purchase 376,394 shares of our common stock at a price of $2.69 per share. The warrant is immediately exercisable and expires five years from the effective date. We estimated the fair value of this warrant as of the issuance date to be $921,000, which was recorded as a debt discount to the loan and consequently a reduction to the carrying value of the loan. The fair value of the warrant was calculated using the Black-Scholes option valuation model, and was based on the contractual term of the warrant of five years, a risk-free interest rate of 2.31%, expected volatility of 84% and 0% expected dividend yield. We also recorded fees paid to Hercules as a debt discount, which further reduced the carrying value of the loan. The debt discount is being amortized to interest expense.

In May 2010, we obtained a committed equity financing facility under which we may sell up to the lesser of $25 million of common stock or 10,581,724 shares of our common stock to Azimuth Opportunity, Ltd., or Azimuth, over a 24-month period. We are not obligated to utilize any of the facility and we remain free to enter into and consummate other equity and debt financing transactions. We will determine, at our sole discretion, the timing, the dollar amount and the price per share of each draw under this facility, subject to certain conditions. When and if we elect to use the facility, we will issue shares to Azimuth at a discount between 5.00% and 6.75% to the volume weighted average price of our common stock over a preceding period of trading days. Azimuth is not required to purchase any shares at a pre-discounted purchase price below $3.00 per share. Any shares sold under this facility will be sold pursuant to a shelf registration statement declared effective by the Securities and Exchange Commission on May 20, 2010. This facility replaces a similar facility that was established in March 2008 and expired after its 24-month term. As of June 30, 2010, there have been no sales of common stock under either of these facilities.

request, Autoliv will manufacture up to two additional production lines for the commercial manufacture of chemical heat packages at a cost not to exceed $2.4 million for each additional line.

The provisions of the amendment superseded (a) our obligation set forth in the supply agreement to reimburse Autoliv for certain expenses related to the equipment and tooling used in production and testing of the chemical heat packages in an amount of up to $12 million upon the earliest of December 31, 2011, 60 days after the termination of the supply agreement or 60 days after approval by the FDA of an NDA filed by us, and (b) the obligation of Autoliv to transfer possession and ownership of such equipment and tooling. Pursuant to the amendment, the parties also agreed to revise the specified purchase price of chemical heat packages supplied by Autoliv, which varies based on annual quantities that we order.

Other than those licensed to Biovail, we have retained all rights to our product candidates and the Staccato system. We intend to capitalize on our internal resources to develop certain product candidates and to identify routes to utilize external resources to develop and commercialize other product candidates.

We were incorporated on December 19, 2000. We have funded our operations primarily through the sale of equity securities, payments received pursuant to collaborations, capital lease and debt financings and government grants. We have generated $16.9 million in revenues from inception through June 30, 2010, $10 million of which was earned through the license and development agreement or development agreement with Endo Pharmaceuticals, Inc, or Endo, and $6.9 million through United States Small Business Innovation Research grants and drug compound feasibility screening fees. In prior years, we have recognized governmental grant revenue and drug compound/new chemical entity feasibility revenue, however, we expect no grant revenue or drug compound feasibility screening revenue in 2010. In January 2009, we mutually agreed with Endo to terminate the development agreement, at which time we fully fulfilled our obligations under the development agreement, and recognized the remaining $9.5 million of deferred revenues into revenue during the three months ended March 31, 2009. To date, we have received funding totaling $40 million from our Biovail collaboration. We do not expect any material product revenue until at least 2011.

We have incurred significant losses since our inception. As of June 30, 2010, our deficit accumulated during development stage was $290.9 million and total stockholders’ deficit was $28.7 million. We recognized net losses of $26.3 million, $56.1 million, $77.0 million, $55.9 million and $336.0 million during the six months ended June 30, 2010, the years ended December 31, 2009, 2008 and 2007, and the period from December 19, 2000 (Inception) to June 30, 2010, respectively. We expect our net losses to continue, however we expect a decrease in operating expenses in 2010 as compared to 2009 due to our decreased clinical activity.

The process of conducting preclinical studies and clinical trials necessary to obtain FDA approval is costly and time consuming. We consider the development of our product candidates to be crucial to our long term success. If we do not complete development of our product candidates and obtain regulatory approval to market one or more of these product candidates, we may be forced to cease operations. The probability of success for each product candidate may be impacted by numerous factors, including preclinical data, clinical data, competition, device development, manufacturing capability, regulatory approval and commercial viability. Our strategy has been to focus our resources on AZ-004, and in July 2010 we announced that we will move AZ-007 into active development. In February 2010, the FDA accepted for filing, the NDA that we submitted in December 2009 for AZ-004 and provided us a PDUFA goal date of October 11, 2010. We have announced that we are seeking partnerships to continue development of our other programs. If in the future we enter into additional partnerships, third parties could have control over preclinical development or clinical trials for some of our product candidates. Accordingly, the progress of any such product candidates would not be under our control. We cannot forecast with any degree of certainty which of our product candidates, if any, will be subject to any future partnerships or how such arrangements would affect our development plans or capital requirements.

As a result of the uncertainties discussed above, the uncertainty associated with clinical trial enrollments, and the risks inherent in the development process, we are unable to determine the duration and completion costs of the current or future clinical stages of our product candidates or when, or to what extent, we will generate revenues from the commercialization and sale of any of our product candidates. Development timelines, probability of success and development costs vary widely. While we are currently focused on developing our product candidates, we anticipate that we and our partners, will make determinations as to which programs to pursue and how much funding to direct to each program on an ongoing basis in

response to the scientific and clinical success of each product candidate, as well as an ongoing assessment as to the product candidate’s commercial potential. We do not expect any of our current product candidates to be commercially available before 2011, if at all.

We believe that with current cash, cash equivalents and marketable securities along with interest earned thereon, the proceeds from option exercises and purchases of common stock pursuant to our 2005 Employee Stock Purchase Plan (our “ESPP”), we will be able to maintain our currently planned operations through the second quarter of 2011 and will extend into 2012 if we achieve the eligible milestones under the Biovail collaboration during the next 12 months. Changing circumstances may cause us to consume capital significantly faster or slower than we currently anticipate. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available financial resources sooner than we currently expect.

Results of Operations

Comparison of Three and Six Months Ended June 30, 2010 and 2009

Revenue

We had no revenues in the three or six months ended June 30, 2010 or the three months ended June 30, 2010 and had $9.5 million of revenues during the six months ended June 30, 2009. In January 2009, we mutually agreed with Endo to terminate our development agreement, at which time we fulfilled our obligations under the development agreement, and recognized the remaining $9.5 million of deferred revenues into revenues. During the three months ended March 31, 2010, we received an upfront payment of $40 million from Biovail upon entering into the collaboration with Biovail. We do not expect to recognize any revenues under the Biovail collaboration in 2010.

Research and Development Expenses

Research and development costs are identified as either directly attributable to one of our product candidates or as general research. Direct costs consist of personnel costs directly associated with a candidate, preclinical study costs, clinical trial costs, related clinical drug and device development and manufacturing costs, contract services and other research expenditures. Overhead, facility costs and other support service expenses are allocated to each candidate or to general research, and the allocation is based on employee time spent on each program.

The following table allocates our expenditures between product candidate costs or general research, based on our internal records and estimated allocations of employee time and related expenses (in thousands):


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2010		2009		2010		2009
Product candidate expenses	$	7,122	$	9,906	$	13,302	$	18,477
General research		1,168		2,099		2,552		4,493

Total research and development expenses	$	8,290	$	12,005	$	15,854	$	22,970

Research and development expenses were $8.3 million and $15.9 million during the three and six months ended June 30, 2010, respectively, and $12.0 million and $23.0 million in the same periods in 2009, respectively. In January 2009, we restructured our operations, including an approximate 33% reduction in headcount, to focus our efforts on the continued rapid development of our AZ-004 (Staccato loxapine) product candidate.

The restructuring resulted in a decrease in both product candidate and general research expenses. The emphasis on the rapid development of AZ-004 resulted in AZ-004 accounting for 99% of product candidate expenses in the three and six months ended June 30, 2010, respectively, as compared to 84% and 77% in the same periods in 2009, respectively.

We have conducted a review of our product candidate portfolio, and we plan to advance the development of AZ-007 (Staccato zaleplon) in the second half of 2010. We are seeking partners to support continued development of our other product candidates, but we may develop one or more of these other product

candidates without partner support. We expect our research and development expenses to slightly increase in the second half of 2010 as we reinitiate the active development of AZ-007.

General and Administrative Expenses

General and administrative expenses were $3.8 million and $8.9 million during the three and six months ended June 30, 2010, respectively, and $4.2 million and $8.1 million in the same periods a year ago, respectively. Our 2010 expenses for the six months ended June 30, 2010 included a charge of $1.1 million related to our entering into a sublease agreement for a portion of one of our Mountain View facilities equal to the difference between the lease payments made by us and the cash receipts to be generated from the sublease over the life of the sublease and a $0.3 million non-cash share-based compensation charge for the surrender of certain stock options. Excluding these charges general and administrative expenses decreased as a result of our restructuring in the first quarter of 2009, as discussed below.

We expect our general and administrative expenses to remain consistent, excluding the above outlined share-based compensation charge and the charge related to our subleasing of a portion of our facilities, with current levels.

Restructuring Charges

In January 2009, we restructured our operations to focus our efforts on the continued rapid development of our AZ-004 (Staccato loxapine) product candidate. The restructuring included a workforce reduction of 50 employees, representing approximately 33% of our total workforce and was completed in the second quarter of 2009. We incurred restructuring expenses related to employee severance and other termination benefits, including a non-cash charge related to modifications to share-based awards.

Change in the Fair Value of Contingent Consideration Liability

In connection with our acquisition of all of the outstanding equity of Symphony Allegro, Inc., or Allegro, in the third quarter of 2009, we are obligated to pay Symphony Allegro Holdings LLC, or Holdings, certain percentages of cash receipts that may be generated from future collaboration transactions for AZ-002, AZ-004 and/or AZ-104. We measure the fair value of this contingent consideration liability on a recurring basis. Any changes in the fair value of this contingent consideration liability are recognized in earnings in the period of the change. Certain events, including, but not limited to, clinical trial results, FDA approval or nonapproval of our submissions, such as our NDA filed in December 2009, the timing and terms of a strategic partnership, and the commercial success of AZ-002, AZ-004 and/or AZ-104, could have a material impact on the fair value of the contingent consideration liability, and as a result, our results of operations.

Interest and Other Income/(Expense), Net

Interest and other income/(expense) was $28,000 and $9,000 the three and six months ended June 30, 2010, respectively, and $(9,000) and $88,000 in the same periods in 2009, respectively. The amounts primarily represent income earned on our cash and cash equivalents and marketable securities and in 2009 on investments held by Allegro as well as losses on the retirement of fixed assets. The decrease for the six month period was primarily due to lower interest earned on those balances and losses incurred on our fixed asset retirements. We expect interest income to continue to remain nominal through 2010 as we expect the low interest rate environment to continue and as we do not expect any material losses on the retirement of fixed assets.

Interest Expense

Interest expense was $370,000 and $425,000 for the three and six months ended June 30, 2010, respectively, and $125,000 and $283,000 in the same periods in 2009, respectively. The amounts represent interest on our equipment financing obligations and term loan agreement. Interest expense increased due to the addition of the $15 million term loan agreement in May 2010. We expect interest expense to increase from levels in the first half of the year due to the addition of the term loan.

Liquidity and Capital Resources

Since inception, we have financed our operations primarily through private placements and public offerings of equity securities, receiving aggregate net proceeds from such sales totaling $244.4 million, revenues primarily from the Endo development agreement and government grants totaling $16.9 million. We have received funding totaling $40 million from our Biovail collaboration, and additional funding from equipment financing obligations and term loans, interest earned on investments, as described below, and

funds received upon exercises of stock options and exercises of purchase rights under our ESPP. As of June 30, 2010, we had $41.7 million in cash, cash equivalents and marketable securities. Our cash and marketable securities balances are held in a variety of interest bearing instruments, including obligations of U.S. government agencies, high credit rating corporate borrowers and money market accounts. Cash in excess of immediate requirements is invested with regard to liquidity and capital preservation.

Cash Flows from Operating Activities. Net cash provided by (used in) operating activities was $23.1 million and $(30.0) million during the six months ended June 30, 2010 and 2009, respectively. The net cash provided in the six months ended June 30, 2010 primarily reflects the receipt of the $40 million up-front payment from Biovail as part of our collaboration and the receipt of the $1.4 million other receivable. Cash flows from operations in the six months ended June 30, 2010 also reflects the net loss of $26.3 million, net of share-based compensation expense of $3.3 million and depreciation of $2.3 million.

The net cash used in the six months ended June 30, 2009 primarily reflects the net loss of $23.9 million, net of non-cash share-based compensation expense of $3.7 million and depreciation of $2.5 million and the decrease in deferred revenues related to the termination of the development agreement with Endo of $9.5 million and decreases in accrued clinical and other accrued expenses of $1.6 million and accounts payables of $1.0 million.

Cash Flows from Investing Activities. Net cash provided by (used in) investing activities was $(27.8) million and $17.8 million during the six months ended June 30, 2010 and 2009, respectively. Investing activities consist primarily of purchases and sales/maturities of marketable securities and capital purchases. During the six months ended June 30, 2010, we had purchases of marketable securities, net of maturities, of $21.0 million, and purchases of property and equipment of $6.8 million, primarily consisting of equipment purchases.

During the six months ended June 30, 2009, we had sales/maturities of marketable securities, net of purchases, of $6.6 million, maturities of available-for-sale securities held by Allegro of $11.9 million, and purchases of property and equipment of $0.7 million, primarily consisting of equipment purchases.

Cash Flows from Financing Activities. Net cash provided by (used in) financing activities was $5.5 million and $(2.0) million during the six months ended June 30, 2010 and 2009, respectively. Cash flows from financing activities have generally consisted of proceeds from the issuance of our common stock and net cash flows from our financing agreements. In the six months ended June 30, 2010, we made a payment of $7.5 million to Holdings as a result of our receipt of the $40 million Biovail payment and we borrowed $15.0 million under a term loan agreement. In the six months ended June 30, 2010 and 2009, principal payments on our equipment financing obligations were $2.4 million and $2.4 million, respectively.

We believe that with current cash, cash equivalents and marketable securities along with interest earned thereon, the proceeds from option exercises and purchases of common stock pursuant to our ESPP, we will be able to maintain our currently planned operations through the second quarter of 2011 and will extend into 2012 if we achieve the eligible milestones under the Biovail collaboration during the next 12 months. Changing circumstances may cause us to consume capital significantly faster or slower than we currently anticipate. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available financial resources sooner than we currently expect. The key assumptions underlying these estimates include:

	•		achievement of the milestones in the Biovail collaboration;

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

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

	•		no significant growth in the number of our employees during this period.

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

outlays and operating expenditures associated with our current and anticipated clinical trials. Our future funding requirements will depend on many factors, including:

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

	•		the cost, timing and outcomes of regulatory approvals; most particularly the approval of our NDA for AZ-004;

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

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

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

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

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

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

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

We will need to raise additional funds to support our operations, and such funding may not be available to us on acceptable terms, or at all. If we are unable to raise additional funds when needed, we may not be able to continue development of our product candidates or we could be required to delay, scale back or eliminate some or all of our development programs, reduce our efforts to build our commercial manufacturing capacity, or suspend other operations. Additionally, any delay in approval of our lead program may affect our ability to fund our other development programs. We may seek to raise additional funds through public or private financing, strategic partnerships or other arrangements. Any additional equity financing may be dilutive to stockholders. If we raise funds through collaborative or licensing arrangements, we may be required to relinquish, on terms that are not favorable to us, rights to some of our technologies or product candidates that we would otherwise seek to develop or commercialize ourselves. Our failure to raise capital when needed may harm our business, financial condition, results of operations, and prospects.

Contractual Obligations

We lease two buildings with an aggregate of 106,894 square feet of manufacturing, office and laboratory facilities in Mountain View, California, which we began to occupy in the fourth quarter of 2007. The lease for both facilities expires on March 31, 2018, and we have two options to extend the lease for five years each. We sublease a total of 40,290 square feet of these facilities. Our sublease agreements expire on January 31, 2011 with regards to 19,334 square feet and on February 28, 2014 with regards to 20,956 square feet. We believe that the Mountain View facilities are sufficient for our office, manufacturing and laboratory needs for at least the next three years.

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

On May 4, 2010, we entered into a Loan and Security Agreement, or loan agreement, with Hercules Technology Growth Capital, Inc., or Hercules. Under the terms of the loan agreement, we have borrowed $15,000,000 at an interest rate equal to the higher of (i) 10.75% or (ii) 6.5% plus the prime rate as reported in the Wall Street Journal, with a maximum interest rate of 14%, and issued to Hercules a secured term promissory note evidencing the loan. We will make interest only payments for the initial eight months, which will be extended for an additional three months if we receive FDA approval for the AZ-004 NDA by February 1, 2011. Thereafter, the loan will be repaid in 33 equal monthly installments.

On November 2, 2007, we entered into a manufacturing and supply agreement, or the supply agreement, with Autoliv ASP, Inc, or Autoliv, relating to the commercial supply of chemical heat packages that can be incorporated into our Staccato device. Autoliv had developed these chemical heat packages for us pursuant to a development agreement between Autoliv and us executed in October 2005. In June 2010, we entered into an agreement to amend the terms of the supply agreement with Autoliv, or the amendment. Under the terms of the amendment, we paid Autoliv $4,000,000 and issued Autoliv a $4,000,000 promissory note in return for a production line for the commercial manufacture of chemical heat packages. The note will bear interest beginning on January 1, 2011 at 8% per annum and will be paid in 48 consecutive and equal installments of $97,000 beginning on that date. At our request, Autoliv will manufacture up to two additional production lines for the commercial manufacture of chemical heat packages at a cost not to exceed $2.4 million for each additional line.

We will pay Autoliv a specified purchase price, which varies based on annual quantities ordered by us, per chemical heat package delivered. The initial term of the supply agreement expires on December 31, 2012, at which time the supply agreement will automatically renew for successive five-year renewal terms unless we or Autoliv notifies the other party no less than 36 months prior to the end of the initial term or the then-current renewal term that such party wishes to terminate the supply agreement.

Our scheduled future minimum contractual payments, net of sublease income, including interest, are as follows (in thousands):


	Operating		Equipment
	Lease		Financing		Loan
	Agreements		Obligations		Agreements		Total
2010 — remaining 6 months	$	3,235	$	803	$	806	$	4,844
2011		4,657		443		6,703		11,803
2012		4,825		—		7,489		12,314
2013		4,469		—		6,962		11,431
2014		4,859		—		1,164		6,023
Thereafter		15,858		—		—		15,858

Total	$	37,903	$	1,246	$	23,124	$	62,273

Due to a late payment in October 2009, the Company may have been in default of the terms of its equipment financing obligations as of June 30, 2010. The Company does not believe it was in default. However, if the Company was in default, the lender would have the right to demand payment on all outstanding obligations. As a result, the Company has classified all of the outstanding equipment financing obligations as a current liability as of June 30, 2010. Subsequent to the late payment, the Company paid the installment that was at issue and has paid all subsequent installments in a timely manner.

Critical Accounting Policies, Estimates and Judgments

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments related to development costs. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making assumptions about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in Note 3 of the notes to the consolidated financial statements in our Annual Report on Form 10-K as filed with the SEC on March 9, 2010, we believe the following accounting policies are critical to the process of making significant estimates and judgments in preparation of our financial statements.

Share-Based Compensation

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

We estimated the expected term of options based on the historical term periods of options that have been granted but are no longer outstanding and the estimated terms of outstanding options. We estimated the volatility of our stock based on our actual historical volatility since our initial public offering. We base the risk-free interest rate that we use in the option pricing model on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option pricing model.

We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. All share-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.

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

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

See Note 5 to the condensed consolidated financial statements in this Quarterly Report on this Form 10-Q for further information regarding SFAS 123R option valuation disclosures.

Contingent Consideration Liability

In August 2009, we completed our purchase of all of the outstanding equity of Allegro and in exchange we: (i) issued to Symphony Capital LLC and other investors, or the Allegro Investors, 10 million shares of our common stock; (ii) issued to the Allegro Investors five year warrants to purchase five million shares of our common stock with an exercise price of $2.26 per share; and (iii) will pay certain percentages of cash payments that may be generated from future partnering transactions for the programs.

We estimate the fair value of the liability associated with the contingent cash payments to the Allegro Investors, or contingent consideration liability, on a quarterly basis using a probability-weighted discounted cash flow model. We derive multiple cash flow scenarios for each of the product candidates subject to the cash payments and apply a probability to each of the scenarios. These cash flows are then discounted at an 18% rate.

Changes in the fair value of the contingent consideration liability are recognized in earnings in the period of the change. Certain events including, but not limited to, clinical trial results, FDA approval or nonapproval of our submissions, such as our NDA submitted in December 2009, the timing and terms of a strategic partnership, the commercial success of the programs, and the discount rate used could have a material impact on the fair value of the contingent consideration liability, and as a result, our results of operations.

Revenue Recognition

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

In determining the accounting for collaboration agreements, we determine whether an arrangement involves multiple revenue-generating deliverables that should be accounted for as a single unit of accounting or divided into separate units of accounting for revenue recognition purposes and, if this division is required, how the arrangement consideration should be allocated among the separate units of accounting. If the arrangement represents a single unit of accounting, the revenue recognition policy and the performance obligation period must be determined, if not already contractually defined, for the entire arrangement. If the arrangement represents separate units of accounting, a revenue recognition policy must be determined for each unit.

Revenues for non-refundable upfront license fee payments, where we continue to have obligations, will be recognized as performance occurs and obligations are completed.

Recently Issued Accounting Standards

The FASB ratified ASU 2010-13, which eliminates the residual method of allocation, and instead requires companies to use the relative selling price method when allocating revenue in a multiple deliverable arrangement. When applying the relative selling price method, the selling price for each deliverable shall be determined using vendor specific objective evidence of selling price, if it exists, otherwise using third-party evidence of selling price. If neither vendor specific objective evidence nor third-party evidence of selling price exists for a deliverable, companies shall use their best estimate of the selling price for that deliverable when applying the relative selling price method. ASU 2010-13 shall be effective in fiscal years beginning on or after June 15, 2010, with earlier application permitted. Companies may elect to adopt this guidance prospectively for all revenue arrangements entered into or materially modified after the date of adoption, or retrospectively for all periods presented. We are currently evaluating the potential impact, if any, of the adoption of this guidance on our financial position, results of operations and cash flows.

In March 2010, the FASB issued new guidance on the use of the milestone method of recognizing revenue for research and development arrangements under which consideration to be received by the vendor is contingent upon the achievement of certain milestones. The update provides guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. A vendor can recognize consideration in its entirety as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. Additional disclosures describing the consideration arrangement and the entity’s accounting policy for recognition of such milestone payments are also required. The new guidance is effective for fiscal years, and interim periods within such fiscal years, beginning on or after June 15, 2010, with early adoption permitted. The guidance may be applied prospectively to milestones achieved during the period of adoption or retrospectively for all prior periods. We are currently evaluating the potential impact, if any, of the adoption of this guidance on our financial position, results of operations and cash flows.

Off Balance Sheet Arrangements

None

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk is confined to our cash, cash equivalents, and marketable securities. The primary objective of our investment activities is to preserve our capital to fund operations. We also seek to maximize income from our investments without assuming significant risk. To achieve our objectives, we maintain a portfolio of cash equivalents and marketable securities in a variety of securities of high credit quality. As of June 30, 2010, we had cash, cash equivalents and marketable securities of $41.7 million. The securities in our investment portfolio are not leveraged, are classified as available-for-sale and are, due to their very short-term nature, subject to minimal interest rate risk. We currently do not hedge interest rate exposure. Because of the short-term maturities of our investments, we do not believe that an increase in market rates would have a material negative impact on the realized value of our investment portfolio. We actively monitor changes in interest rates. We perform quarterly reviews of our investment portfolio and

believe we have minimal exposure related to mortgage and other asset-backed securities. We have no exposure to auction rate securities.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

Our management (with the participation of our chief executive officer, chief financial officer and outside counsel) has reviewed our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on that evaluation, our chief executive officer and chief financial officer have concluded that, as of June 30, 2010, our internal disclosure controls and procedures were effective.

Changes in Internal Controls over Financial Reporting

There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls.

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

PART II. OTHER INFORMATION

Item 1A.

RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below, together with all of the other information included in this Quarterly Report, before deciding whether to invest in shares of our common stock. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. The occurrence of any of the following risks could harm our business, financial condition or results of operations. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment.

Risks Relating to Our Business

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

We are not profitable and have incurred significant net losses in each year since our inception, including net losses of $26.3 million, $56.1 million, $77.0 million, $55.9 million and $336.0 million for the six months ended June 30, 2010, the years ended December 31, 2009, 2008 and 2007, and the period from December 19, 2000 (inception) to June 30, 2010, respectively. As of June 30, 2010, we had a deficit accumulated during development stage of $290.9 million and a stockholders’ deficit of $28.7 million. Although we expect our expenses to decrease in 2010 compared to 2009 due to lower expected clinical expenses with respect to our lead development program, we expect to incur substantial net losses and negative cash flow for the foreseeable future. These losses and negative cash flows have had, and will continue to have, an adverse effect on our stockholders’ equity and working capital.

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

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

You must evaluate us in light of the uncertainties and complexities affecting a development stage pharmaceutical company. We have not completed clinical development for any of our product candidates. We submitted our NDA for AZ-004 in December 2009, and each of our other product candidates is at an earlier stage of development. Each of our product candidates will be unsuccessful if it:

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

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

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

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

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

The process for obtaining approval of an NDA is time consuming, subject to unanticipated delays and costs, and requires the commitment of substantial resources.

The FDA is conducting an in-depth review of our NDA to determine whether to approve AZ-004 for commercial marketing for the indications we have proposed. If the FDA is not satisfied with the information we provide, the agency may refuse to approve our NDA or may require us to perform additional studies or provide other information in order to secure approval. The FDA may delay, limit or refuse to approve our NDA for many reasons, including:

	•		the information we submit may be insufficient to demonstrate that AZ-004 is safe and effective;

	•		the FDA might not approve the processes or facilities of Alexza, or those of our vendors, that will be used for the commercial manufacture of AZ-004; or

	•		the FDA’s interpretation of the nonclinical, clinical or manufacturing data we provided in our NDA may differ from our own interpretation of such data.

If the FDA determines that the clinical trials of AZ-004 that were submitted in support of our NDA were not conducted in full compliance with the applicable protocols for these studies, as well as with applicable regulations and standards, or if the agency does not agree with our interpretation of the results of such studies, the FDA may reject the data that resulted from such studies. The rejection of data from clinical trials required to support our NDA for AZ-004 could negatively impact our ability to obtain marketing authorization for this product candidate and would have a material adverse effect on our business and financial condition.

In addition, our NDA may not be approved, or approval may be delayed, as a result of changes in FDA policies for drug approval during the review period. For example, although many products have been approved by the FDA in recent years under Section 505(b)(2) under the Federal Food, Drug and Cosmetic Act, objections have been raised to the FDA’s interpretation of Section 505(b)(2). If challenges to the FDA’s interpretation of Section 505(b)(2) are successful, the agency may be required to change its interpretation, which could delay or prevent the approval of our NDA for AZ-004.

Under goals set in accordance with the Prescription Drug User Fee Act of 1992, as amended, the FDA reviews most NDAs within 10 months of submission. The review process may be formally extended by three months or longer if the FDA requires additional time to review any additional information that the agency requests or that we elect to provide. If we are unable to timely respond to the FDA’s requests for additional information in the course of its review of the NDA for AZ-004, the approval of the NDA would be delayed. In addition, other companies have announced that the FDA has notified them that their scheduled review dates were delayed due to the FDA’s internal resource constraints. There can be no assurance that the FDA will not impose such delays on the continuing review of our NDA for AZ-004, and any failure or significant delay in obtaining the required approval would have a material adverse effect on our business and financial condition.

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

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

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

	•		the cost, timing and outcomes of regulatory proceedings;

	•		the cost and timing of developing manufacturing capacity;

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

	•		revenues received from any existing or future products;

	•		payments received under our collaboration with Biovail and any future strategic partnerships;

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

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

We believe that with current cash, cash equivalents and marketable securities along with interest earned thereon, the proceeds from option exercises and purchases of common stock pursuant to our ESPP, we will be able to maintain our currently planned operations through the second quarter of 2011 and will extend into 2012 if we achieve the eligible milestones under the Biovail collaboration during the coming 12 months. Further, if the FDA does not approve AZ-004 for commercial marketing in October 2010, we may delay the clinical development of AZ-007. Changing circumstances may cause us to consume capital significantly faster or slower than we currently anticipate. We have based these estimates on assumptions that may prove to be wrong, and we could exhaust our available financial resources sooner than we currently expect. The key assumptions underlying these estimates include:

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

	•		achievement of the milestone payments pursuant to our collaboration with Biovail;

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

	•		no growth in the number of our employees during this period.

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

Unstable market conditions may have serious adverse consequences on our business.

The recent economic downturn and market instability has made the business climate more volatile and more costly. Our general business strategy may be adversely affected by unpredictable and unstable market conditions. If the current equity and credit markets deteriorate further, or do not improve, it may make any necessary debt or equity financing more difficult, more costly, and more dilutive. While we believe that with current cash, cash equivalents and marketable securities along with interest earned thereon, the proceeds from option exercises and purchases of common stock pursuant to our ESPP, we will be able to maintain our currently planned operations through the second quarter of 2011 and will extend into 2012 if we achieve the eligible milestones under the Biovail collaboration during the coming 12 months, we may obtain additional financing on less than attractive rates or on terms that are excessively dilutive to existing stockholders. Failure to secure any necessary financing in a timely manner and on favorable terms could

have a material adverse effect on our business, financial condition and stock price and could require us to delay or abandon clinical development plans. There is a risk that one or more of our current component manufacturers and partners may encounter difficulties during challenging economic times, which would directly affect our ability to attain our operating goals on schedule and on budget.

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

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

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

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

	•		our product candidates may cause undesirable side effects.

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

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

In our daily dosing animal toxicology studies of prochlorperazine, the active pharmaceutical ingredient, or API, in AZ-001, we detected changes to, and increases of, the cells in the upper airway of the test animals. The terms for these changes and increases are “squamous metaplasia” and “hyperplasia,” respectively. We also observed lung inflammation in some animals. These findings occurred in daily dosing studies at doses that were proportionately substantially greater than any dose we expect to continue to develop or commercialize. In subsequent toxicology studies of AZ-001 involving intermittent dosing consistent with its intended use, we detected lower incidence and severity of the changes to, and increases of, the cells in the upper airway of the test animals compared to the daily dosing results. We did not observe any lung inflammation with intermittent dosing. In 2008, we completed a 28-day repeat dose inhalation study in dogs. Consistent with previous findings in shorter-term and higher dose studies, we observed dose-related minimal to slight squamous metaplasia in the upper respiratory tract, primarily in the lining of the nasal passages, in all treated groups. No lower respiratory tract or lung findings were reported. These findings suggest that the delivery of the pure drug compound of AZ-001 at the proportionately higher doses used in daily dosing toxicology studies may cause adverse consequences if we were to administer prochlorperazine chronically for prolonged periods of time. If we observe these findings in our clinical trials of AZ-001, it could prevent further development or commercialization of AZ-001.

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

We have not completed all the clinical trials necessary to support an application with the FDA for approval to market any of our product candidates other than what we believe to be adequate clinical trials to support the marketing approval for AZ-004 in the United States. Future clinical trials may be delayed or terminated as a result of many factors, including:

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

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

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

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

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

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

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

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

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

	•		we may experience delays in our ability to manufacture clinical trial materials in a timely manner as a result of ongoing process and design enhancements to our Staccato system.

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

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

A majority of our clinical studies to date for our product candidates, other than AZ-003, have been completed using a version of our single dose Staccato device we refer to as the chemical single dose, or CSD, device. We are developing a version of the CSD that is intended to cost less to manufacture and is more scalable than the current version of CSD. We refer to the newer version of this single dose device as the commercial production device, or CPD. The CPD incorporates the same basic chemical heat package and electronics as the CSD. The four NDA-supporting studies completed during 2009 were conducted with the CPD. Additionally, we have conducted a device comparability/bioequivalence study in normal volunteers using the CSD and the CPD versions of the device to determine if the drug dose dispensed by the two devices is comparable and/or bioequivalent. If the FDA determines that the results of this study and the available analytical and other in vitro data from these devices do not support the comparability and/or bioequivalency of the two devices, or if the FDA or foreign regulatory authorities determine the CPD is unacceptable for any other reason, we may be required to conduct additional clinical research for AZ-004 with the CPD. Conducting any additional clinical trials could delay any potential marketing approval.

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

We have filed an NDA for AZ-004, however we have not yet received regulatory approval from the FDA or any foreign regulatory authority to market AZ-004, and our other product candidates are in various stages of clinical development. The clinical development and regulatory approval process is extremely expensive and takes many years. The timing of any approval cannot be accurately predicted. If we fail to obtain regulatory approval for our current or future product candidates, we will be unable to market and sell them and therefore we may never be profitable.

As part of the regulatory process, we must conduct clinical trials for each product candidate to demonstrate safety and efficacy to the satisfaction of the FDA and other regulatory authorities abroad. The number and design of clinical trials that will be required varies depending on the product candidate, the condition being evaluated, the trial results and regulations applicable to any particular product candidate. In June 2008, we announced that our Phase 2a proof-of-concept clinical trial of AZ-002 (Staccato Alprazolam) did not meet either of its two primary endpoints. In September 2009, we announced that our Phase 2b clinical trial of AZ-104 (Staccato loxapine) for the treatment of migraine did not meet its primary endpoint.

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

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

The design of our clinical trials is based on many assumptions about the expected effect of our product candidates, and if those assumptions prove incorrect, the clinical trials may not produce statistically significant results. Our Staccato system is not similar to other approved drug delivery methods, and there is no precedent for the application of detailed regulatory requirements to our product candidates. We cannot assure you that the design of, or data collected from, the clinical trials of our product candidates will be sufficient to support the FDA and foreign regulatory approvals.

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

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

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

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

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

Part of the FDA approval process includes FDA inspections on manufacturing facilities to ensure adherence to applicable regulations and, to date, the FDA has not conducted any such inspections on our Mountain View manufacturing facility or on any of our component vendors. The FDA may delay, limit or deny marketing approval of our product candidates as a result of such inspections.

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

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

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

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

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

	•		restrictions on the products, suppliers or manufacturing processes;

	•		warning letters or untitled letters;

	•		civil or criminal penalties or fines;

	•		injunctions;

	•		product seizures, detentions or import bans;

	•		voluntary or mandatory product recalls and publicity requirements;

	•		suspension or withdrawal of regulatory approvals;

	•		total or partial suspension of production; and

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

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

Our Staccato system based product candidates contain electronic and other components in addition to the active pharmaceutical ingredients. As a result of the cost of developing and producing these components, the cost to produce our product candidates, and any approved products, will likely be higher per dose than the cost to produce intravenous or oral tablet products. This increased cost of goods may prevent us from ever selling any products at a profit. In addition, we are developing single dose and multiple dose versions of our Staccato system. Developing multiple versions of our Staccato system may reduce or eliminate our ability to achieve manufacturing economies of scale. Developing multiple versions of our Staccato system reduces our ability to focus development resources on each version, potentially reducing our ability to effectively develop any particular version. We expect to continue to modify each of our product candidates throughout their clinical development to improve their performance, dependability, manufacturability and quality. Some of these modifications may require additional regulatory review and approval, which may delay or prevent us from conducting clinical trials. The development and production of our technology entail a number of technical challenges, including achieving adequate dependability, that may be expensive or time consuming to solve. Any delay in or failure to develop and manufacture any future products in a cost effective way could prevent us from generating any meaningful revenues and prevent us from becoming profitable.

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

We do not have the ability to conduct preclinical studies or clinical trials independently for our product candidates. We must rely on third parties, such as contract research organizations, medical institutions, academic institutions, clinical investigators and contract laboratories, to conduct our preclinical studies and clinical trials. We are responsible for confirming that our preclinical studies are conducted in accordance with applicable regulations and that each of our clinical trials is conducted in accordance with its general investigational plan and protocol. The FDA requires us to comply with regulations and standards,

commonly referred to as good laboratory practices, or GLP, for conducting and recording the results of our preclinical studies and good clinical practices for conducting, monitoring, recording and reporting the results of clinical trials, to assure that data and reported results are accurate and that the clinical trial participants are adequately protected. Our reliance on third parties does not relieve us of these responsibilities. If the third parties conducting our clinical trials do not perform their contractual duties or obligations, do not meet expected deadlines, fail to comply with the FDA’s good clinical practice regulations, do not adhere to our clinical trial protocols or otherwise fail to generate reliable clinical data, we may need to enter into new arrangements with alternative third parties and our clinical trials may be extended, delayed or terminated or may need to be repeated, and we may not be able to obtain regulatory approval for or commercialize the product candidate being tested in such trials.

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

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

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

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

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

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

We outsource the manufacturing of the components of our Staccato system, including the printed circuit boards, the plastic airways, and the chemical heat packages to be used in our commercial single dose device. We have no experience in the manufacturing of components, other than our current chemical heat packages, and we currently lack the resources and the capability to manufacture them, on either a clinical or commercial scale. As a result, we rely on third parties to supply these components. We expect to continue to depend on third parties to supply these components for our current product candidates and any devices based on the Staccato system we develop in the foreseeable future.

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

confirming that the components used in the Staccato system are manufactured in accordance with the QSR or other applicable regulations.

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

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

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

A key element of our business strategy is our intent to selectively partner with pharmaceutical, biotechnology and other companies to obtain assistance for the development and potential commercialization of our product candidates. In December 2006, we entered into such a development relationship with Symphony Allegro, Inc., or Allegro, and in December 2007 we entered into a strategic relationship with Endo Pharmaceuticals, Inc., or Endo, for the development of AZ-003. In January 2009, we mutually agreed with Endo to terminate our agreement. In June 2009, we amended the terms of our option agreement with Allegro, resulting in our acquisition of Allegro and the termination of the agreement in August 2009. In February 2010, we entered into a collaboration with Biovail for the commercialization of AZ-004 in the United States and Canada. We intend to enter into additional strategic partnerships with third parties to develop and commercialize our product candidates. To date, other than Allegro, Endo and Biovail, we have not entered into any strategic partnerships for any of our product candidates. We face significant competition in seeking appropriate strategic partners, and these strategic partnerships can be intricate and time consuming to negotiate and document. We may not be able to negotiate additional strategic partnerships on acceptable terms, or at all. We are unable to predict when, if ever, we will enter into any additional strategic partnerships because of the numerous risks and uncertainties associated with establishing strategic partnerships. If we are unable to negotiate additional strategic partnerships for our product candidates we may be forced to curtail the development of a particular candidate, reduce or delay its development program or one or more of our other development programs, delay its potential commercialization, reduce the scope of our sales or marketing activities or undertake development or commercialization activities at our own expense. In addition, we will bear all the risk related to the development of that product candidate. If we elect to increase our expenditures to fund development or commercialization activities on our own, we may need to obtain additional capital, which may not be available to us on acceptable terms, or at all. If we do not have sufficient funds, we will not be able to bring our product candidates to market and generate product revenue.

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

Due to our relationship with Biovail, and for any other strategic partnerships or collaborations with pharmaceutical or biotechnology companies we may establish, we may be subject to a number of risks including:

•

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

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

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

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

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

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

	•		strategic partners may experience financial difficulties;

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

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

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

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

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

	•		demonstration of efficacy and safety in clinical trials;

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

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

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

	•		the timing of market entry relative to competitive treatments;

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

	•		relative convenience, product dependability and ease of administration;

	•		the strength of marketing and distribution support;

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

•

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Our current or potential strategic partners’ ability to obtain patents is uncertain because, to date, some legal principles remain unresolved, there has not been a consistent policy regarding the breadth or interpretation of claims allowed in patents in the United States, and the specific content of patents and patent applications

that are necessary to support and interpret patent claims is highly uncertain due to the complex nature of the relevant legal, scientific and factual issues. Furthermore, the policies governing pharmaceutical and medical device patents outside the United States may be even more uncertain. Changes in either patent laws or interpretations of patent laws in the United States and other countries may diminish the value of our intellectual property or narrow the scope of our patent protection.

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

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

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

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

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

In addition, administrative proceedings, such as interferences and reexaminations before the U.S. Patent and Trademark Office, could limit the scope of our patent rights. We may incur substantial costs and diversion of management and technical personnel as a result of our involvement in such proceedings. In particular, our patents and patent applications may be subject to interferences in which the priority of invention may be awarded to a third party. We do not know whether our patents and patent applications would be entitled to priority over patents or patent applications held by such a third party. Our issued patents may also be subject to reexamination proceedings. We do not know whether our patents would survive reexamination in light of new questions of patentability that may be raised following their issuance.

Third parties may assert that we are employing their proprietary technology or their proprietary products without authorization. In addition, third parties may already have or may obtain patents in the future and claim that use of our technologies or our products infringes these patents. We could incur substantial costs and diversion of management and technical personnel in defending our self against any of these claims. Furthermore, parties making claims against us may be able to obtain injunctive or other equitable relief, which could effectively block our ability to further develop, commercialize and sell any future products and could result in the award of substantial damages against us. In the event of a successful claim of infringement against us, we may be required to pay damages and obtain one or more licenses from third

parties. We may not be able to obtain these licenses at a reasonable cost, if at all. In that event, we could encounter delays in product introductions while we attempt to develop alternative methods or products. In the event we cannot develop alternative methods or products, we may be effectively blocked from developing, commercializing or selling any future products. Defense of any lawsuit or failure to obtain any of these licenses would be expensive and could prevent us from commercializing any future products.

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

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

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

We anticipate that, if approved, AZ-004 would compete with the available intramuscular, or IM, injectable form and oral forms of loxapine and other forms, such as IM, oral tablets, or oral solutions of available antipsychotic drugs for the treatment of agitation.

We anticipate that, if approved, AZ-007 would compete with non-benzodiazepine GABA-A receptor agonists. We are also aware of more than 10 generic versions of zolpidem oral tablets and one version of zaleplon that has received a Complete Response letter from the FDA, as well as at least five insomnia products that are under review by the FDA. Also, we are aware that a company has received a complete response letter from the FDA with respect to a version of zolpidem intended to treat middle of the night awakening. Additionally, we are aware of three products in Phase 3 development for the treatment of insomnia.

We anticipate that, if approved, AZ-001 and AZ-104 would compete with currently marketed triptan drugs and with other migraine headache treatments, including intravenous, or IV, delivery of prochlorperazine, the API in AZ-001. In addition, we are aware of at least 15 product candidates in development for the treatment of migraines, including triptan products.

We anticipate that, if approved, AZ-003 would compete with some of the available forms of fentanyl, including injectable fentanyl, oral transmucosal fentanyl formulations and ionophoretic transdermal delivery of fentanyl. We are also aware of three fentanyl products under review by regulatory agencies either in the United States or abroad, and at least 19 products in Phase 3 clinical trial development for acute pain, seven of which are fentanyl products. There are two inhaled forms of fentanyl products that are in Phase 2 development. In addition, if approved, AZ-003 would compete with various generic opioid drugs, such as oxycodone, hydrocodone and morphine, or combination products including one or more of such drugs.

We anticipate that, if approved, AZ-002 would compete with the oral tablet form of alprazolam and possibly IV and oral forms of other benzodiazepines.

Many of our competitors have significantly greater financial resources and expertise in research and development, manufacturing, preclinical testing, conducting clinical trials, obtaining regulatory approvals and marketing approved products than we do. Established pharmaceutical companies may invest heavily to discover quickly and develop novel compounds or drug delivery technology that could make our product candidates obsolete. Smaller or early stage companies may also prove to be significant competitors, particularly through strategic partnerships with large and established companies. In addition, these third

parties compete with us in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient registration for clinical trials, as well as in acquiring technologies and technology licenses complementary to our programs or advantageous to our business. Accordingly, our competitors may succeed in obtaining patent protection, receiving FDA approval or discovering, developing and commercializing products before we do. If we are not able to compete effectively against our current and future competitors, our business will not grow and our financial condition will suffer.

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

Although we have entered into an agreement to grant Biovail the rights to sell, market, and distribute AZ-004 in the United States and Canada, we have not entered into similar arrangements with respect to any other countries or jurisdictions, we do not have an internal sales organization and we have no experience in the sales and distribution of pharmaceutical products. There are risks involved with establishing our own sales capabilities and increasing our marketing capabilities, as well as entering into arrangements with third parties to perform these services. Developing an internal sales force is expensive and time consuming and could delay any product launch. On the other hand, if we enter into arrangements with third parties to perform sales, marketing and distribution services, our product revenues or the profitability of these product revenues are likely to be lower than if we market and sell any products that we develop ourselves.

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

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

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

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

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

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

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

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

termination or a change in role or responsibility in connection with a change of control of our company. We do not maintain life insurance policies on any employees. Failure to attract and retain personnel would prevent us from developing and commercializing our product candidates.

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

We face an inherent risk of product liability as a result of the clinical testing of our product candidates in clinical trials and will face an even greater risk if we commercialize any products. We may be held liable if any product we develop causes injury or is found otherwise unsuitable during product testing, manufacturing, marketing or sale. Regardless of merit or eventual outcome, liability claims may result in decreased demand for any product candidates or products that we may develop, injury to our reputation, withdrawal of clinical trials, costs to defend litigation, substantial monetary awards to clinical trial participants or patients, loss of revenue and the inability to commercialize any products that we develop. We have product liability insurance that covers our clinical trials up to a $10 million aggregate annual limit. We intend to expand product liability insurance coverage to include the sale of commercial products if we obtain marketing approval for AZ-004 or any other products that we may develop. However, this insurance may be prohibitively expensive, or may not fully cover our potential liabilities. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or delay the commercialization of our product candidates. If we are sued for any injury caused by any future products, our liability could exceed our total assets.

Healthcare law and policy changes, based on recently enacted legislation, may have an adverse effect on us.

Healthcare costs have risen significantly over the past decade. In March 2010, President Obama signed the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act, or, collectively, the Healthcare Reform Act. This law substantially changes the way health care is financed by both governmental and private insurers, and significantly impacts the pharmaceutical industry. The Healthcare Reform Act contains a number of provisions that are expected to impact our business and operations, including those governing enrollment in federal healthcare programs, reimbursement changes and fraud and abuse, which will impact existing government healthcare programs and will result in the development of new programs, including Medicare payment for performance initiatives and improvements to the physician quality reporting system and feedback program. We anticipate that if we obtain approval for our product candidates, some of our revenue and the revenue from our collaborators may be derived from U.S. government healthcare programs, including Medicare. Furthermore, beginning in 2011, the Healthcare Reform Act imposes a non-deductible excise tax on pharmaceutical manufacturers or importers who sell “branded prescription drugs,” which includes innovator drugs and biologics (excluding orphan drugs or generics) to U.S. government programs. We expect that the Healthcare Reform Act and other healthcare reform measures that may be adopted in the future could have an adverse effect on our industry generally and our ability to successfully commercialize our product candidates or could limit or eliminate our spending on development projects.

In addition to this recently enacted legislation, there will continue to be proposals by legislators at both the federal and state levels, regulators and third-party payors to keep these costs down while expanding individual healthcare benefits. Certain of these changes could impose limitations on the prices we will be able to charge for any product candidates that are approved or the amounts of reimbursement available for these products from governmental agencies or third-party payors, or may increase the tax obligations on life sciences companies such as ours. While it is too early to predict specifically what effect the recently enacted Health Reform Act and its implementation or any future legislation or policies will have on our business, we believe that healthcare reform may have an adverse effect on our business and financial condition.

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

The Controlled Substances Act imposes various registration, recordkeeping and reporting requirements, procurement and manufacturing quotas, labeling and packaging requirements, security controls and a restriction on prescription refills on certain pharmaceutical products. A principal factor in determining the

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

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

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

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

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

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

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

The laws and regulations affecting public companies, including the current provisions of the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, and rules enacted and proposed by the SEC and by the Nasdaq Global Market, will result in increased costs to us as we continue to undertake efforts to comply with rules

and respond to the requirements applicable to public companies. The rules make it more difficult and costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage as compared to the polices previously available to public companies. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or our board committees or as executive officers.

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

Our business is subject to increasingly complex corporate governance, public disclosure and accounting requirements that could adversely affect our business and financial results.

We are subject to changing rules and regulations of federal and state government as well as the stock exchange on which our common stock is listed. These entities, including the Public Company Accounting Oversight Board, the SEC and the Nasdaq Global Market, have issued a significant number of new and increasingly complex requirements and regulations over the course of the last several years and continue to develop additional regulations and requirements in response to laws enacted by Congress. On July 21, 2010, the Dodd-Frank Wall Street Reform and Protection Act, or the Dodd-Frank Act, was enacted. There are significant corporate governance and executive compensation-related provisions in the Dodd-Frank Act that require the SEC to adopt additional rules and regulations in these areas such as “say on pay” and proxy access. Our efforts to comply with these requirements have resulted in, and are likely to continue to result in, an increase in expenses and a diversion of management’s time from other business activities.

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

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

Risks Relating to Owning Our Common Stock

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

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

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

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

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

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

	•		period to period fluctuations in our operating results;

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

	•		changes in financial estimates or recommendations by securities analysts;

	•		sales results for AZ-004, if it is approved for marketing;

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

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

	•		developments in domestic and international governmental policy or regulations;

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

	•		additions or departures of key personnel;

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

	•		sales of our common stock (or other securities) by us; and

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

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

If we sell shares of our common stock in future financings, existing common stockholders will experience immediate dilution and, as a result, our stock price may go down.

We will need to raise additional capital to fund our operations, to develop our product candidates and to develop our manufacturing capabilities. We may obtain such financing through the sale of our equity securities from time to time. As a result, our existing common stockholders will experience immediate dilution upon any such issuance. For example, in August 2009 we issued 10,000,000 shares of our common stock and warrants to purchase an additional 5,000,000 shares of our common stock in connection with the closing of our acquisition of all of the equity of Symphony Allegro, Inc., in October 2009 we issued 8,107,012 shares of our common stock and warrants to purchase an additional 7,296,312 shares of our common stock in a private placement and in May 2010 we issued a warrant to purchase 376,394 shares of our common stock in connection with a secured term debt financing, and we entered into a common stock purchase agreement with Azimuth, which provides that, upon the terms and subject to the conditions set forth therein, Azimuth is committed to purchase up to the lesser of $25 million of our common stock or 10,581,724 shares of our common stock at times and in amounts determined by us. If we enter into other financing transactions in which we issue equity securities in the future, our existing common stockholders will experience immediate dilution upon any such issuance.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

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

Recent Sales of Unregistered Equity Securities

None

Use of Proceeds from the Sale of Registered Securities

None

Issuer Purchases of Equity Securities

None

Item 3. Defaults Upon Senior Securities

Due to a late payment, we may be in default of the terms of our equipment financing obligations, We do not believe we are in default. However, if we are in default, the lender would have the right to demand payment on all outstanding obligations. As result, we have classified all of the outstanding equipment financing obligations as a current liability. We paid the installment of $304,570 that was at issue in October 2009 and are current in our payment obligations as of the date of the filing of this report.

Item 5. Other Information

None.

Item 6. Exhibits

3.5		Amended and Restated Certificate of Incorporation. (1)

3.6		Amended and Restated Bylaws. (1)

3.7		Amendment to Amended and Restated Bylaws. (2)

4.1		Specimen Common Stock Certificate. (1)

4.2		Second Amended and Restated Investors’ Right Agreement dated November 5, 2004, by and between Alexza and certain holders of Preferred Stock. (1)

10.1		Loan and Security Agreement between Alexza and Hercules Technology Growth Capital, Inc. dated May 4, 2010.

10.2		Warrant issued by Alexza to Hercules Technology Growth Capital, Inc. dated May 4, 2010.

10.3		Common Stock Purchase Agreement between Alexza and Azimuth Opportunity Ltd. dated May 26, 2010. (3)

10.4†		Amendment No. 1 to Manufacturing and Supply Agreement between Alexza and Autoliv ASP, Inc. dated June 30, 2010.

10.5		Promissory Note issued by Alexza to Autoliv ASP, Inc. dated June 30, 2010.

31.1		Certification required by Rule 13a-14(a) or Rule 15d-14(a).

31.2		Certification required by Rule 13a-14(a) or Rule 15d-14(a).

32.1		Certifications required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).


†		Confidential treatment has been requested with respect to certain portions of this exhibit. This exhibit omits the information subject to this confidentiality request. Omitted portions have been filed separately with the SEC.

(1)		Incorporated by reference to exhibits to our Registration Statement on Form S-1 filed on December 22, 2005, as amended (File No. 333-130644).

(2)		Incorporated by reference to exhibit to our Annual Report on Form 10-K/A filed on April 10, 2007.

(3)		Incorporated by reference to exhibits to our Current Report on Form 8-K filed on May 26, 2010.

SIGNATURES

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


	Alexza Pharmaceuticals, Inc. (Registrant)
July 26, 2010	/s/ Thomas B. King
	Thomas B. King
	President and Chief Executive Officer


July 26, 2010	/s/ August J. Moretti
	August J. Moretti
	Senior Vice President, Chief Financial Officer and Secretary (principal financial officer)


July 26, 2010	/s/ Mark K. Oki
	Mark K. Oki
	Vice President, Finance and Controller (principal accounting officer)

Alexza Pharmaceuticals Inc. - FORM 10-Q - July 26, 2010

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