UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-K

(MARK ONE)

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

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

For the transition period from                    to                    

ANADYS PHARMACEUTICALS, INC.

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

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

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

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

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

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

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

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

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

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

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

     The aggregate market value of the common stock held by non-affiliates of the registrant computed by reference to the closing price of the registrant’s common stock reported on the Nasdaq Global Market as of the last business day of the registrant’s most recently completed second fiscal quarter was approximately $60,521,084 as of such date. In calculating such aggregate market value, shares of common stock owned of record or beneficially by officers or directors, and persons or entities known to the registrant to own more than ten percent of the registrant’s voting securities were excluded because such persons or entities may be deemed to be affiliates. This number is provided only for purposes of this Annual Report on Form 10-K and the registrant disclaims the existence of control or any admission thereof for any other purpose.

     As of February 28, 2010, the Registrant had outstanding 57,141,223 shares of common stock.

     Portions of the Company’s Proxy Statement to be filed with the Securities and Exchange Commission in connection with the 2011 Annual Meeting of Stockholders are incorporated herein by reference into Part III.

 

 

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

Table of Contents

		Page
PART I
Item 1. Business			3
Item 1A. Risk Factors			16
Item 1B. Unresolved Staff Comments			32
Item 2. Properties			32
Item 3. Legal Proceedings			32
Item 4. Reserved			32
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			33
Item 6. Selected Financial Data			35
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			36
Item 7A. Quantitative and Qualitative Disclosure About Market Risk			42
Item 8. Financial Statements and Supplementary Data			42
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			42
Item 9A. Controls and Procedures			43
Item 9B. Other Information			45
PART III
Item 10. Directors, and Executive Officers and Corporate Governance			46
Item 11. Executive Compensation			46
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			46
Item 13. Certain Relationships and Related Transactions, and Director Independence			47
Item 14. Principal Accounting Fees and Services			47
PART IV
Item 15. Exhibits and Financial Statement Schedules			48
EX-10.19
EX-10.20
EX-10.21
EX-10.22
EX-10.23
EX-23.1
EX-31.1
EX-31.2
EX-32.1

INFORMATION RELATED TO FORWARD-LOOKING STATEMENTS

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

PART I

Item 1. Business

Overview

     Anadys Pharmaceuticals, Inc. is a biopharmaceutical company dedicated to improving patient care by developing novel medicines for the treatment of hepatitis C. We believe hepatitis C represents a large and significant unmet medical need. Our objective is to contribute to an improved treatment outcome for patients with this serious disease.

     We are currently focusing most of our efforts on the development of ANA598, a direct-acting antiviral (DAA) for the treatment of hepatitis C. We are also making plans to resume the clinical development of ANA773, an oral, small-molecule inducer of endogenous interferons that acts via the Toll-like receptor 7, or TLR7, pathway for the treatment of hepatitis C.

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

     We have also investigated ANA773 in a separate Phase I trial for the treatment of patients with advanced cancer. Although we believe that ANA773 has potential utility in cancer, we do not have plans to continue the development of ANA773 for this indication at this time.

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

ANA598

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

     In 2009 we initiated a Phase IIa clinical study of ANA598 in combination with pegylated interferon-alfa and ribavirin, which is the current standard of care (SOC) for the treatment of hepatitis C. Dosing of ANA598 in this study concluded in 2010. In the Phase

IIa study, treatment-naïve (previously untreated) genotype 1 patients received ANA598 or placebo in combination with SOC for 12 weeks at dose levels of 200 mg twice daily (bid) or 400 mg bid, each with a loading dose of 800 mg bid on day one. After week 12, patients continued receiving SOC alone. Patients who achieved undetectable levels of virus at weeks four and 12 were randomized to stop all treatment at week 24 or 48. The primary endpoint of the study was the proportion of patients who achieved undetectable levels of virus at week 12 (defined as complete Early Virological Response, or cEVR). Additional endpoints include safety and tolerability as well as the proportion of patients with undetectable levels of virus at week four (defined as Rapid Virological Response, or RVR). Patients are being followed for 24 weeks after stopping therapy to determine the rate of Sustained Virological Response, or SVR. Approximately 90 patients participated in this study — with approximately 30 patients receiving ANA598 and 15 receiving placebo at each dose level.

     In 2010, we reported cEVR data from the ANA598 Phase IIa study, showing that ANA598 added to SOC accelerated the rate of viral clearance, with comparable antiviral response at ANA598 doses of 200 mg bid and 400 mg bid. ANA598 showed an excellent safety profile at both dose levels through the 12 weeks of dosing, with reported adverse events being typical for patients treated with interferon and ribavirin alone, although conclusions regarding safety cannot be made until results in more patients over longer duration are known. Based on a more favorable tolerability profile at 200 mg bid compared to 400 mg bid, and comparable antiviral response at both doses, we selected 200 mg bid as the dose to take forward into Phase IIb. The resistance profile of ANA598 seen in the Phase IIa study was very favorable, with only a single patient (<2% of patients in the ANA598 arms) experiencing viral breakthrough while receiving ANA598 plus SOC. Initial SVR data has also been encouraging. We intend to analyze the remaining SVR data after all patients have been off therapy for 24 weeks, which we expect to occur in the summer of 2011. We plan to analyze the entire data set at that time and potentially submit the data for presentation at a medical conference. We cannot guarantee that the remaining SVR data will be as favorable as the data we have seen to date.

     In January 2011 we initiated a Phase IIb clinical study of ANA598 in combination with SOC for the treatment of hepatitis C. In the Phase IIb study, approximately 200 chronically infected genotype 1 hepatitis C patients are to receive ANA598 200 mg bid in combination with SOC, with a loading dose of 800 mg ANA598 bid on day one. In addition, approximately 66 chronically infected genotype 1 hepatitis C patients are to receive placebo added to SOC. Enrollment is expected to include approximately equal numbers of treatment-naïve patients and treatment-experienced patients who have failed a prior course of pegylated interferon and ribavirin, including difficult to treat prior null-responders. Treatment duration for treatment-naïve patients will be response-guided, while treatment-experienced patients are to receive all three agents for 48 weeks, with all patients receiving SOC and either ANA598 or placebo for a concurrent duration. We expect to receive viral response data through 24 weeks of treatment prior to the end of 2011. The Phase IIb study is being conducted at a number of sites within and outside of the United States.

     Substantial further investment will be necessary in order to progress ANA598 beyond the events referenced above and through additional clinical testing before regulatory approval can be sought.

ANA773

     ANA773 is a novel, oral inducer of endogenous interferons that acts via the TLR7 pathway that we have investigated as a treatment for both HCV and cancer. Both the prodrug and its active substance were discovered, designed and synthesized by Anadys scientists. Animal pharmacology studies have shown that ANA773 can elicit desired immune responses and that components of the response can be modulated by both dose and schedule of administration. We have also shown in our Phase I HCV clinical study that ANA773 can stimulate the immune system at a tolerated dose.

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

     In June 2009, in order to direct sufficient investment toward ANA598, we suspended development of ANA773 prior to our receipt of data from the last cohort enrolled in a monotherapy trial of ANA773 in HCV patients. The data from this last 2000 mg cohort suggests that the antiviral activity of ANA773 in HCV patients could be comparable to pegylated interferon over a similar timeframe. We also believe that recent developments in the HCV landscape, including clinical data indicating that it may be difficult to replace pegylated interferon entirely in the treatment of HCV, support the potential commercial value of an oral interferon replacement such as ANA773. As a result, in the fall of 2010 we decided to resume clinical investigation of ANA773 in HCV. We are preparing to conduct a 28 day combination study of ANA773 with ribavirin. If supported by the data from the first cohorts utilizing ANA773 and ribavirin only, this study may also include additional cohorts in which ANA773 will be tested as a triple combination with ribavirin

and a DAA, to parallel the likely future use of interferon. We intend to conduct this study in Europe and potentially other countries, and we expect that up to approximately 75 patients will participate in the trial, inclusive of the DAA cohorts. We expect to receive four week data from the first two cohorts of ANA773 plus ribavirin in this study during the fourth quarter of 2011.

     Substantial further investment will be necessary in order to progress ANA773 beyond the events referenced above and through additional clinical testing before regulatory approval can be sought.

Industry Background

     HCV

     Based on available market data, we estimate that the global HCV market in 2010 was between $2 and 3 billion. Due to significant global prevalence and substantial unmet medical need, improving the treatment of chronic HCV infection remains an important priority for the medical community and the pharmaceutical industry. Many patients with chronic HCV infection do not receive the current standard of care due to concerns about adverse events or have incomplete response to the current standard of care. If untreated or inadequately treated, chronic HCV infection can result in significant liver damage (cirrhosis), liver transplantation and liver cancer.

     The World Health Organization (WHO) estimates that 170 million people globally are chronically infected with HCV and 3 to 4 million people are newly infected each year. Cirrhosis develops in about 10% to 20% of people with chronic infection, and liver cancer develops in 1% to 5% of people with chronic infection over a period of 20 to 30 years. It is estimated that more than 3 million people are chronically infected with HCV in the U.S. and that as of 2009 only about 100,000 of these patients were under treatment. The National Institutes of Health estimates that HCV results in approximately 15,000 deaths in the U.S. annually and the Center for Disease Control and Prevention has estimated that the number of deaths would increase to nearly 40,000 by 2010. HCV also exacerbates the severity of underlying liver disease when it coexists with other hepatic conditions. In particular, liver disease progresses more rapidly among persons with alcoholic liver disease and HIV infection.

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

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

     In response to the limitations of existing treatments for HCV infection, direct acting antiviral (DAA) therapies (including protease, polymerase and NS5A inhibitors) have emerged as a potential addition to or alternative to the current standard of care. Unlike interferons, which work by stimulating the immune system’s response to viral infection, HCV DAAs directly target the virus by inhibiting the protease, polymerase or NS5A region of the virus. Accordingly, DAAs have the potential to significantly improve treatment outcomes, when added to the standard of care in difficult-to-treat patients, including patients infected with HCV genotype 1. The addition of DAAs to the standard of care could also lead to shorter treatment duration, which could increase patient compliance. While DAAs will likely initially be used in combination with pegylated interferon-alfa and ribavirin, it may be possible eventually to replace one or both components of the current treatment regimen with a combination of oral therapies directed at HCV, including protease, polymerase and NS5A inhibitors.

     Quantification of viral concentration (viral load) in the blood is an accepted surrogate of clinical effect in viral diseases. New treatments are evaluated on the ability to decrease or eliminate detectable viral particles in blood. With viral load as an accepted

surrogate, proof of concept in the treatment of viral diseases can be obtained in Phase I human clinical trials. We believe this early proof of concept results in a higher probability of success post Phase I than the probability of success associated with drug development in many other therapeutic areas.

     Toll-Like Receptors

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

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

     TLR Agonists in Viral Diseases

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

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

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

Our Strategy

     The key elements of our strategy include the following:

•

Advance the Development of ANA598 in HCV. We are developing ANA598, a DAA, as a treatment for hepatitis C. During 2011 we intend to:

	•		Conduct a Phase IIb study of ANA598 with SOC;
	•		Obtain 8-week viral response data for treatment-naive patients from the ANA598 Phase IIb study;
	•		Obtain 12-week viral response data from the ANA598 Phase IIb study;
	•		Obtain 24-week viral response data from the ANA598 Phase IIb study; and
	•		Analyze final SVR data from the ANA598 Phase IIa study.

•

Maintain flexible development avenues for ANA598. We are developing ANA598 with the intention of maintaining flexibility to participate in a broad array of potential treatment paradigms as the HCV landscape evolves. Among other things, this flexibility encompasses:

	•		Building up the safety database by conducting the current Phase IIb study, which will be relevant for all development avenues; and
	•		Setting the stage for utilizing ANA598 in combination with other DAAs.

•

Advance the Development of ANA773 in HCV. We are also developing ANA773, a selective TLR7 agonist, as a treatment for hepatitis C. During 2011 we intend to:

	•		Initiate a Phase IIa 28-day combination study of ANA773 and ribavirin; and
	•		Obtain 4 week viral load data for ANA773 with ribavirin.

•

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

     We currently have no ongoing collaborations.

     Our Development Programs

     ANA598 for HCV

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

     We believe that non-nucleoside NS5B polymerase inhibitors offer an exciting potential new way to treat HCV infection, as part of combination regimens which may include other DAAs (such as protease inhibitors, nucleoside polymerase inhibitors, NS5A inhibitors and/or cyclophilin inhibitors) and/or immunomodulators (such as pegylated interferon). We believe that polymerase inhibitors have the potential to be equally important components of future regimens as protease inhibitors, which is another class of HCV DAAs currently in clinical development by a number of companies, including Vertex (with Mitsubishi and Tibotec/Johnson & Johnson) and Merck. Historically, it has been challenging to identify non-nucleoside polymerase inhibitors that display both potency and sustained drug levels in blood. With ANA598, we believe we have created a product candidate that has the potential to overcome this challenge. We believe that we have the opportunity to be competitive in the HCV landscape as we believe that ANA598 is one of the most advanced and well characterized non-nucleoside polymerase inhibitors in development for the treatment of HCV. Furthermore, to our knowledge the number of non-nucleosides in development is smaller than the number of potentially attractive combinations that can be formed with attractive protease inhibitors and nucleoside polymerase inhibitors in development. We believe that the future evolution of HCV therapy will likely include protease inhibitors, nucleosides and non-nucleosides used in various combinations and potential additional mechanisms such as cyclophilin inhibitors and NS5A inhibitors. Therefore, we view ANA598 as complementary to, rather than competitive with, protease inhibitors and nucleosides that are currently in development as HCV therapies.

     Preclinical evaluation of ANA598 required for initiation of clinical investigation was completed in the first quarter of 2008, leading to submission of an Investigational New Drug application (IND) to the U.S. Food and Drug Administration (FDA), subsequent allowance of the IND by the FDA and initiation of clinical investigation in the second quarter of 2008. In December 2008, we announced that the FDA had granted fast track designation to ANA598 for the treatment of chronic HCV infection. We have completed three Phase I studies of ANA598 that have demonstrated potent antiviral activity and good tolerability and are nearing conclusion of a Phase IIa study in which ANA598 was dosed in patients for 12 weeks in combination with pegylated interferon-alfa and ribavirin, which is the current standard of care (SOC) for the treatment of hepatitis C. In January 2011, we initiated a Phase IIb study of ANA598 in combination with SOC in which ANA598 will be dosed for 28 or 48 weeks.

     In the Phase IIb study, approximately 200 chronically infected genotype 1 hepatitis C patients are to receive ANA598 200 mg twice-daily (bid) in combination with SOC, with a loading dose of 800 mg bid of ANA598 day one. In addition, approximately 66 chronically infected genotype 1 hepatitis C patients are to receive placebo added to SOC. Enrollment is expected to include approximately equal numbers of treatment-naïve (previously untreated) patients and treatment-experienced patients who have failed a prior course of pegylated interferon and ribavirin, including difficult to treat prior null-responders. Treatment duration for naïve patients will be response-guided, with patients being dosed for either 28 or 48 weeks, while treatment-experienced patients are to receive all three agents for 48 weeks. While HCV patients who respond quickly to dual or triple therapy may largely be treated with a treatment duration of six months in the future, we believe there will remain a significant population for harder to treat patients in whom viral load decline is slower. We believe these patients may benefit from extended treatment with ANA598 through 48 weeks. The Phase IIb trial design is intended to further define patient populations suitable for shortened therapy and populations who may benefit from extended therapy. We expect to receive viral response data through 24 weeks of treatment prior to the end of 2011. We are conducting the study at a number of sites within and outside of the United States.

     We are nearing conclusion of a Phase IIa study of ANA598 in combination with SOC for the treatment of hepatitis C. In this study, ANA598 was dosed with SOC, after which patients continued to receive SOC alone. Dosing of ANA598 was completed in 2010 and we are currently in the follow-up stage of collecting SVR data. In the Phase IIa study, treatment-naïve genotype 1 patients received ANA598 or placebo in combination with SOC for 12 weeks at dose levels of 200 mg bid or 400 mg bid, each with a loading dose of 800 mg bid on day one. Patients who achieved undetectable levels of virus at weeks four and 12 were randomized to stop all treatment at week 24 or 48. Patients are then measured 12 weeks and 24 weeks after all treatment is ended to determine their hepatitis C virus (HCV) levels. Those who show undetectable levels of virus 24 weeks after cessation of all treatment are deemed to have achieved a Sustained Virologic Response (SVR or SVR24), recognized as a viral cure. Those patients who show undetectable levels of virus 12 weeks following cessation of treatment are deemed to have achieved a sustained virologic response as of week 12 (SVR12), which is recognized within the HCV community as having significant predictive effect of achieving SVR24. The primary endpoint of the study is the proportion of patients who achieve undetectable levels of virus at week 12 (defined as cEVR). Additional endpoints include safety and tolerability as well as the proportion of patients with undetectable levels of virus at week four (defined as RVR). Approximately 90 patients participated in the Phase IIa study — with approximately 30 patients receiving ANA598 and 15 receiving placebo at each dose level. The study is being conducted at a number of clinical sites in the United States.

     In May of 2010 we announced antiviral response, safety and tolerability results through 12 weeks from the Phase IIa study. The data showed that ANA598 added to SOC accelerated the rate of viral clearance, with comparable response at ANA598 doses of 200 mg bid and 400 mg bid. At the 200 mg bid dose level, 73% of patients receiving ANA598 in combination with SOC achieved undetectable levels of virus (<15 IU/ml) at week 12, referred to as cEVR. At the 400 mg bid dose level, the cEVR rate was 75% and for the control arm the cEVR rate was 63%.

Antiviral Response Through 12 Weeks

Proportion of Patients (%) with Undetectable Levels of Virus (<15 IU/mL) by Week

		Week 1				Week 2				Week 3				Week 4				Week 6				Week 8				Week 10				Week 12
ANA598 + SOC 200 mg bid			11				22				44				56				65				69				73				73
ANA598 + SOC 400 mg bid			9				27				30				42				56				72				75				75
Placebo + SOC			0				3				9				13				19				38				48				63

     One patient who received ANA598 400 mg bid experienced viral breakthrough (defined as a confirmed increase of >1 log from any prior measurement) between weeks 10 and 12. No other patient who received either dose of ANA598 experienced viral breakthrough while receiving ANA598.

     In 2009, a genetic marker in patients was discovered that predicts response to SOC. Recent scientific studies have shown that individuals with the IL28B CC genotype, which is estimated to be present in approximately 37% of Caucasian HCV patients and a lower percentage of patients in other ethnic groups, are substantially more responsive to SOC than patients with other IL28B genotypes. This industry knowledge became available after the ANA598 Phase IIa study was designed and initiated and so patients were not stratified based on IL28B genotype in the study. Subsequently, we determined the available patients’ IL28B genotypes. In the SOC control arm of the Phase IIa study, 46% of the patients who were genotyped were of the CC genotype, while in the ANA598-treated arms only 22% of the patients who were genotyped were of the CC genotype. These numbers are based on the assessment of IL28B genotyping from approximately 81% of the patients in the Phase IIa study. We believe that the high proportion of CC patients in the SOC control arm relative to the overall population may have contributed to a higher cEVR rate in the control arm than has been seen historically with interferon and ribavirin.

     As reported during 2010, our analysis of the available IL28B genotype information has led to a further understanding of ANA598’s potential for beneficial effect on HCV patients regardless of IL28B genotype. The IL28B marker is represented in the human population as one of three values — CC, CT or TT. As described above, it has been determined that patients with the CC marker have a much faster antiviral response to SOC over 12 weeks than patients with CT or TT, who are collectively grouped as non-CC. Within the context of response-guided therapy, which is expected to become standard if and when DAAs are approved, patients with faster antiviral response could be candidates for successful treatment with a six-month treatment course instead of the standard twelve-month course, thereby eliminating the tolerability and cost burdens of the second six months of pegylated interferon and ribavirin treatment. Data generated from the ANA598 Phase IIa study demonstrated that adding ANA598 to SOC accelerated the antiviral response in both CC and non-CC patient types.

     Also during 2010, we reported the safety and tolerability results from the ANA598 Phase IIa study. Both doses of ANA598 demonstrated a favorable safety and tolerability profile through 12 weeks, although conclusions regarding safety and tolerability cannot be made until results in more patients over longer duration are known. Safety laboratory values were comparable between the ANA598 and control arms. At the 200 mg bid dose level, the incidence of all adverse events was similar between the active and control arms, with reported adverse events being typical for patients treated with interferon and ribavirin. In the 400 mg bid arm, a higher incidence of rash was seen relative to the 200 mg bid and control arms. The incidence of all other adverse events was comparable between the 400 mg bid and control arms. In the 400 mg bid arm, 62% of patients receiving ANA598 developed rash, compared to 41% of patients that received 200 mg bid and 34% of patients that received placebo plus SOC. In the 400 mg bid group, 17 of 21 rashes were mild, with one grade 2 rash and three grade 3 rashes. In the 200 mg bid arm, the incidence of rash was comparable with the placebo control arm and also consistent with historical reports of rash incidence due to interferon and ribavirin alone. The rashes that were classified as grade 3 were done so due to the extent of body surface covered by the rash, which was maculopapular in nature (red spots, some raised). In the 200 mg bid arm, one patient in the ANA598 group experienced a grade 3 rash which began resolving rapidly upon stopping all study medication. Per protocol, this patient resumed interferon/ribavirin alone and continued in the study. In the 400 mg bid arm, four patients discontinued ANA598 due to rash; three with grade 3 rash and one with grade 1 rash.

     We are encouraged by the preliminary SVR data from the Phase IIa study. In the 200 mg bid cohort, six patients who received ANA598 were randomized to stop all treatment at week 24. We have analyzed the HCV level data measured 24 weeks after all treatment was ended for four of these six patients. This data shows that all four of these patients achieved SVR24. A fifth patient in this group, who was previously reported to have achieved SVR12, was determined to have continued receiving SOC past week 24 due to an error in duration of administration at a clinical site. This patient has maintained undetectable levels of virus through week 48, but this response is now properly characterized as undetectable levels of virus at end-of-treatment. We have not yet assessed achievement of SVR24 for the final patient in this first group.

     In the 400 mg bid cohort, seven patients who received ANA598 were randomized to stop all treatment at week 24. We currently have data on the HCV levels for six of these seven patients, measured 12 weeks after all treatment was ended. This data shows that three out of the six reported patients achieved SVR12, while three did not. Based on our initial analysis of the data from this group, it appears that the three patients who did not achieve SVR12 had low levels of ribavirin at week four of the study. Industry literature references regarding HCV therapy have reported that patients who have low levels of ribavirin early in the treatment regimen are less likely to achieve a sustained virologic response after completion of therapy, despite achieving undetectable levels of virus while on therapy. This phenomenon is well recognized within the HCV community as the unexplained positive effect of ribavirin, which is necessary in the large majority of patients in order to achieve an SVR after having achieved undetectable levels of virus during treatment. We believe that this phenomenon was a contributing factor leading to the failure of these three patients to achieve SVR12. We have not yet assessed achievement of SVR12 for the last patient in this group.

     We intend to analyze the remaining SVR data from the ANA598 Phase IIa study after all patients have been off therapy for 24 weeks, which we expect to occur in the summer of 2011. We plan to analyze the entire data set at that time and potentially submit the data for presentation at a medical conference. We cannot guarantee that the remaining SVR data will be as favorable as the data we have seen to date.

     Previously, we conducted three Phase I studies of ANA598 that led to Phase II development.

     We have presented pre-clinical data showing enhanced antiviral activity and suppression of resistance when ANA598 is combined in vitro with other anti-HCV agents that act through diverse mechanisms, including protease inhibition, polymerase inhibition (both nucleoside and complementary non-nucleoside inhibitors), NS5A inhibition, and cyclophillin inhibition, as well as interferons. In particular, we have presented in vitro data showing that combinations of ANA598 with either the protease inhibitor telaprevir, the nucleoside polymerase inhibitor PSI-6130 (the prodrug of RG-7128), an NS5A inhibitor or interferon-alfa appear to be synergistic whereas other combinations are additive. Synergistic means that the actual combined effect of the two agents is greater than would be predicted from simply adding the effects of each agent alone. The combination of ANA598 with any one of these agents has demonstrated the ability in vitro to eliminate virus that is resistant to any single therapeutic agent. These studies also show that ANA598 retained activity in vitro against mutants known to confer resistance to other classes of DAAs, including protease inhibitors, nucleoside inhibitors and non-nucleosides that, through virtue of binding at a different site than ANA598, display a resistance profile distinct from that of ANA598. We also showed that genotypic mutations resistant to ANA598 appear to be fully susceptible to interferon-alfa, telaprevir and PSI-6130. Previously, we have also presented data demonstrating synergy between ANA598 and immunoregulatory proteins termed “cytokines” induced by ANA773, Anadys’ TLR7 agonist oral prodrug.

     ANA773 for HCV

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

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

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

     In the fall of 2010 we decided to resume clinical investigation of ANA773 in HCV. We are preparing to conduct a 28 day combination study of ANA773 with ribavirin. If supported by the data from the first cohorts utilizing ANA773 and ribavirin only, this study may also include additional cohorts in which ANA773 will be tested as a triple combination with ribavirin and a DAA, to parallel the likely future use of interferon. We intend to conduct this study in Europe and potentially other countries, and we expect that up to approximately 75 patients will participate in the trial, inclusive of the DAA cohorts. We expect to receive four week data from the first two cohorts of ANA773 plus ribavirin in this study during the fourth quarter of 2011.

Manufacturing and Supply

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

Intellectual Property

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

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

	•		Obtain and maintain patent and other proprietary protection for the technology, inventions and improvements we consider important to our business;
	•		Defend and enforce our patents;
	•		Preserve the confidentiality of our trade secrets; and
	•		Operate without infringing the patents and proprietary rights of third parties.

     We hold issued patents and pending patent applications in the United States and in foreign countries we deem appropriate, covering intellectual property developed as part of our research and development programs. Our intellectual property holdings as of December 31, 2010, include, but are not limited to, the United States and foreign patents and patent applications described below.

     In our HCV non-nucleoside polymerase program, we hold three issued United States patents related to our ANA598 program (patent numbers 7,462,611; 7,582,754; and 7,842,838) with expiration dates in 2027 and 2028, one issued patent in Singapore expiring in 2027, one issued patent in each of Malta and Lebanon expiring in 2028, and 62 pending United States and/or foreign patent applications (in Australia, Brazil, Canada, China, the European Patent Convention, India, Japan, Mexico, Taiwan and certain other foreign jurisdictions) covering ANA598 and/or other non-nucleoside NS5B polymerase inhibitor compounds and the manufacture, pharmaceutical compositions, and methods of use of these compounds.

     In our ANA773 program, we hold three issued United States patents (patent numbers 7,560,544; 7,709,448; and 7,781,581) with expiration dates in 2026, 2027 and 2028, two issued patents in Malta with expiration dates in 2025 and 2027, one issued patent in each of Belarus, Eurasia, New Zealand, Russian Federation, Singapore, and Ukraine expiring in 2025, one issued patent in each of France, Germany, Italy, Netherlands, Spain, Switzerland and the United Kingdom expiring in 2026, and 77 pending United States and/or foreign patent applications (in Australia, Brazil, Canada, China, the European Patent Convention, India, Japan, Mexico, Taiwan and certain other foreign jurisdictions) covering ANA773 and related compounds and prodrugs, and the manufacture, pharmaceutical compositions, and methods of use of these compounds.

     We also hold two United States patents (patent numbers 7,576,068 and 7,858,637) with expiration dates in 2024 and 2026, one issued patent in each of Australia, New Zealand, Mexico, Morocco and Georgia expiring in 2024, one issued patent in each of France, Germany, Italy, Netherlands, Spain, Switzerland and the United Kingdom expiring in 2024, and 10 pending United States and/or foreign patent applications (in Brazil, Canada, China, Japan, Taiwan and certain other foreign jurisdictions) that relate to methods of use of certain TLR7 agonists and TLR7 agonist prodrugs. In addition, we hold patents and patent applications in the United States and foreign countries covering composition of matter and methods of use of certain other TLR7 agonists and TLR7 agonist prodrugs, with patent expiration dates beginning in 2022.

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

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

     We also rely on trade secrets and proprietary know-how, especially when we do not believe that patent protection is appropriate or can be obtained. Our practice is to require our employees, consultants, outside scientific collaborators, sponsored researchers and other advisors to execute confidentiality agreements upon the commencement of employment or other relationships with us. These agreements generally provide that all confidential information developed by or made known to the individual during the course of the individual’s relationship with us is to be kept confidential and not disclosed to third parties. In the case of employees, the agreements generally provide that all discoveries, developments, inventions and other intellectual property conceived or reduced to practice by the individual while employed by us will be our exclusive property. In the case of advisors and consultants, the agreements generally provide that all discoveries, developments, inventions, and other intellectual property conceived or reduced to practice by the individual as a result of performance of services for us and not resulting from research related to work supported by another entity with which the individual is party to a confidentiality agreement, shall be our exclusive property. These agreements may not effectively prevent disclosure of confidential information nor result in the effective assignment to us of intellectual property, and may not provide an adequate remedy to us in the event of unauthorized disclosure of confidential information or other breaches of the agreements.

Competition

     The biotechnology and pharmaceutical industries are very competitive and subject to rapid and significant technological change. Our product candidates, if approved for sale, will compete with existing therapies. In addition, a number of companies are pursuing

the development of therapies for hepatitis C. We believe that a significant number of drugs are currently under development and may become available in the future for the treatment of HCV. Due to the level of focus on developing treatments for this indication, ongoing research efforts are intense and new treatments are being sought out and developed by our competitors. Some of these products use therapeutic approaches that may compete directly or indirectly with ANA598 or ANA773. In addition, less expensive generic forms of currently marketed drugs could lead to additional competition upon patent expiration or invalidations.

     HCV

     Treating HCV with Interferon-based Therapies

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

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

     Direct Antivirals in Development for Treating HCV

     In response to the limitations of existing treatments for HCV infection, companies are developing direct-acting antivirals (DAAs) for use in combination with the current treatment regimen of interferon and ribavirin. Two DAAs, both protease inhibitors are currently under review by the FDA for regulatory approval; telaprevir developed by Vertex in collaboration with Tibotec (Janssen Pharmaceutica / Johnson & Johnson) and Mitsubishi-Tanabe Pharma and boceprevir developed by Merck. Unlike interferons, which work by stimulating the immune system’s response to viral infection, HCV DAAs inhibit viral replication by targeting viral proteins essential for replication: the protease, polymerase or NS5A region of the virus. Accordingly, DAAs when added to the current standard of care may significantly improve treatment outcomes in difficult to treat patients such as those infected with HCV genotype 1. The addition of DAAs to the current standard of care could also lead to shorter treatment duration, which could increase patient compliance. While DAAs will likely initially be used in combination with pegylated interferon-alfa and ribavirin, it may be possible to eventually replace one or both of these agents with a combination of DAAs. This would allow for an all oral-based treatment regimen for HCV that eliminates the untoward side effects associated with inferferon-alfa treatment.

     ANA598 belongs to a class of DAAs known as non-nucleoside polymerase inhibitors. If approved, ANA598 would likely be used in combination with the current standard of care and/or other DAAs, such as protease inhibitors, other polymerase inhibitors, or NS5A inhibitors. ANA598 may also be combined with cyclophilin inhibitors whose action is mediated via inhibition of a host (human) enzyme. Although any product currently approved or approved in the future for the treatment of HCV infection could potentially decrease or eliminate the commercial opportunity of ANA598, we expect that in a combination setting a non-nucleoside polymerase inhibitor would be complementary with a protease inhibitor, a nucleoside polymerase inhibitor, NS5A inhibitor and cyclophilin inhibitors. We believe that other non-nucleoside polymerase inhibitors would likely be the most direct competitors of ANA598, but depending on the resistance profiles of the compounds, it is possible that even two non-nucleoside polymerase inhibitors could be complementary. To our knowledge, the following non-nucleoside polymerase inhibitor programs are currently under clinical evaluation: filibuvir by Pfizer, GS-9190 by Gilead, TMC-647055 by Tibotec/Johnson & Johnson (Janssen), ABT-072 and ABT-333 by Abbott, BI-207127 by Boehringer Ingelheim, BMS-791325 by Bristol-Myers Squibb, IDX-375 by Idenix, and VX-222 by Vertex. Further, a number of companies have non-nucleoside polymerase inhibitor research and pre-clinical development programs.

     Additional late stage DAAs in clinical development for HCV that may be complementary to or competitive with ANA598 include: the protease inhibitors telaprevir, in development by Vertex Pharmaceuticals, Tibotec (Janssen Pharmaceutica / Johnson & Johnson)

and Mitsubishi Tanabe Pharma; boceprevir, in development by Merck; danoprevir, in development by Roche; TMC-435350, in development by Tibotec (Janssen Pharmaceutica / Johnson & Johnson) and Medivir and BMS-650032, in development by Bristol-Myers Squibb; as well as, BI-201335, in development by Boehringer Ingelheim; the nucleoside polymerase inhibitors RG7128, in development by Roche; and PSI-7977 in development by Pharmasset; and the NS5A inhibitor BMS-790052, in development by Bristol-Myers Squibb. Cyclophilin inhibitors, such as DEB-025, in development by Novartis may also be competitive with ANA598.

     Immunological Agents in Development for Treating HCV

     Due to the side effects and poor treatment response to interferon therapy discussed above, there are currently a number of agents in development that could potentially replace today’s pegylated interferons. ANA773 is an oral prodrug of a TLR7 agonist that we have evaluated for the treatment of HCV. There are a number of agents in clinical development that could potentially compete with ANA773 as a new agent for the treatment of HCV, including Locteron, in development by Biolex Therapeutics and Omega DUROS interferon (ITCA-638) in development by Intarcia Therapeutics, both of which are longer-acting versions of interferon alfa. Also, in development as potential improvements to existing interferons are PEG-Interferon Lambda, in development by Bristol Myers-Squibb, IMO-2125, a TLR9 agonist in development by Idera, and SD-101, a TLR9 agonist in development by Dynavax Technologies, each of which is currently being studied in early stage clinical trials in HCV patients. In addition, Gilead has advanced GS-9620, a TLR7 agonist into a Phase I clinical trial in HCV patients.

     Competitive Risks

     We are in the early stages of a Phase IIb study of ANA598, which was initiated following completion of three short term Phase I studies and a nearly concluded Phase IIa study in which ANA598 was dosed in combination with standard of care for 12 weeks, and we have only conducted short term Phase I studies of ANA773. Therefore, it is difficult to predict the efficacy, safety and tolerability that these product candidates will demonstrate in longer term trials, alone or in combination with other agents. It is also difficult to predict how these product candidates will interact with other product candidates in development or on the market, until we perform combination studies. Further, it is difficult to predict whether our product candidates will cause any toxicity issues, potential side effects, or other negative consequences associated with their long-term use. During the course of future clinical trials, we may discover that these product candidates are less effective, require unacceptable dosing regimens, or have a similar side effect profile as the profile associated with current therapies or future competitors. This may result in our product candidates being less advantageous or less desirable from a patient and treating physician perspective as compared to current or alternative therapies for HCV.

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

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

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

Government Regulations

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

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

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

	•		Phase I: Studies are conducted on normal, healthy human volunteers or patients to determine safety, dosage tolerance, absorption, metabolism, distribution and excretion. If possible, Phase I studies may also be designed to gain early evidence of effectiveness.
	•		Phase II: Studies are conducted on small groups of patients afflicted with a specific disease to gain preliminary evidence of efficacy, to determine the common short-term side effects and risks associated with the substance being tested and to determine dosage tolerance and optimal dosage.
	•		Phase III: Involves large-scale studies conducted on disease-afflicted patients to provide statistical evidence of efficacy and safety and to provide an adequate basis for physician labeling.

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

Environmental and Safety Matters

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

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

Research and Development Expenses

     Research and development expenses consist primarily of costs associated with the discovery, preclinical and clinical development of our product candidates. Research and development expenses are the primary source of our expenses and totaled $12.0 million, $19.5 million and $26.0 million for the years ended December 31, 2010, 2009 and 2008, respectively.

Employees

     As of March 1, 2011, we had 24 regular, full-time employees and three other employees, including 16 in research and development, and the balance in general and administrative positions, with 14 of our employees holding Ph.D., M.D. or other advanced degrees. None of our employees is represented by a labor union, and we consider our employee relations to be good.

Executive Officers of the Registrant

     The following table sets forth information regarding our executive officers as of March 1, 2011:

Name		Age				Position
Steve Worland, Ph.D.			53			President and Chief Executive Officer
James L. Freddo, M.D.			56			Senior Vice President, Drug Development and Chief Medical Officer
Kevin L. Eastwood			47			Senior Vice President, Corporate Development
James Appleman, Ph.D.			54			Senior Vice President, Research and Chief Scientific Officer
Elizabeth E. Reed, J.D.			40			Senior Vice President, Legal Affairs and General Counsel
Peter T. Slover, CPA			36			Vice President, Finance and Operations

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

     James L. Freddo, M.D. was appointed a member of the Board of Directors in January 2011 and has served as Senior Vice President, Drug Development and Chief Medical Officer since July 2008. Prior to joining Anadys in July 2006, Dr. Freddo was Vice President, Clinical Site Head and Development Site Head, Pfizer Global Research and Development, La Jolla. Previously at Pfizer, he was Executive Director, Site Therapeutic Area Leader, Clinical Development, Oncology. While at Pfizer, Dr. Freddo led the team responsible for the registration of Sutent^® (sunitinib malate), a drug approved by the FDA in January 2006 for treating advanced kidney cancer and gastrointestinal stromal tumors. Prior to Pfizer, Dr. Freddo held a variety of senior management positions at Wyeth-Ayerst Research from December 1996 until June 2002, including Senior Director, Oncology, Senior Director, Infectious Diseases, and Senior Director, Transplantation Immunology. Dr. Freddo currently serves as a member of the Board of Directors of InfuSystem Holdings, Inc., a healthcare services company. He holds a B.S. degree in Medical Technology from the State University of New York at Stony Brook, and a M.D. degree from the University of North Carolina, where he also completed his fellowship training.

     Kevin L. Eastwood joined us in January 2011 as Senior Vice President, Corporate Development. Prior to joining Anadys, Mr. Eastwood was Vice President, Corporate Development at Ambrx, Inc. from May 2006 to December 2010, Senior Vice President, Business Development at Achillion Pharmaceuticals, Inc. from June 2000 to May 2006 and Senior Manager, Business Development at Agouron Pharmaceuticals, Inc. from August 1997 to June 2000. In these positions, Mr. Eastwood was responsible for executing business transactions with a number of leading biotechnology and pharmaceutical companies, including Pfizer, Inc., Merck and Co., Inc., Eli Lilly and Co., and Gilead Sciences. Mr. Eastwood began his pharmaceuticals career in sales and marketing at Marion Laboratories and transitioned to business development while at Agouron. He received a B.S. degree in Biology from Missouri State University.

     James Appleman, Ph.D. was named Senior Vice President, Research and Chief Scientific Officer in January 2011. Dr. Appleman joined us in 2001 and has held several positions of increasing responsibility with us including Senior Vice President, Research in 2010, Vice President, Research in 2009, Vice President, Biology from February 2007 to 2009 and Senior Director of Project Management and Planning from 2005 to February 2007, as well as earlier positions. Prior to joining Anadys, Dr. Appleman was a faculty member at St. Jude Children’s Research Hospital and subsequently held positions at Gensia, Inc., a biopharmaceutical company and Metabasis, a biopharmaceutical company. Dr. Appleman received a Ph.D. in Biochemistry from Oklahoma State University and completed his postdoctoral training at Dartmouth Medical School.

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

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

Company Website

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

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

Item 1A. Risk Factors

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

Risks Related to Our Business

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

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

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

     Our near and long-term viability will depend in part on our ability to successfully establish transactions with pharmaceutical and biotechnology companies. Since we do not currently possess the resources necessary to advance ANA598 or ANA773 fully through

later stage development, we either will need to develop or acquire these resources on our own, which will require substantial funding, time and effort, or will need to enter into collaborative agreements to assist in the development of these programs. If we fail to establish collaborations or licensing arrangements on acceptable terms, we may need to forego the future development of one or both of our programs. Even if we successfully establish new collaborations, these relationships may never result in the successful development or commercialization of any product candidates or the generation of milestone, sales or royalty revenue.

     In order to advance ANA598 and ANA773 through later stage development, we will require additional funds and we may not be able to obtain such funds.

     Prior to advancing ANA598 and ANA773 through completion of later stage development, we will need to obtain additional funds. However, we may not be successful in obtaining such funds. Potential sources of additional funds include a new strategic alliance or other transaction, the sale of equity securities, project financing or debt financing. We cannot be sure that additional funding will be available or that such funding will be obtained on terms favorable to us or our stockholders.

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

     Our December 31, 2010 cash, cash equivalents and marketable securities balance was $38.0 million. We believe that this balance will be sufficient to satisfy our anticipated operational cash needs for at least the next 12 months. However, we will need to seek additional funding in order to advance our programs fully through later stage development. There is no guarantee that additional funding will be available to us on acceptable terms, or at all. If funds are not available, we may be required to delay, reduce the scope of or eliminate one or both of our development programs.

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

	•		fund our development programs;
	•		acquire rights to products or product candidates, technologies or businesses;
	•		establish and maintain manufacturing, sales and marketing operations; and
	•		commercialize our product candidates, if any, that receive regulatory approval.

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

	•		the progress of our clinical trials;
	•		the progress of our nonclinical development activities;
	•		our ability to establish and maintain strategic alliances;
	•		the costs involved in enforcing or defending patent claims and other intellectual property rights;
	•		the pace and timing of development activities conducted under joint development arrangements we may establish;
	•		the cost and timing of regulatory approvals;
	•		the costs of establishing or expanding manufacturing, sales and distribution capabilities;
	•		the costs related to development and manufacture of pre-clinical, clinical and validation lots for regulatory and commercialization of drug supply;
	•		the commercialization of ANA598, ANA773 and any additional products; and
	•		the extent to which we acquire or invest in other products technologies and businesses.

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

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

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

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

     Our existing organizational structure was formed in May 2000. Since then, most of our resources have been dedicated to the development of our proprietary drug discovery technologies, research and development and preclinical and early-stage clinical testing of compounds. Our current product candidates are at only the early-to-mid stages of clinical trials. ANA598, ANA773 and any other compounds that we may develop, may never be approved for commercial sales. These compounds will require extensive and costly development, preclinical testing and clinical trials prior to seeking regulatory approval for commercial sales. The time required to attain product sales and profitability is lengthy and highly uncertain, and we cannot assure you that we will be able to achieve or maintain product sales.

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

     We have incurred net losses since our incorporation in 1992, and through December 31, 2010 we have an accumulated deficit of $299.7 million. Our losses are attributable in large part to the significant research and development costs required to identify and validate potential product candidates and conduct preclinical studies and clinical trials. To date, we have generated limited revenues, consisting of one-time or limited payments associated with past collaborations or grants, and we do not anticipate generating product revenues for at least several years, if ever. We will need to increase our operating expenses over at least the next several years in order to fund the development costs of our product candidates and further our development activities. As a result we expect to continue to incur significant and increasing operating losses for the foreseeable future. Because of the numerous risks and uncertainties associated with our research and product development efforts, we are unable to predict the extent of any future losses or when we will become profitable in our business operations, if ever. Even if we do achieve profitability in our business operations, we may not be able to sustain or increase such profitability on an ongoing basis.

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

     Our current product candidates, ANA598 and ANA773, were selected based on the presumption that intervention at their respective targets, HCV polymerase and TLR7, offers a therapeutic benefit. There can be no assurance that intervention at either target will offer sufficient benefit and acceptable toxicity to warrant continued development and approval. ANA773 relies on the biology of a specific receptor, or protein, named Toll-Like Receptor-7, or TLR7. However, the interaction between small molecules and TLR7 represents a relatively new mechanism of action for the treatment of disease, including HCV, and there is no guarantee that an acceptable balance between therapeutic benefit and risk will be achieved with TLR7 agonists in HCV infected patients. For example, in June 2006 we suspended dosing of ANA975, a TLR7 agonist prodrug, in our then on-going ANA975 clinical trial due to information from 13-week toxicology studies in animals that showed intense immune stimulation. We subsequently conducted additional pre-clinical studies and were unable to identify an acceptable balance between therapeutic benefit and risk using a daily

dosing schedule over 13-weeks. Accordingly, we subsequently discontinued the development of ANA975 as a therapy for HCV infection. The science underlying ANA598 is also new and unproven, as no products acting at the HCV polymerase have been approved for marketing. ANA598 and ANA773 are at only the early stage to mid stage of clinical investigation. The process of successfully discovering product candidates is expensive, time-consuming and unpredictable, and the historical rate of failure for drug candidates is extremely high. If our approaches to drug discovery and development are not successful, we will not be able to establish or maintain a clinical development portfolio or generate product revenue.

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

     Positive results from preclinical studies or early clinical trials should not be relied upon as evidence that later or larger-scale clinical trials will succeed. There is typically an extremely high rate of attrition from the failure of drug candidates proceeding through clinical trials. There is no guarantee that viral load declines or durability of response seen in early patient trials will be replicated in future trials of longer duration and/or larger patient populations. For example, the favorable 12 week viral response data from our ANA598 Phase IIa study may not be repeated in the ANA598 Phase IIb study and may not translate into long-term benefit due to the potential emergence of resistant variants or other factors, such as low ribavirin levels in patients. Similarly, there is no guarantee that favorable safety and tolerability seen in short term studies will be replicated in studies of longer duration and/or in larger subject populations. Furthermore, if future toxicology studies have unexpected results, the clinical development of the compound at issue could be suspended, delayed and/or terminated. If ANA598 or ANA773 fails to demonstrate sufficient safety and efficacy in any clinical trial or shows unexpected findings in future toxicology studies, we would experience potentially significant delays in, or be required to abandon, development of ANA598 or ANA773. If we delay or abandon our development efforts related to ANA598 or ANA773, we may not be able to generate sufficient revenues to become profitable, and our reputation in the industry and in the investment community would likely be significantly damaged, each of which would cause our stock price to decrease significantly.

     Future results of our ongoing ANA598 Phase II combination studies and results of future trials may not be as favorable as results we have seen to date.

     To date, we have seen positive preliminary antiviral response and safety data in our ongoing Phase IIa combination study in which ANA598 was dosed for 12 weeks in combination with pegylated interferon and ribavirin, after which patients continued to receive pegylated interferon and ribavirin. This data includes on-treatment data showing a durable antiviral response through 12 weeks, with only a single patient (<2%of patients in the ANA598 arms) experiencing viral breakthrough while receiving ANA598 plus pegylated interferon and ribavirin. This data also includes data through 48 weeks for the 200 mg bid cohort and through 36 weeks for the 400 mg bid dose cohort. Included in the 48 week data for the 200 mg cohort is data showing that four of four patients for whom data has been analyzed who received ANA598 and were randomized to stop all therapy at week 24 maintained undetectable levels of virus 24 weeks later, referred to as achieving a Sustained Virological Response, or SVR. Included in the 36 week data for the 400 mg cohort is data showing that three of six patients for whom data is available who received ANA598 and were randomized to stop all therapy at week 24 maintained undetectable levels of virus 12 weeks later (SVR12). We believe that low ribavirin levels in the three patients who failed to achieve an SVR12 were a contributing factor to this outcome. There is no guarantee that additional data from this study, once analyzed, or data from future studies, will be as favorable, or viewed as favorably, as the data analyzed to date. The overall number of patients in this study is small, and therefore it may be difficult to assess the true impact of ANA598 based on limited SVR data. If the SVR rates from this small study are less than hoped for, or do not meet your, analysts’, potential collaborators’ or others’ expectations, the perception of the value of ANA598 could be harmed, causing our stock price to suffer.

     More generally, it remains unknown whether the favorable antiviral response and durability of response we have seen to date with ANA598 will provide sustained benefit resulting in improved SVR rates in larger studies. Also, there is no guarantee that the very low viral breakthrough rate that we have seen in the Phase IIa study will be replicated in future studies. If the results of future ANA598 studies do not show improved SVR rates over pegylated interferon and ribavirin alone and if there are no alternative paths in which ANA598 shows benefit in combination with another direct-acting antiviral, then the prospects for developing ANA598 as a competitive component of future HCV treatment could be limited.

     We intend to develop ANA598 and ANA773 as components of combination treatments, which presents additional challenges to the drug development process.

     We are developing ANA598 and ANA773 as potential components of future combination treatments. We may face additional challenges with this approach, as opposed to developing product candidates for monotherapy. For example, any negative properties of

our product candidates may be exacerbated when combined with other agents and/or have unexpected effects in humans. Furthermore, the optimal development of our product candidates may entail explorations of combinations with other agents, which, except for drugs about to be approved, could require us to establish agreements or alliances with other companies or third parties. There is no guarantee that we will be able to enter into such alliances or agreements on terms that we view as favorable, or at all. An important element of development for an agent such as ANA598 will be to test the agent in combination with one or more other direct antivirals. In order for us to pursue this development strategy, we will need to utilize approved DAAs if available or engage the interest of other biopharmaceutical or pharmaceutical companies, since we do not have another direct antiviral to combine with ANA598. Our ability to engage this interest from other companies that have direct antivirals in development will be impacted by such companies’ internal HCV portfolio dynamics, with such dynamics influencing the companies’ perceived attractiveness of combining with an agent such as ANA598. For those companies that have a desire to combine with an agent such as ANA598, we will be dependent on their perception of the profile of ANA598. If they do not view the profile of ANA598 as favorably as we do, or if they establish other criteria for combination that we have not yet satisfied with ANA598, we could experience difficulties or delays in pursuing such combination trials. For example, within the HCV community to date there has been an emphasis on the genetic barrier to resistance of antiviral agents (leading to a potential conclusion that the administration of non-nucleosides is more likely to result in resistance than the administration of nucleosides due to the lower genetic barrier of resistance of nucleosides). Only more recently has there been an appreciation of the importance of a pharmacological barrier to resistance, which ANA598 exhibited in the Phase IIa combination study. Depending on other companies’ perception of this issue, we could experience less enthusiasm for ANA598 as a combination partner. If we are unable to optimize the development of ANA598, our business prospects could be harmed, causing our stock price to suffer.

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

     We have recently initiated a Phase IIb study in which ANA598 will be dosed for up to 48 weeks in combination with current standard of care. To date, ANA598 has not been dosed beyond 12 weeks, and there is no guarantee that the safety, tolerability or durability of response of ANA598 will be as favorable when dosed for longer durations. In addition, although we have presented in vitro data showing that combinations of ANA598 with current standard of care and with certain direct antiviral agents appear to be synergistic, these results may not be replicated in clinical trials. Also, it is possible that ANA598 will not be additive or synergistic with other potential components of future treatment regimens. Furthermore, it is possible that tolerability will be worse over longer durations of treatment than was seen for the same dose at a shorter duration of treatment. For example, in a 14 day healthy volunteer study conducted in 2009, three of the 24 subjects who received ANA598 discontinued from the study due to the onset of a skin rash characterized as mild to moderate with itching during the study, at comparable dose levels that were well tolerated over three days in patients. Similarly, if the tolerability of doses of ANA598 required for long-term treatment as part of future combinations is unacceptable or unfavorable relative to competitive product candidates, then the prospects for developing ANA598 as a treatment for chronic hepatitis C will be diminished, causing our stock price to decrease significantly.

     Our projected development timelines for ANA598 and ANA773 are contingent, among other things, on our anticipated interactions with ex-US regulatory authorities for both programs. There is no guarantee that the ex-US regulatory authorities will allow the studies to proceed or that they will not impose requirements which could result in unexpected cost increases and/or delays to our desired timelines for the studies.

     We will need to obtain clearance from applicable foreign regulatory authorities prior to initiating dosing in the ANA598 Phase IIb study in countries outside of the United States and prior to initiating the ANA773 Phase IIa study. There is no guarantee that we will be able to timely satisfy the requests of any such foreign regulatory authorities or that such regulatory authorities will not impose additional requirements on the conduct or the studies, or allow the studies to proceed.

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

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

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

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

     We have recently decided to resume clinical investigation of ANA773 for HCV. There is no guarantee that development of the program will be continued beyond the upcoming Phase IIa study.

     We have recently decided to resume clinical investigation of ANA773 in HCV. We intend to conduct a Phase IIa 28 day combination study of ANA773 where initial cohorts will be dosed with ANA773 and ribavirin and subsequent cohorts will test ANA773 as a triple combination with ribavirin and a direct-acting antiviral, to parallel the likely future use of interferon. We plan to conduct this trial in Europe and potentially countries outside of Europe. If ANA773 does not achieve viral load reduction at levels comparable to injectable interferon but with a cleaner side effect profile, the prospects for developing ANA773 as a competitive HCV product will be diminished. Furthermore, prior clinical development of ANA773 for HCV was conducted in the Netherlands and not under a U.S. Investigational New Drug Application, or IND. If, in the future, we want to proceed with the development of ANA773 for HCV in the United States, approval from the FDA under a U.S. IND will be required. There is no assurance that the FDA will agree that ANA773 should be tested as an investigational treatment for HCV. Currently, there is no evidence that a TLR7 agonist can confer long-term benefit as a therapy for HCV at an acceptable safety risk, and there is no assurance that the FDA will view the data from our ex-US studies as sufficiently compelling to allow clinical investigation. If the FDA does not view the data from our ex-US studies as sufficiently compelling, it may not allow studies under a U.S. IND, in which case development and commercialization of ANA773 for HCV in the United States would be precluded.

     In 2007 we terminated our ANA975 development program due to challenges seen in animal toxicology studies. To the extent that the ANA975 toxicology observations are mechanism related, our ANA773 program could be negatively impacted, causing our stock price to decline.

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

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

     Our potential drug products will require additional nonclinical testing and extensive clinical trials prior to submission of any regulatory application for commercial sales. Previously, we have conducted only early-stage clinical trials on our own. As a result, we have very limited experience conducting clinical trials. In part because of this limited experience, we cannot be certain that planned clinical trials will begin or be completed on time, if at all. Delays in the commencement of clinical testing could significantly increase our product development costs and delay product commercialization. In addition, many of the factors that may cause, or lead to, a delay in the commencement of clinical trials may also ultimately lead to denial of regulatory approval of a product candidate.

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

	•		demonstrating sufficient safety and efficacy to obtain regulatory approval to commence a clinical trial;
	•		reaching agreement on acceptable terms with prospective contract research organizations and trial sites;
	•		manufacturing sufficient quantities or producing drug meeting our quality standards for a product candidate;
	•		obtaining approval of an IND application or proposed trial design from the FDA; and
	•		obtaining institutional review board approval to conduct a clinical trial at a prospective site.

     In addition, the commencement of clinical trials may be delayed due to insufficient patient enrollment, which is a function of many factors, including the size and nature of the patient population, the nature of the protocol, the proximity of patients to clinical sites, the availability of effective treatments for the relevant disease, the number of other products under development competing for the same patients in trials and the eligibility criteria for the clinical trial.

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

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

	•		ongoing discussions with the FDA or other regulatory authorities regarding the scope or design of our clinical trials;
	•		failure to conduct clinical trials in accordance with regulatory requirements;
	•		lower than anticipated enrollment or retention rate of patients in clinical trials;
	•		inspection of the clinical trial operations or trial sites by the FDA or other regulatory authorities resulting in the imposition of a clinical hold;
	•		lack of adequate funding to continue clinical trials;
	•		negative results of clinical trials;
	•		negative or potentially problematic results of ongoing and concurrent non-clinical toxicology studies;
	•		requests by the FDA for supplemental information on, or clarification of, the results of clinical trials conducted in other countries;
	•		insufficient supply or deficient quality of drug candidates or other materials necessary for the conduct of our clinical trials; or
	•		serious adverse events or other undesirable drug-related side effects experienced by participants.

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

     Even if we successfully complete clinical trials of ANA598, ANA773 or any future product candidate, there are no assurances that we will be able to submit, or obtain FDA approval of, a new drug application.

     There can be no assurance that if our clinical trials of ANA598, ANA773 or any other potential product candidate are successfully completed, we will be able to submit a new drug application, or NDA, to the FDA or that any NDA we submit will be approved by the FDA in a timely manner, if at all. If we are unable to submit a NDA with respect to ANA598, ANA773 or any future product candidate, or if any NDA we submit is not approved by the FDA, we will be unable to commercialize that product in the United States. The FDA can and does reject NDAs and may require additional clinical trials, even when drug candidates performed well or achieved favorable results in large-scale Phase III clinical trials. If we fail to commercialize ANA598, ANA773 or any future product

candidate, we may be unable to generate sufficient revenues to attain profitability, and our reputation in the industry and in the investment community would likely be damaged, each of which would cause our stock price to decrease.

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

     Even if ANA598, ANA773 or any future product candidates are approved for commercial sale by the FDA or other regulatory authorities, the degree of market acceptance of any approved product candidate by physicians, healthcare professionals and third-party payors and our profitability and growth will depend on a number of factors, including:

	•		our ability to provide acceptable evidence of safety and efficacy;
	•		relative convenience and ease of administration;
	•		the prevalence and severity of any adverse side effects;
	•		availability of alternative treatments;
	•		pricing and cost effectiveness;
	•		effectiveness of our or our collaborators’ sales and marketing strategy;
	•		our ability to obtain sufficient third-party insurance coverage or reimbursement; and
	•		our ability to establish or maintain an attractive price for ANA598 when used in combination with other agents.

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

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

	•		new products or technologies are introduced that are more favorably received than our products, are more cost effective or render our products obsolete; or
	•		complications, such as long-term toxicities and viral resistance, arise with respect to use of our products.

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

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

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

     Our ability to develop and commercialize products will depend in part on our ability to manufacture, or arrange for collaborators or other parties to manufacture, our products at a competitive cost, in accordance with regulatory requirements and in sufficient

quantities for clinical testing and eventual commercialization. Our current manufacturing agreements reflect a much smaller scale than would be required for commercialization. If we are unable to enter into or maintain commercial-scale manufacturing agreements with future collaborators or capable contract manufacturers on acceptable terms the development and commercialization of our products could be delayed, which would adversely affect our ability to generate revenues and would increase our expenses.

     If we are unable to establish sales and marketing capabilities or enter into agreements with third parties to sell and market any products we may develop, we may not be able to generate product revenue.

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

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

     We are a small company and have approximately 25 employees. Our success depends on our continued ability to retain and motivate highly qualified management and scientific personnel. In particular, our programs depend on our ability to retain highly skilled clinical and preclinical personnel in the field of HCV.

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

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

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

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

     A portion of our securities available-for-sale is invested in marketable securities. Our cash position may be adversely affected by changes in the value of these securities. In particular, the value of these holdings may be adversely affected by increases in interest rates, downgrades by rating agencies on the issuers of corporate bonds included in the portfolio and by other factors which may result

in other than temporary declines in value of the investments. Each of these events may cause us to record charges to reduce the carrying value of our investment portfolio and may adversely affect our cash position.

Risks Related to Our Industry

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

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

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

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

	•		we might not have been the first to make, conceive, or reduce to practice the inventions covered by all or any of our pending patent applications and issued patents;
	•		we might not have been the first to file patent applications for these inventions;
	•		others may independently develop similar or alternative technologies or duplicate any of our technologies;
	•		it is possible that none of our pending patent applications will result in issued patents;
	•		our issued or acquired patents may not provide a basis for commercially viable products, may not provide us with any competitive advantages, or may be challenged by third parties;
	•		our issued patents may not be valid or enforceable;
	•		we may not develop additional proprietary technologies that are patentable; or
	•		the patents of others may have an adverse effect on our business.

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

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

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

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

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

     Our commercial success also depends upon our ability to develop, manufacture, market and sell our product candidates and use our proprietary technologies without infringing the proprietary rights of third parties. We may be exposed to future litigation by third parties based on claims that our product candidates, technologies or activities infringe the intellectual property rights of others. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in HCV. These could materially affect our ability to develop our drug candidates or sell our products. Because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our product candidates or technologies may infringe. There also may be existing patents, of which we are not aware, that our product candidates or technologies may inadvertently infringe. Further, there may be issued patents and pending patent applications in fields relevant to our business, of which we may become aware from time to time, that we believe we do not infringe or that we believe are invalid or relate to immaterial portions of our overall drug discovery and development efforts. We cannot assure you that third parties holding any of these patents or patent applications will not assert infringement claims against us for damages or seeking to enjoin our activities. We also cannot assure you that, in the event of litigation, we will be able to successfully assert any belief we may have as to non-infringement, invalidity or immateriality, or that any infringement claims will be resolved in our favor.

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

	•		cease selling, incorporating or using any of our product candidates or technologies that incorporate the challenged intellectual property;
	•		obtain a license from the holder of the infringed intellectual property right, which license may be costly or may not be available on reasonable terms, it at all; or
	•		redesign our processes or technologies so that they do not infringe, which could be costly and time consuming and may not be possible.

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

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

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

     The defense and prosecution of intellectual property suits and related legal and administrative proceedings can be both costly and time-consuming. Litigation and interference proceedings could result in substantial expense to us and significant diversion of effort by our technical and management personnel. Further, the outcome of patent litigation is subject to uncertainties that cannot be adequately

quantified in advance, including the demeanor and credibility of witnesses and the identity of the adverse party. This is especially true in biotechnology related patent cases that may turn on the testimony of experts as to technical facts upon which experts may reasonably disagree and which may be difficult to comprehend by a judge or jury. An adverse determination in an interference proceeding or litigation with respect to ANA598 or ANA773, to which we may become a party could subject us to significant liabilities to third parties or require us to seek licenses from third parties. If required, the necessary licenses may not be available on acceptable terms, or at all. Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from commercializing ANA598 or ANA773, which could have a material and adverse effect on our results of operations.

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

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

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

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

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

	•		research and development;
	•		preclinical testing;
	•		clinical trials;
	•		regulatory approvals;
	•		manufacturing; and
	•		sales and marketing of approved products.

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

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

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

     ANA598, a non-nucleoside polymerase inhibitor, was selected as a development candidate for the treatment of chronic hepatitis C virus infection in June 2007. If approved, ANA598 would likely be used in combination with the current standard of care and/or other direct antiviral agents (DAAs) such as protease inhibitors, NS5A inhibitors, and/or polymerase inhibitors. ANA598 may also be used in combination with cyclophilin inhibitors which target a host (human) enzyme. Any product currently approved or approved in the future for the treatment of HCV infection could decrease or eliminate the commercial opportunity of ANA598. Other non-nucleoside inhibitors would likely be the most direct competitors for ANA598. To our knowledge, non-nucleoside polymerase inhibitor programs are currently under clinical evaluation by Pfizer, Gilead, Tibotec/Johnson & Johnson (Janssen), Abbott, Boehringer Ingelheim, Bristol-Myers Squibb, Idenix, and Vertex. Further, a number of companies have non-nucleoside polymerase inhibitor research and pre-clinical development programs.

     Other potential competitors are products currently approved for the treatment of HCV infection: PegIntron (pegylated interferon-alfa-2b), which are marketed by Merck; and Pegasys (pegylated interferon-alfa-2a), Copegus (ribavirin USP), and Roferon- A (interferon-alfa-2a), which are marketed by Roche. ANA598 may also face competition from DAAs currently in later stage clinical development for the treatment of HCV including the protease inhibitors (telaprevir, which is being developed by Vertex Pharmaceuticals, Tibotec (Janssen Pharmaceutica / Johnson & Johnson) and Mitsubishi Tanabe Pharma; boceprevir, in development by Merck; TMC-435350, in development by Johnson & Johnson (Tibotec) and Medivir; BMS-650032 in development by Bristol-Myers Squibb; BI-201335, in development by Boehringer Ingelheim; and danoprevir, in development by Roche), the nucleoside polymerase inhibitors (RG7128, in development by Roche; and PSI-7977, in development by Pharmasset), the NS5A inhibitor (BMS-790052, in development by Bristol-Myers Squibb), and the non-nucleoside inhibitors (GS-9190, in development by Gilead; VX-222, in development by Vertex; ABT-072 and ABT-333, in development by Abbott; BMS-791325, in development by BMS, IDX375 by Idenix, BI-207127 by Boehringer Ingelheim, TMC-647055 by Tibotec / Johnson & Johnson; and filibuvir, in development by Pfizer). Cyclophilin inhibitors, such as DEB-025, in development by Novartis may also be competitive with ANA598.

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

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

	•		our ability to set a price we believe is fair for any products we or our collaborators may develop;
	•		our ability to generate adequate revenues and gross margins; and
	•		the availability of capital.

     In certain foreign markets, the pricing of prescription pharmaceuticals is subject to government control. In the United States, comprehensive health care reform legislation was recently enacted by the Federal government and we expect that there will continue to be a number of federal and state proposals to implement government control over the cost of prescription pharmaceuticals and on the reform of the Medicare and Medicaid systems. The trend toward managed health care in the United States will continue to put pressure on the rate of adoption and pricing of prescription pharmaceuticals, which may result in lower prices for our product candidates. We are currently unable to predict what additional legislation or regulation, if any, relating to the health care industry or third-party coverage and reimbursement may be enacted in the future or what effect the recently enacted federal health care reform legislation or any such additional legislation or regulation would have on our business.

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

     Our ability to commercialize ANA598 or any other product candidate successfully will depend in part on the extent to which governmental authorities, private health insurers and other organizations establish appropriate reimbursement levels for the cost of ANA598 or any other product and related treatments. Third party payors are increasingly challenging the prices charged for medical products and services, including treatments for HCV. Also, the trend toward managed health care in the United States as well as the comprehensive health care reform legislation recently enacted by the Federal government could result in exclusion of our product candidates from reimbursement programs such as Medicare and Medicaid. The cost containment measures that health care payors and providers are instituting and the effect of the comprehensive health care reform legislation recently enacted by the Federal government could materially and adversely affect our ability to earn product revenue and generate significant profits and could impact our ability to raise capital.

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

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

	•		decreased demand for our product candidates;
	•		injury to our reputation;
	•		withdrawal of clinical trial participants;
	•		the inability to establish new collaborations with potential collaborators;
	•		substantial costs of related litigation;
	•		substantial monetary awards to patients; and
	•		the inability to commercialize our product candidates.

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

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

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

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

     Despite the implementation of security measures, our internal computer systems are vulnerable to damage from computer viruses, unauthorized access, natural disasters, terrorism, war and telecommunication and electrical failures. Any system failure, accident or security breach that causes interruptions in our operations could result in a material disruption of our development programs. To the extent that any disruption or security breach results in a loss or damage to our data or applications, or inappropriate disclosure of confidential or proprietary information, we may incur liability as a result, our development programs may be adversely affected and the further development of our product candidates may be delayed. In addition, we may incur additional costs to remedy the damages caused by these disruptions or security breaches.

Risks Related to Our Common Stock

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

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

     Our stock price may be volatile.

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

	•		changes in the regulatory status of our product candidates, including the status and results of our clinical trials of ANA598 and ANA773;
	•		significant contracts, new technologies, acquisitions, commercial relationships, joint ventures or capital commitments;
	•		disputes or other developments relating to proprietary rights, including patents, trade secrets, litigation matters, and our ability to patent or otherwise protect our product candidates and technologies;
	•		conditions or trends in the pharmaceutical and biotechnology industries;
	•		fluctuations in stock market prices and trading volumes of similar companies, of our competitors or of the markets generally;
	•		variations in our quarterly operating results;
	•		changes in securities analysts’ estimates of our financial performance;
	•		failure to meet or exceed securities analysts’ or investors’ expectations of our quarterly financial results, clinical results or our achievement of milestones;
	•		sales of large blocks of our common stock, or the expectation that such sales may occur, including sales by our executive officers, directors and significant stockholders;
	•		additions or departures of key personnel;
	•		discussion of our business, products, financial performance, prospects or our stock price by the financial and scientific press and online investor communities such as chat rooms;
	•		regulatory developments in the United States and foreign countries;
	•		economic and political factors, including wars, terrorism and political unrest; and
	•		technological advances by our competitors.

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

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

	•		the status of development of ANA598, ANA773 and our other product candidates, including results of preclinical studies and clinical trials and changes in regulatory status;
	•		our execution of collaborative, licensing or other arrangements and the timing and accounting treatment of payments we make or receive under these arrangements;
	•		whether or not we achieve specified research or commercialization milestones under any agreement that we enter into with collaborators and the timely payment by commercial collaborators of any amounts payable to us;
	•		variations in the level of expenses related to our product candidates or potential product candidates during any given period; and
	•		the effect of competing technological and market developments.

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

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

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

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

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

	•		dividing our board of directors into three classes serving staggered three-year terms;
	•		prohibiting our stockholders from calling a special meeting of stockholders;
	•		permitting the issuance of additional shares of our common stock or preferred stock without stockholder approval;
	•		prohibiting our stockholders from making certain changes to our amended and restated certificate of incorporation or amended and restated bylaws except with 66 2/3% stockholder approval; and
	•		requiring advance notice for raising matters of business or making nominations at stockholders’ meetings.

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

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

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

Item 1B. Unresolved Staff Comments

     Not Applicable.

Item 2. Properties

     Our headquarters and research and development facility is located in approximately 14,000 square feet of office and laboratory space in San Diego, California. We occupy this facility under a lease, which expires on January 31, 2012.

Item 3. Legal Proceedings

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

Item 4. Reserved

     Reserved.

Part II

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

     Market Information

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

2010		High				Low
First Quarter		$	2.65			$	1.83
Second Quarter			3.24				1.92
Third Quarter			2.42				1.67
Fourth Quarter			2.38				0.90

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

     Holders

     As of January 28, 2011, there were approximately 5,400 holders of our common stock.

     Dividend Policy

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

     Performance Measurement Comparison ⁽¹⁾

     The following graph shows a comparison of the five year total cumulative returns of an investment of $100 in cash on December 31, 2005 in (i) our common stock (ii) the Nasdaq Composite Index and (iii) the Nasdaq Biotechnology Index. All values assume reinvestment of the full amount of all dividends (to date, we have not declared any dividends).

     Comparison of cumulative total return on investment since December 31, 2005:

		December 31, 2005				December 31, 2006				December 31, 2007				December 31, 2008				December 31, 2009				December 31, 2010
Anadys Pharmaceuticals, Inc.		$	100.00			$	55.91			$	18.30			$	17.84			$	23.98			$	16.14
NASDAQ Composite Index			100.00				109.52				120.27				71.51				102.89				120.29
NASDAQ Biotechnology Index			100.00				101.02				105.65				92.31				106.74				122.76

Item 6. Selected Financial Data

     The selected financial data set forth below with respect to our consolidated statements of operations for each of the three years in the period ended December 31, 2010 and, with respect to our consolidated balance sheets, at December 31, 2010 and 2009 are derived from our audited consolidated financial included elsewhere in this Annual Report on Form 10-K. The statement of operations data for the years ended December 31, 2007 and 2006 and the balance sheet data as of December 31, 2008, 2007 and 2006 are derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K. The information set forth below is not necessarily indicative of the results of future operations and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on
Form 10-K.

		For the year ended December 31,
		2010				2009				2008				2007				2006
						(In thousands, except net loss per share)
Consolidated Statements of Operations Data:
Revenues		$	—			$	—			$	—			$	24,118			$	5,420
Operating expenses:
Research and development			12,026				19,494				25,993				28,192				25,419
General and administrative			6,478				8,243				8,109				8,692				11,308
Total operating expenses			18,504				27,737				34,102				36,884				36,727
Loss from operations			(18,504	)			(27,737	)			(34,102	)			(12,766	)			(31,307	)
Other income (expense):
Interest income			106				478				1,482				3,611				4,727
Interest expense			—				—				—				—				(69	)
Gain (loss) from valuation of common stock warrant liability			2,016				(151	)			—				—				—
Other, net			33				132				218				(17	)			(111	)
Total other income (expense), net			2,155				459				1,700				3,594				4,547
Net loss		$	(16,349	)		$	(27,278	)		$	(32,402	)		$	(9,172	)		$	(26,760	)
Net loss per share, basic and diluted:		$	(0.38	)		$	(0.81	)		$	(1.13	)		$	(0.32	)		$	(0.94	)
Shares used in calculating net loss per share, basic and diluted:			43,570				33,775				28,750				28,646				28,512

		As of December 31,
		2010				2009				2008				2007				2006
										(In thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and securities available-for-sale		$	37,984			$	20,490			$	27,936			$	56,495			$	82,149
Working capital			34,452				13,769				24,325				52,084				75,054
Total assets			39,537				21,735				31,674				61,526				89,401
Long-term debt, net of current portion			—				—				—				—				—
Accumulated deficit			(299,681	)			(283,332	)			(256,054	)			(223,652	)			(214,480	)
Total stockholders’ equity			34,673				14,429				25,825				55,679				60,325

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

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

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

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

Overview

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

     We are also making plans to resume the clinical investigation of ANA773, an oral, small-molecule inducer of endogenous interferons that acts via the Toll-like receptor 7, or TLR7, pathway. In 2009, we elected to suspend the development of ANA773 so that we could focus our resources on ANA598. In October 2010, we announced that we are resuming development of ANA773 for the treatment of hepatitis C. We have also previously investigated ANA773 for the treatment of cancer.

     In June 2009, we initiated a strategic restructuring to focus our operations on the development of ANA598. The strategic restructuring resulted in a reduction in our workforce of approximately 40%.

     On June 1, 2010, we sold approximately 5.8 million registered shares of common stock to institutional investors for gross proceeds of approximately $12.5 million. The shares of common stock were at a purchase price of $2.15 per share. The net proceeds related to this transaction were $11.4 million. On October 20, 2010, we sold approximately 13.9 million registered shares of common stock to institutional and retail investors for gross proceeds of approximately $25.0 million. The shares of common stock were at a purchase price of $1.80 per share. The net proceeds related to this transaction were $23.3 million. We intend to use the net proceeds from these financings to support the Phase IIb study of ANA598 and for general corporate purposes, including working capital.

     We have incurred significant operating losses since our inception and, as of December 31, 2010, our accumulated deficit was $299.7 million. We expect to incur substantial losses for at least the next several years as we:

	•		continue the development of ANA598 for the treatment of HCV;
	•		optimize methods for and scale-up manufacturing of ANA598 for clinical trials and potential commercialization;
	•		commercialize any product candidates that receive regulatory approval; and
	•		potentially in-license technology and acquire or invest in businesses, products or technologies that are synergistic with our own.

Research and Development

     During 2010, 2009 and 2008, research and development expenses consisted primarily of costs associated with clinical development of the Company’s product candidates. Research and development expenses may include external costs such as fees paid to clinical research organizations, clinical trial investigators, contract research organizations, drug substance and drug product manufacturers and consultants. Research and development expenses may also include internal costs such as compensation, supplies, materials, an allocated portion of facilities costs, an allocated portion of information systems support personnel and depreciation.

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

     The following summarizes our research and development expenses for the years ended December 31, 2010, 2009 and 2008 (in thousands):

		For the year ended December 31,
		2010				2009				2008
ANA598		$	8,808			$	10,355			$	11,044
ANA773			264				3,103				8,177
Infrastructure, support personnel and other			2,718				4,052				5,501
Section 48D grant			(489	)			—				—
Severance related to 2009 strategic restructuring			—				630				—
Non-cash employee and non-employee share-based compensation			725				1,354				1,271
Total research and development expense		$	12,026			$	19,494			$	25,993

     We submitted applications for qualified investments for ANA598 and ANA773 in a qualifying therapeutic discovery project under section 48D of the Internal Revenue Code. In October 2010, we received notification of grants in the aggregate amount of $0.5 million being approved.

General and Administrative

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

Critical Accounting Policies

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

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

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

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

Results of Operations

     Comparison of the Years Ended December 31, 2010, 2009 and 2008

     Research and Development Expenses. Research and development expenses were $12.0 million, $19.5 million and $26.0 million for the years ended December 31, 2010, 2009 and 2008, respectively. The $7.5 million decrease from 2009 to 2010 was attributable to a $2.8 million decrease in ANA773 development costs, a $1.5 million decrease in ANA598 development costs and a $0.7 million decrease in facility costs associated with the relocation of our corporate headquarters in July 2009. The remaining decrease of $2.5 million was primarily attributed to personnel cost savings from our completed strategic restructuring which was initiated in June 2009. During 2010, we incurred external development costs of $4.1 million associated with our ANA598 program. External development costs in 2010 related to the following: our Phase IIa combination study, the manufacturing of clinical trial materials for our Phase IIb combination study and our Phase IIb combination study which initiated screening in December 2010. During 2009, we incurred external development costs of $5.0 million associated with our ANA598 program. External development costs in 2009 related to the following: our completed Phase Ib clinical trial in HCV patients, our completed long-term chronic toxicology studies of ANA598, our completed 14-day healthy volunteer study and our Phase IIa clinical trial in HCV patients. During 2009, we elected to suspend further development of ANA773 in order to focus our resources on ANA598. As such, development costs associated with ANA773 decreased $2.8 million during 2010 when compared to the same period in 2009. ANA773 development costs during the year ended December 31, 2009 were primarily driven by our now completed Phase Ib clinical trial for the treatment of HCV. Our non-cash share-based compensation expense associated with share-based payments granted to our research and development employees was $0.7 million and $1.4 million for the years ended December 31, 2010 and 2009, respectively. Included as a component of our share-based compensation expense for the year ended December 31, 2009 was $0.3 million of expense associated with the modification of stock options for individuals included in our completed 2009 strategic restructuring.

     The $6.5 million decrease from 2008 to 2009 was primarily due to $6.4 million in cost savings associated with our strategic restructuring initiated in June 2009 of which $5.1 million was due to reduced ANA773 development costs and $1.3 million of which was due to reduced infrastructure and support personnel costs. These decreases were partially offset by severance costs of $0.6 million. During 2009, we incurred $5.0 million of external development costs associated with the following ANA598 program activities which consisted of the following: our completed Phase Ib clinical trial in HCV patients, our completed long-term chronic toxicology studies of ANA598, our completed 14-day healthy volunteer study and our on-going Phase IIa clinical trial in HCV patients. During 2009, we incurred $1.7 million of external development costs associated with our ANA773 program activities: our completed Phase Ib clinical trial for HCV and our Phase I clinical trial for oncology. As we are not currently pursing the development of ANA773 for oncology we do not anticipate incurring significant costs related to this indication in future periods. Our non-cash share-based compensation expense associated with share-based payments granted to our research and development employees was $1.4 million for the year ended December 31, 2009 compared to $1.3 million for the year ended December 31, 2008. Included in our non-cash share-based compensation expense for the year-ended December 31, 2009 is $0.3 million associated with the modification of stock options for individuals included in our strategic restructuring.

     General and Administrative Expenses. General and administrative expenses were $6.5 million, $8.2 million and $8.1 million for the years ended December 31, 2010, 2009 and 2008, respectively. Included as a component of our general and administrative expenses for the year ended December 31, 2009 was $0.7 million in severance related costs associated with our 2009 strategic restructuring. The remaining decrease in costs from 2009 to 2010 was primarily related to personnel cost savings associated with our completed

strategic restructuring and to a lesser extent fluctuations in costs associated with our patent portfolio. The $0.1 million increase from 2008 to 2009 was primarily attributable to severance costs of $0.7 million, which were partially offset by a reduction in allocated facility costs associated with the relocation of our corporate headquarters to a smaller facility. Non-cash share-based compensation expense associated with share-based payments granted to our general and administrative employees and non-employee directors for the years ended December 31, 2010, 2009 and 2008 was $1.1 million, $1.4 million and $1.5 million, respectively. Included in our non-cash share-based compensation expense for the year-ended December 31, 2009 is $0.1 million associated with the modification of stock options for individuals included in our 2009 strategic restructuring.

     Interest Income. Interest income was $0.1 million, $0.5 million and $1.5 million for the years ended December 31, 2010, 2009 and 2008, respectively. The $0.4 million decrease in our interest income from 2009 to 2010 was primarily the result of lower yields on our securities as higher yield securities matured in 2009 and 2010 and were replaced with lower yield securities. The $1.0 million decrease in our interest income from 2008 to 2009 was the result of a lower average cash, cash equivalents and securities available-for-sale balance and lower interest rates during 2009 compared to 2008. Our average balance of cash, cash equivalents and securities available-for-sale, which were invested in interest bearing securities, was $22.9 million in 2009 compared to $40.6 million in 2008. The decrease in our average cash balance from 2008 to 2009 was driven by our use of cash, cash equivalents and securities to fund our on-going operations partially offset by proceeds received from the equity financing during June 2009.

     Valuation of Common Stock Warrant Liability. During 2010, the Company recorded a non-cash gain of $2.0 million associated with the decrease in the fair value our common stock warrant liability from December 31, 2009 to December 31, 2010. This decrease was primarily a result of a decrease in the Company’s stock price from December 31, 2009 and December 31, 2010. The fair value was calculated using the Black Scholes pricing model and is remeasured at each reporting period. During 2009, the Company recorded a non-cash loss of $0.2 million associated with an increase in our common stock liability from June 3, 2009 (issuance date of the warrants) to December 31, 2009. Potential future increases in our stock price will result in losses being recognized in our statement of operations in future periods. Conversely, potential future declines in our stock price will result in gains being recognized in our statement of operations in future periods.

Liquidity and Capital Resources

Overview

     Our December 31, 2010 cash, cash equivalents and marketable securities balance was $38.0 million. Our cash, cash equivalents and available-for sale securities increased by $17.5 million from December 31, 2009 to December 31, 2010. The increase in cash, cash equivalents and securities available-for-sale is the result of net proceeds of $34.7 million received from our completed equity financings in June and October 2010, partially offset by our year-to-date cash utilization to fund our operations. We believe that our existing cash, cash equivalents and securities available-for-sale will be sufficient to meet our projected operating requirements for at least the next twelve months.

     On June 1, 2010, we sold approximately 5.8 million registered shares of common stock to institutional investors for gross proceeds of approximately $12.5 million. The shares of common stock were at a purchase price of $2.15 per share. The net proceeds related to this transaction were $11.4 million. On October 20, 2010, we sold approximately 13.9 million registered shares of common stock to institutional and retail investors for gross proceeds of approximately $25.0 million. The shares of common stock were at a purchase price of $1.80 per share. The net proceeds related to this transaction were $23.3 million.

     Excluding the net proceeds from our equity financings completed during June and October 2010, we used $17.2 million in cash to fund operations during the year ended December 31, 2010 compared to $23.4 million during the year ended December 31, 2009. The decease in our operating cash burn can be attributed to the following factors: our strategic restructuring, initiated in June 2009, our decision to suspend the development of ANA773 for HCV and oncology and the relocation of our corporate headquarters to a smaller facility in July 2009.

Future Cash Requirements

     We expect our cash burn to increase significantly in 2011 when compared to 2010 as we conduct our Phase IIb combination study for ANA598. In addition, we announced in October 2010 that we are resuming development of ANA773 for the treatment of hepatitis C. We plan to begin a Phase IIa combination study for ANA773 in the second quarter of 2011.

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

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

	•		the progress of our clinical trials;
	•		the progress of our nonclinical development activities;
	•		our ability to establish and maintain strategic alliances;
	•		the costs involved in enforcing or defending patent claims and other intellectual property rights;
	•		the costs and timing of regulatory approvals;
	•		the costs of establishing or expanding manufacturing, sales and distribution capabilities;
	•		the costs related to development and manufacture of non-clinical, clinical and validation lots for regulatory and commercialization of drug supply;
	•		the success of the commercialization of ANA598, ANA773 or any other product candidates we may develop; and
	•		the extent to which we acquire or invest in other products, technologies and businesses.

Investment Portfolio

     As of December 31, 2010, we have $37.7 million of marketable securities consisting of money market funds, commercial paper, municipal bonds, U.S. government sponsored enterprise securities and corporate debt securities with maturities that range from one day to 27.4 months with an overall average months to maturity of 6.2 months. We have the ability to liquidate these marketable securities without restriction or penalty.

     As of December 31, 2010, we performed a review of all of the securities in our portfolio with an unrealized loss position, to determine if any other-than-temporary impairments were required to be recorded. Factors considered in our assessment included but were not limited to the following: our ability and intent to hold the security until maturity; the number of months until the security’s maturity, the number of quarters that each security was in an unrealized loss position, ratings assigned to each security by independent rating agencies, the magnitude of the unrealized loss compared to the face value of the security and other market conditions. No other-than-temporary impairments were identified as of December 31, 2010 related to securities currently in our portfolio. We also noted that none of the securities as of December 31, 2010 have been in an unrealized loss position for greater than one year. As of December 31, 2010 we do not own any asset-backed securities or auction rate securities.

Cash Flows from Operating Activities and Investing Activities

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

		For the year ended December 31,
		2010				2009				2008
Net cash used in operating activities		$	(16,988	)		$	(24,229	)		$	(28,288	)
Cash (used in) provided by investing activities
Purchase of securities available-for-sale		$	(38,934	)		$	(24,657	)		$	(8,806	)
Proceeds from sale of securities available-for-sale			24,191				26,484				12,463
Purchase of property and equipment			(7	)			(88	)			(213	)
Proceeds from disposal of property and equipment			6				111				392
Net cash (used in) provided by investing activities		$	(14,744	)		$	1,850			$	3,836

     We expect to continue to utilize cash and marketable securities to fund our operating activities as we continue to advance our wholly owned product candidates ANA598 and ANA773. We are not currently party to any development collaborations and therefore cash to fund future operations will most likely have to be obtained from one of the following sources: our current investment portfolio, the sale of equity securities, new strategic alliance agreements or other transactions, project financing or debt financing.

Cash Flows from Financing Activities

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

		For the year ended December 31,
		2010				2009				2008
Cash provided by financing activities
Proceeds from exercise of stock options and employee stock purchase plan		$	158			$	385			$	259
Proceeds from equity financing, net of issuance costs			34,694				16,015				—
Net cash provided by financing activities		$	34,852			$	16,400			$	259

     On June 1, 2010, we sold approximately 5.8 million registered shares of common stock to institutional investors for gross proceeds of approximately $12.5 million. The shares of common stock were at a purchase price of $2.15 per share. The net proceeds related to this transaction were $11.4 million. On October 20, 2010, we sold approximately 13.9 million registered shares of common stock to institutional and retail investors for gross proceeds of approximately $25.0 million. The shares of common stock were at a purchase price of $1.80 per share. The net proceeds related to this transaction were $23.3 million. The proceeds from these equity financings are being utilized to fund operating activities and to advance ANA598 and ANA773 for the treatment of HCV.

Aggregate Contractual Obligations

     The following summarizes our contractual obligations as of December 31, 2010 (in thousands):

						Less
						than 1				20012 to				2014 to
Contractual Obligations		Total				Year				2013				2015				Thereafter
Operating leases 1		$	324			$	296			$	28			$	—			$	—
Minimum royalty commitment			600				100				200				200				100
		$	924			$	396			$	228			$	200			$	100

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

Fair Value Inputs

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

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

Off-Balance Sheet Arrangements

     As of December 31, 2010, 2009 and 2008, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships. We do not have relationships or transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

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

Item 8. Financial Statements and Supplementary Data

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

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

     Not Applicable.

Item 9A. Controls and Procedures

     Management’s Report on Internal Control Over Financial Reporting

     Evaluation of Disclosure Controls and Procedures: Our President and Chief Executive Officer and Vice President, Finance and Operations performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-l5(e) and l5d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this Annual Report. Based on that evaluation, our Chief Executive Officer and Vice President, Finance and Operations concluded that our disclosure controls and procedures were effective as of December 31, 2010 in providing them with material information related to the Company in a timely manner, as required to be disclosed in the reports the Company files under the Exchange Act.

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

     Under the supervision and with the participation of our management, including our President and Chief Executive Officer and Vice President, Finance and Operations, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control — Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2010.

     The effectiveness of our internal control over financial reporting as of December 31, 2010 has been audited by Ernst & Young LLP, an independent registered public accounting firm.

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

     Report of Independent Registered Public Accounting Firm

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

     We have audited Anadys Pharmaceuticals, Inc.’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Anadys Pharmaceuticals, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

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

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

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

     In our opinion, Anadys Pharmaceuticals, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the COSO criteria.

     We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Anadys Pharmaceuticals, Inc. as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2010 of Anadys Pharmaceuticals, Inc. and our report dated March 4, 2011 expressed an unqualified opinion thereon.

San Diego, California
March 4, 2011

Item 9B. Other Information

     Not applicable.

Part III

     Certain information required by Part III of Form 10-K is omitted from this report because we expect to file a definitive proxy statement for our 2011 Annual Meeting of Stockholders (the Proxy Statement) within 120 days after the end of our fiscal year pursuant to Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended, and the information included in the Proxy Statement is incorporated herein by reference to the extent provided below.

Item 10. Directors, Executive Officers and Corporate Governance

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

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

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

Item 11. Executive Compensation

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

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

     The following table summarizes our outstanding securities and securities available for future issuance under our equity compensation plans as of December 31, 2010. Security holders of the Company have approved the 2002 Equity Incentive Plan, 2004 Equity Incentive Plan (2004 Plan), 2004 Non-Employee Directors’ Stock Option Plan and 2004 Employee Stock Purchase Plan.

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

(c)

Number of securities

remaining available for

(a)

(b)

future issuance under equity

Number of securities to

Weighted-average

compensation plans

be issued upon exercise

exercise price of

(excluding securities

Plan Category

of outstanding options

outstanding options

reflected in column (a))

Equity compensation plans approved by security holders

6,820,466

$

3.25

3,027,533

Equity compensation plans not approved by security holders

200,000

$

3.00

—

Total

7,020,466

3,027,533

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

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

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

Item 14. Principal Accounting Fees and Services

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

Part IV

Item 15. Exhibits and Financial Statement Schedules

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

	(1)		Financial Statements. See index to consolidated financial statements on page F-1.
	(2)		Financial Statement Schedules. All financial statements schedules for which provision is made in Regulation S-X are omitted because they are not required under the related instructions, are inapplicable, or the required information is given in the financial statements, including the notes thereto.
	(3)		Exhibits.

Exhibit
Number		Exhibit Description		Incorporated by Reference or Attached Hereto
3.1		Form of Amended and Restated Certificate of Incorporation of the Registrant		Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on May 14, 2004.
3.2		Amended and Restated Bylaws of the Registrant		Incorporated by reference to the Registrant’s Current Report on Form 8-K (SEC File No. 000-50632) filed on December 5, 2007.
4.1		Form of Specimen Common Stock Certificate		Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.
4.2		Form of Warrant		Incorporated by reference to the Registrant’s Current Report on Form 8-K (SEC File No. 000-50632) filed on June 4, 2009.
10.1#		2002 Equity Incentive Plan		Incorporated by reference to Exhibit 10.3 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on November 14, 2003.
10.2#		Form of Stock Option Agreement under 2002 Equity Incentive Plan		Incorporated by reference to Exhibit 10.4 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on November 14, 2003.
10.3#		2004 Equity Incentive Plan		Incorporated by reference to Exhibit 10.5 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.
10.4#		Form of Stock Option Agreement under 2004 Equity Incentive Plan		Incorporated by reference to Exhibit 10.6 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.
10.5#		Form of Amendment to Stock Option Agreement Under 2004 Equity Incentive Plan, applicable to Non-Employee Director grants		Incorporated by reference to Exhibit 10.5 in the Registrant’s Annual Report on Form 10-K (SEC File No. 000-50632) filed on March 3, 2009.
10.6#		2004 Employee Stock Purchase Plan		Incorporated by reference to Exhibit 10.7 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.
10.7#		Form of Offering Document under the 2004 Employee Stock Purchase Plan		Incorporated by reference to Exhibit 10.8 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.
10.8#		Form of Indemnification Agreement by and between the Registrant and each of its directors and officers		Incorporated by reference to Exhibit 10.11 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on November 14, 2003.

Exhibit
Number		Exhibit Description		Incorporated by Reference or Attached Hereto
10.9#		Form of Stock Option Agreement Under 2004 Non-Employee Directors’ Stock Option Plan		Incorporated by reference to Exhibit 10.10 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.
10.10#		Terms of Employment dated February 1, 2001 by and between the Registrant and Steve Worland, Ph.D.		Incorporated by reference to Exhibit 10.27 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on November 14, 2003.
10.11#		Terms of Employment dated October 2, 2001 by and between the Registrant and Elizabeth E. Reed		Incorporated by reference to Exhibit 10.30 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 18, 2004.
10.12#		Form of Inducement Stock Option Agreement		Incorporated by reference to Exhibit 10.42 in the Registrant’s Current Report on Form 8-K (SEC File No. 000-50632) filed on September 25, 2006.
10.13#		Terms of Employment dated June 21, 2006 by and between the registrant and James L. Freddo, M.D.		Incorporated by reference to Exhibit 10.21 in the Registrant’s Annual Report on Form 10-K (SEC File No. 000-50632) filed on March 5, 2008.
10.14#		Amended and Restated 2004 Non-Employee Directors’ Stock Option Plan		Incorporated by reference to Exhibit 10.24 in the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on May 1, 2008.
10.15		Sub-lease agreement dated June 18, 2009 by and between the Registrant and Phenomix Corporation		Incorporated by reference to Exhibit 10.24 in the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on July 31, 2009.
10.16#		Terms of Employment dated July 1, 2009 for Peter T. Slover		Incorporated by reference to Exhibit 10.26 in the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on July 31, 2009.
10.17#		Anadys Pharmaceuticals, Inc. Executive Officer Bonus Plan		Incorporated by reference to Exhibit 10.29 in the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-50632) filed on October 30, 2009.
10.18#		Amended and Restated Severance and Change in Control Agreement dated January 24, 2011 by and between the Registrant and James L. Freddo, M.D.		Incorporated by reference to Exhibit 10.27 in the Registrant’s Current Report on Form 8-K (SEC File No. 000-50632) filed on January 24, 2011.
10.19#		Amended and Restated Severance and Change in Control Agreement dated February 6, 2011 by and between the Registrant and Stephen T. Worland, Ph.D.		Attached Hereto.
10.20#		Amended and Restated Severance and Change in Control Agreement dated January 24, 2011 by and between the Registrant and Elizabeth E. Reed		Attached Hereto.
10.21#		Amended and Restated Severance and Change in Control Agreement dated January 24, 2011 by and between the Registrant and Peter T. Slover		Attached Hereto.
10.22		First Amendment to Lease dated December 20, 2010 by and between the Registrant, ARE-SD Region No. 31, LLC, and Phenomix Corporation		Attached Hereto.
10.23		Lease dated February 28, 2011 by and between the Registrant and ARE-SD Region No. 31, LLC.		Attached Hereto.
21.1		List of Subsidiaries of the Registrant		Incorporated by reference to Exhibit 21.1 in the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-110528) filed on November 14, 2003.
23.1		Consent of Independent Registered Public Accounting Firm		Attached Hereto.

Exhibit
Number		Exhibit Description		Incorporated by Reference or Attached Hereto
31.1		Certification of President and Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Act of 1934, as amended		Attached Hereto.
31.2		Certification of Vice President, Finance and Operations pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Act of 1934, as amended		Attached Hereto.
32.1		Certifications of President and Chief Executive Officer and Vice President, Finance and Operations pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002		Attached Hereto.

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Diego, State of California, on the 4^th day of March, 2011.

POWER OF ATTORNEY

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

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

Signature		Title		Date
/s/ STEPHEN T. WORLAND, PH.D.   Stephen T. Worland, Ph.D.		President, Chief Executive Officer and Director  (Principal Executive Officer)		March 4, 2011
/s/ PETER T. SLOVER   Peter T. Slover		Vice President, Finance and Operations (Principal Financial and Accounting Officer)		March 4, 2011
/s/ STELIOS PAPADOPOULOS, PH.D.   Stelios Papadopoulos, Ph.D.		Chairman of the Board		March 4, 2011
/s/ MARK G. FOLETTA   Mark G. Foletta		Director		March 4, 2011
/s/ MARIOS FOTIADIS   Marios Fotiadis		Director		March 4, 2011
/s/ JAMES L. FREDDO   James L. Freddo		Director		March 4, 2011
/s/ KLEANTHIS G. XANTHOPOULOS, PH.D.   Kleanthis G. Xanthopoulos, Ph.D.		Director		March 4, 2011

ANADYS PHARMACEUTICALS, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

		Page
Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets as of December 31, 2010 and 2009		F-3
Consolidated Statements of Operations for each of the years ended December 31, 2010, 2009 and 2008		F-4
Consolidated Statements of Stockholders’ Equity for each of the years ended December 31, 2010, 2009 and 2008		F-5
Consolidated Statements of Cash Flows for each of the years ended December 31, 2010, 2009 and 2008		F-6
Notes to Consolidated Financial Statements		F-7

Report of Independent Registered Public Accounting Firm

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

We have audited the accompanying consolidated balance sheets of Anadys Pharmaceuticals, Inc. as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Anadys Pharmaceuticals, Inc. at December 31, 2010 and 2009, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Anadys Pharmaceuticals, Inc.’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 4, 2011 expressed an unqualified opinion thereon.

		/s/ Ernst & Young LLP

San Diego, California
March 4, 2011

ANADYS PHARMACEUTICALS, INC.

CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

		December 31,				December 31,
		2010				2009
Assets
Current assets:
Cash and cash equivalents		$	7,617			$	4,497
Securities available-for-sale			30,367				15,993
Prepaid expenses and other current assets			1,319				559
Total current assets			39,303				21,049
Property and equipment, net			234				626
Other assets			—				60
Total assets		$	39,537			$	21,735
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	251			$	740
Accrued expenses			2,719				2,643
Common stock warrant liability			1,881				3,897
Total current liabilities			4,851				7,280
Other long-term liabilities			13				26
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.001 par value; 10,000,000 shares authorized at December 31, 2010 and December 31, 2009; no shares issued and outstanding at December 31, 2010 and December 31, 2009			—				—
Common stock, $0.001 par value; 90,000,000 shares authorized at December 31, 2010 and December 31, 2009; 57,141,223 and 37,341,957 shares issued and outstanding at December 31, 2010 and December 31, 2009, respectively			57				37
Additional paid-in capital			334,298				297,687
Accumulated other comprehensive (loss) gain			(1	)			37
Accumulated deficit			(299,681	)			(283,332	)
Total stockholders’ equity			34,673				14,429
Total liabilities and stockholders’ equity		$	39,537			$	21,735

See accompanying notes to consolidated financial statements.

ANADYS PHARMACEUTICALS, INC.

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

		For the year ended December 31,
		2010				2009				2008
Operating Expenses:
Research and development		$	12,026			$	19,494			$	25,993
General and administrative			6,478				8,243				8,109
Total operating expenses			18,504				27,737				34,102
Loss from operations			(18,504	)			(27,737	)			(34,102	)
Other income (expense):
Interest income			106				478				1,482
Gain (loss) from valuation of common stock warrant liability			2,016				(151	)			—
Other, net			33				132				218
Total other income (expense), net			2,155				459				1,700
Net loss		$	(16,349	)		$	(27,278	)		$	(32,402	)
Net loss per share, basic and diluted		$	(0.38	)		$	(0.81	)		$	(1.13	)
Shares used in calculating net loss per share, basic and diluted			43,570				33,775				28,750

See accompanying notes to consolidated financial statements.

ANADYS PHARMACEUTICALS, INC.

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

																						Accumulated
																						other
																		Additional				comprehensive								Total
		Preferred stock								Common stock								paid-in				gain				Accumulated				stockholders’
		Shares				Amount				Shares				Amount				capital				(loss)				deficit				equity
Balance at December 31, 2007			—			$	—				28,696,948			$	29			$	279,221			$	81			$	(223,652	)		$	55,679
Issuance of common stock pursuant to the exercise of stock options and warrants			—				—				36,567				—				106				—				—				106
Issuance of common stock pursuant to the employee stock purchase plan			—				—				83,248				—				153				—				—				153
Compensation related to stock options and warrants issued to non-employees			—				—				—				—				66				—				—				66
Share-based compensation expense including forfeitures			—				—				—				—				2,751				—				—				2,751
Comprehensive loss:
Unrealized loss on securities available for sale			—				—				—				—				—				(528	)			—				(528	)
Net loss			—				—				—				—				—				—				(32,402	)			(32,402	)
Comprehensive loss			—				—				—				—				—				—				—				(32,930	)
Balance at December 31, 2008			—			$	—				28,816,763			$	29			$	282,297			$	(447	)		$	(256,054	)		$	25,825
Issuance of common stock pursuant to the exercise of stock options and warrants			—				—				84,465				—				232				—				—				232
Issuance of common stock pursuant to the employee stock purchase plan			—				—				82,729				—				153				—				—				153
Issuance of common stock associated with equity financing, net of issuance costs			—				—				8,358,000				8				16,007				—				—				16,015
Fair value of common stock warrants issued in connection with equity financing			—				—				—				—				(3,746	)			—				—				(3,746	)
Compensation related to stock options and warrants issued to non-employees			—				—				—				—				125				—				—				125
Share-based compensation expense including forfeitures			—				—				—				—				2,619				—				—				2,619
Comprehensive loss:
Unrealized gain on securities available for sale			—				—				—				—				—				484				—				484
Net loss			—				—				—				—				—				—				(27,278	)			(27,278	)
Comprehensive loss			—				—				—				—				—				—				—				(26,794	)
Balance at December 31, 2009			—			$	—				37,341,957			$	37			$	297,687			$	37			$	(283,332	)		$	14,429
Issuance of common stock pursuant to the exercise of stock options			—				—				21,619				—				47				—				—				47
Issuance of common stock pursuant to the employee stock purchase plan			—				—				74,804				—				111				—				—				111
Issuance of common stock associated with equity financings, net of issuance costs			—				—				19,702,843				20				34,674				—				—				34,694
Compensation related to stock options and warrants issued to non-employees			—				—				—				—				18				—				—				18
Share-based compensation expense including forfeitures			—				—				—				—				1,761				—				—				1,761
Comprehensive loss:
Unrealized loss on securities available for sale			—				—				—				—				—				(38	)			—				(38	)
Net loss			—				—				—				—				—				—				(16,349	)			(16,349	)
Comprehensive loss			—				—				—				—				—				—				—				(16,387	)
Balance at December 31, 2010			—			$	—				57,141,223			$	57			$	334,298			$	(1	)		$	(299,681	)		$	34,673