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TABLE OF CONTENTS Anacor Pharmaceuticals, Inc. Form 10-K Index
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Table of Contents

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549



FORM 10-K

(Mark One)    

ý

 

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

For the Fiscal Year Ended December 31, 2013

or

o

 

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

Commission File Number: 001-34973

ANACOR PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
  2834
(Primary Standard Industrial
Classification Code Number)
  25-1854385
(I.R.S. Employer
Identification No.)

1020 East Meadow Circle
Palo Alto, CA 94303-4230

(Address of Principal Executive Offices) (Zip Code)

(650) 543-7500
(Registrant's Telephone Number, Including Area Code)

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

Title of Each Class:   Name of Each Exchange on which Registered
Common Stock, par value $0.001 per share   The NASDAQ Global Market

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

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

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

         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 ý    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 ý    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. ý

         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 definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

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

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

         The aggregate market value of the voting and non-voting common equity held by non-affiliates was $132.2 million computed by reference to the last sales price of $5.59 as reported by the NASDAQ Global Market, as of the last business day of the registrant's most recently completed second fiscal quarter, June 28, 2013. This calculation does not reflect a determination that certain persons are affiliates of the registrant for any other purpose. The number of outstanding shares of the registrant's common stock on March 10, 2014 was 41,838,760 shares.

DOCUMENTS INCORPORATED BY REFERENCE

         Part III incorporates information by reference to the definitive proxy statement for the Company's Annual Meeting of Stockholders to be held on or about May 29, 2014, to be filed within 120 days of the registrant's fiscal year ended December 31, 2013.

   


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TABLE OF CONTENTS
Anacor Pharmaceuticals, Inc.
Form 10-K
Index

 
   
  Page  

Part I

 

 

       

Item 1.

 

Business

    1  

Item 1A.

 

Risk Factors

    31  

Item 1B.

 

Unresolved Staff Comments

    65  

Item 2.

 

Properties

    65  

Item 3.

 

Legal Proceedings

    65  

Item 4.

 

Mine Safety Disclosures

    66  

Part II

 

 

   
 
 

Item 5.

 

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

    67  

Item 6.

 

Selected Financial Data

    69  

Item 7.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

    71  

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

    87  

Item 8.

 

Financial Statements and Supplementary Data

    88  

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

    131  

Item 9A.

 

Controls and Procedures

    131  

Item 9B.

 

Other Information

    133  

Part III

 

 

   
 
 

Item 10.

 

Directors, Executive Officers and Corporate Governance

    133  

Item 11.

 

Executive Compensation

    133  

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

    133  

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

    133  

Item 14.

 

Principal Accountant Fees and Services

    134  

Part IV

 

 

   
 
 

Item 15.

 

Exhibits and Financial Statement Schedules

    135  

Signatures

    136  

Exhibit Index

    138  

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

        This report contains forward-looking statements, including statements regarding the progress, timing and results of clinical trials, the safety and efficacy of our product candidates, timing and potential approval of our product candidates, timing and potential commercial success of our products, actions to be taken by our partners, GlaxoSmithKline LLC, Eli Lilly and Company, Bill & Melinda Gates Foundation and United States Department of Defense, Defense Threat Reduction Agency, our ability to enter into and maintain additional collaborations, our ability to scale and support commercial activities, the goals of our research and development activities, estimates of the potential markets for our product candidates, availability of drug product, our expected future revenues, operations and expenditures and projected cash needs. The forward-looking statements are contained principally in the sections entitled "Business," "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that could cause our actual results, levels of activity, performance or achievement to differ materially from those expressed or implied by these forward-looking statements.

        Forward-looking statements include all statements that are not historical facts. In some cases, you can identify forward-looking statements by terms such as "may," "will," "should," "could," "would," "expects," "plans," "anticipates," "believes," "estimates," "projects," "predicts," "potential," or the negative of those terms, and similar expressions and comparable terminology intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. These forward-looking statements represent our estimates and assumptions only as of the date of this Annual Report on Form 10-K and, except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this Annual Report on Form 10-K.

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PART I

ITEM 1.    BUSINESS

Overview

        We are a biopharmaceutical company focused on discovering, developing and commercializing novel small-molecule therapeutics derived from our boron chemistry platform. We have demonstrated that our organization, utilizing our boron chemistry platform, is highly productive and efficient at creating novel clinical product candidates. We have discovered, synthesized and developed eight molecules that are currently in development, and we believe that our organization and boron chemistry platform have the potential to continue to yield clinical candidates at a relatively constant rate and efficiency in the future. While drug development is often uncertain and occasionally uneven, our current portfolio of product candidates and our ability to efficiently fill our own pipeline provide us with a unique opportunity to create a valuable and sustainable biopharmaceutical company.

        We believe that our expertise in boron chemistry enables us to identify compounds that interact with known drug targets in novel ways and also inhibit drug targets that have been historically difficult to inhibit with traditional chemistry. We have applied this expertise across a range of fungal, inflammatory, bacterial and parasitic diseases that represent significant unmet medical needs. We have discovered and advanced into clinical development and multiple differentiated product candidates that we believe have significant disease-modifying potential and attractive pharmaceutical properties. We believe that our product candidates may offer significant improvements over the standard of care for diseases that represent large, well-defined commercial opportunities.

        The productivity of our internal discovery capability has enabled us to generate a pipeline of both topical and systemic boron-based compounds. Our lead product candidates include two topically administered dermatologic compounds—tavaborole (formerly referred to as AN2690) and AN2728. Tavaborole is a topical treatment for onychomycosis, a fungal infection of the nail and nail bed. We filed a New Drug Application (NDA) for tavaborole in July 2013, which was accepted for review by the United States Food and Drug Administration (FDA) in September 2013 with a Prescription Drug User Fee Act (PDUFA) V goal date of July 29, 2014. AN2728 is our lead topical anti-inflammatory product candidate for the treatment of atopic dermatitis and psoriasis, chronic inflammatory skin diseases that affect millions of people worldwide. We held an End of Phase 2 meeting with the FDA for AN2728 in atopic dermatitis in the first quarter of 2014 and expect to initiate Phase 3 studies in atopic dermatitis in the first half of 2014. In addition, we have three other wholly-owned clinical product candidates—AN2718 and AN2898, which are backup compounds to tavaborole and AN2728, respectively, and AN3365 (formerly referred to as GSK2251052, or GSK '052), an antibiotic for the treatment of infections caused by Gram-negative bacteria, which previously was licensed to GlaxoSmithKline LLC (GSK). We are currently considering our options for further development, if any, of AN3365. We have also discovered three other compounds that we have out-licensed for further development—one is licensed to Eli Lilly and Company (Lilly), for the treatment of an animal health indication; a second compound, AN5568, also referred to as SCYX-7158, is licensed to Drugs for Neglected Diseases initiative (DNDi), for human African trypanosomiasis (HAT, or sleeping sickness); and a third compound is licensed to GSK for tuberculosis (TB). We also have a pipeline of other internally discovered topical and systemic boron-based compounds in earlier stages of research and pre-clinical development.

        We have entered into and are seeking partnerships to expand the therapeutic application and commercial value of our boron chemistry platform. In October 2007, we entered into a research and development collaboration, option and license agreement with GSK for the discovery, development and worldwide commercialization of boron-based systemic anti-infectives. In July 2010, GSK exercised its option to license AN3365 and developed it until October 2012 when GSK discontinued its development and returned all rights to the compound back to Anacor. In September 2011, we amended and

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expanded our research and development collaboration with GSK to provide GSK the option to extend its rights around the bacterial enzyme target leucyl-tRNA synthetase (LeuRS), as well as to add new programs for tuberculosis (TB) and malaria using Anacor's boron chemistry platform. In August 2010, we entered into a four-year research collaboration with Lilly, under which we collaborated to discover products for a variety of animal health applications. In January 2014, we received notice that Lilly will terminate further funded research efforts under the collaboration but the agreement continues in effect, including provisions related to future potential payments and royalties that may be paid to us, as Lilly continues to develop an animal health development candidate that was discovered under this collaboration. In addition, we are applying our boron chemistry platform to the development of treatments for various neglected diseases in collaboration with leading not-for-profit organizations at the University of San Francisco (UCSF), including DNDi, Medicines for Malaria Ventures (MMV), the Center for Discovery and Innovation in Parasitic Diseases at UCSF and the Bill and Melinda Gates Foundation (the Gates Foundation). In March 2012, DNDi commenced the first Phase 1 human clinical trial for AN5568, the first oral drug candidate for sleeping sickness.

        In April 2013, we entered into a research agreement with the Gates Foundation, to discover drug candidates intended to treat two filarial worm diseases (onchocerciasis, or river blindness, and lymphatic filariasis, commonly known as elephantiasis) and tuberculosis (TB). As part of the funded research activities, we are responsible for creating an expanded library of boron compounds to screen for additional potential drug candidates to treat neglected diseases, which will be accessible to the Gates Foundation and other third parties. In October 2013, we entered into a research agreement with the United States Department of Defense, Defense Threat Reduction Agency (DTRA) to apply our boron chemistry to discover rationally designed novel antibiotics that target DTRA-priority pathogens known to exhibit resistance to existing antibiotics.

        On October 24, 2012, we provided notice to Valeant Pharmaceuticals International, Inc. (Valeant), successor in interest to Dow Pharmaceutical Sciences, Inc. (DPS), seeking to commence arbitration with JAMS of a breach of contract dispute under a master services agreement dated March 26, 2004 between Anacor and DPS. This agreement related to certain development services provided by DPS in connection with our efforts to develop tavaborole for the treatment of onychomycosis. Our assertions included breach of contract, breach of implied covenant of good faith and fair dealing, misappropriation of trade secrets and unfair competition. On October 17, 2013, the arbitrator appointed to resolve our dispute with Valeant related to DPS issued an Interim Final Award in our favor, awarding us $100 million in damages as well as all costs of the arbitration and reasonable attorney's fees. On October 27, 2013, Anacor and Valeant agreed that Valeant would pay us $142.5 million to settle all existing and future claims including the damages awarded in that October 17, 2013 ruling, as well as resolve our dispute with Medicis Pharmaceutical Corporation (Medicis) and all other disputes between Anacor, Valeant and DPS related to Anacor's intellectual property, confidential information and contractual rights. Valeant paid Anacor $142.5 million on November 7, 2013.

Boron Chemistry Platform

        All of our current research and development programs, including our eight development-stage product candidates, are based on compounds that have been internally discovered using our boron chemistry platform. Boron is a naturally occurring element that is ingested frequently through consumption of fruits, vegetables, milk and coffee. Boron has two attributes that we believe confer compounds with drug-like properties. First, boron-based compounds have a unique geometry that allows them to have two distinct shapes, giving boron-based drugs the ability to interact with biological targets in novel ways and to address targets not amenable to intervention by traditional carbon-based compounds. Second, boron's enhanced reactivity as compared to carbon allows us to design molecules that can hit targets that are difficult to inhibit with carbon chemistry.

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        Despite the ubiquity of boron in the environment, researchers have faced challenges in evaluating boron-based compounds as product candidates due to previously limited understanding of the physical properties necessary to provide boron-based compounds with the chemical and biological attributes required of pharmaceutical therapies as well as difficulty in chemical synthesis.

        We have developed expertise and an understanding of the interactions of boron-based compounds with key biological targets relevant to treating disease. This know-how is primarily related to methods for modulating boron's reactivity to optimize reactions with the target and minimize unwanted chemical reactivity. Our advances have enabled the efficient optimization of disease-modifying properties for our lead compounds and their rapid progression from the research stage into clinical trials.

        Additionally, we have discovered new methods of synthesis of boron compounds, allowing for the creation of new compound families with broad chemical diversity and retention of drug-like properties. These new compound families expand the universe of biological targets that can be addressed by small-molecule, boron-based compounds. We have been in operation since 2002 and began generating clinical candidates in our second year of operations. Since that time, we have discovered and synthesized thousands of boron-containing molecules and, of these, eight are currently in development. The rate of discovery of molecules and promotion to clinical development has occurred at a relatively constant rate.

        We believe our focus on boron-based chemistry provides us with multiple advantages in the small-molecule drug discovery process. These advantages include:

    Novel access to biological targets  Due to the unique geometry and reactivity of boron-based molecules, our boron-based compounds are able to modulate existing biological targets and can address targets not amenable to intervention by traditional carbon-based compounds. This may enable us to treat diseases that have not been effectively addressed by carbon-based compounds, for example, by developing antibiotic or antifungal therapies that kill pathogens that have become resistant to existing drugs.

    Broad utility across multiple disease areas.  Our compounds have exhibited extensive preclinical activity in multiple disease areas, including fungal, inflammatory and bacterial diseases, which are our core areas of focus, as well as in parasitic, cancer and ophthalmic indications and for applications in animal health.

    Rapid and efficient synthesis of drug-like compounds.  Our proprietary technological advances in the synthesis of boron-based compounds, coupled with our rational drug design capabilities, have enabled us to rapidly create large families of boron-based compounds with drug-like properties. We believe that these advances have made manufacturing of boron-based compounds economical on a commercial scale.

    Unencumbered intellectual property landscape.  We believe the intellectual property landscape for boron-based pharmaceutical products is relatively unencumbered compared to that of carbon-based products, providing an attractive opportunity for us to build our intellectual property portfolio.

Our Strategy

        Our objective is to discover, develop and commercialize proprietary boron-based drug compounds with superior efficacy, safety and convenience for the treatment of a variety of diseases. The key elements of our strategy to achieve this objective are to:

    Drive rapid, efficient discovery of novel boron-based compounds.  We believe the unique characteristics of boron and the expertise we have developed allow us to design novel product candidates that target a broad range of diseases and drive a rapid and efficient drug development process. Since 2002, we have discovered and advanced eight compounds that are

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      currently in development and, in addition, have other active research and development programs ongoing.

    Focus development activities in our core therapeutic areas.  We intend to focus our development activities in our core therapeutic areas of fungal, inflammatory and bacterial diseases. To fully leverage our boron chemistry platform, we have established and will continue to pursue development partnerships in these therapeutic areas.

    Commercialize our products internally or through partnerships in specialty markets in the United States.  We intend to build a sales force and/or form one or more partnerships to focus on domestic specialty markets, such as dermatology and podiatry. We have entered into and will continue to seek commercialization partners for products in non-specialty and international markets.

    Leverage partnerships for non-core therapeutic areas.  We believe boron chemistry has utility in a broad range of diseases outside of our core therapeutic areas. To maximize the value of our boron chemistry platform and to provide non-dilutive capital to support development in our core therapeutic areas, we have entered into and will continue to seek partnerships early in development for compounds in non-core areas, such as parasitic, cancer and ophthalmic indications and for applications in animal health.

    Expand and protect our intellectual property.  We intend to expand and aggressively prosecute our intellectual property in the area of boron chemistry and boron-based compounds. Since a relatively limited amount of research has been done in the area of boron-based drug development, we believe that we can establish a defensible and valuable intellectual property portfolio.

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Our Product Candidates

Our Clinical Pipeline

        The following table summarizes the current status and the anticipated next steps in the development plans for our clinical-stage product candidates:

GRAPHIC

Our Topical Antifungal Programs

    Tavaborole for Onychomycosis

        Our most advanced product candidate is tavaborole, a topical treatment for onychomycosis, which is a fungal infection of the nail and nail bed. We submitted an NDA in July 2013, which was accepted for review by the FDA in September 2013, and currently has a PDUFA V goal date of July 29, 2014.

    Onychomycosis Market

        Onychomycosis is primarily caused by dermatophytes, which are fungi that infect the skin, hair or nails. The infection involves the nail plate, the nail bed and, in some cases, the skin surrounding the nail plate. Onychomycosis causes nails to deform, discolor, thicken, become brittle and split and separate from the nail bed. Toenails affected by onychomycosis can become so thick that routine trimming of the nails becomes difficult. The condition can also cause pain when individuals wear shoes, leading to difficulties walking. Onychomycosis can also lead to social embarrassment due to the

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unsightly appearance of the infected nails and because it may be perceived to be an active infection and contagious.

        According to Podiatry Today, 35 to 36 million people in the United States have onychomycosis. Over 95% of onychomycosis infections are infections of the toenail, according to a report in U.S. Dermatology Review. According to market data, approximately 75% of those affected by onychomycosis are not receiving treatment. For those who do seek treatment, options include debridement, oral or topical drugs or a combination of debridement and drug therapies. Debridement consists of scraping, cutting away or removal of the affected nail. Onychomycosis may persist or worsen if not treated. Onychomycosis often recurs in susceptible individuals because the fungi that cause onychomycosis are present in many common locations such as floors, the soil, socks and shoes. Consequently, the nail can be reinfected, and additional courses of treatment are frequently required even after successful treatment.

        Lamisil (terbinafine), a systemic drug approved for onychomycosis, had worldwide peak sales of $1.2 billion in 2004 before generic entry. According to IMS Health, for the 12-month period ending December 31, 2012, 1.5 million new prescriptions were filled in the United States for both branded and generic versions of terbinafine. Despite its high labeled efficacy (38%), we believe the usage of branded and generic terbinafine has been limited due to safety concerns related to liver toxicity. Penlac Nail Lacquer (ciclopirox), the only U.S. approved topical agent for onychomycosis, had U.S. sales of $125.0 million in 2002, before generic entry. According to IMS Health, for the 12-month period ending December 31, 2012, over 400,000 new prescriptions were filled in the United States for branded or generic ciclopirox. While ciclopirox has been shown to be safe due in part to its topical administration, we believe the usage of branded and generic ciclopirox has been limited due to its low labeled efficacy (5.5% - 8.5%), which was achieved with concomitant monthly debridement, as well as its inconvenient application.

    Limitations of Current Onychomycosis Therapies

        Current therapies for onychomycosis include debridement and drug therapies. Debridement is time consuming and only marginally effective in eliminating the fungal infection. Drug therapies are available in two types, either oral therapies such as Lamisil, or topical therapies such as Penlac. According to the Lamisil product label, 38% of patients treated in clinical trials with a 12-week course of therapy achieved 100% clear nail and mycological cure. However, Lamisil has been associated with rare cases of liver failure, some leading to death or liver transplant. We believe this risk of liver failure limits acceptance of this therapy by both physicians and patients. Patients are recommended to undergo liver function tests prior to initiating Lamisil treatment and those patients with pre-existing liver disease cannot be treated with it.

        Penlac is approved for use in onychomycosis in conjunction with monthly debridement. In the two clinical trials cited on Penlac's product label, even with frequent debridement, only 5.5% and 8.5%, respectively, of patients treated with Penlac achieved 100% clear nail and mycological cure. We believe that a significant barrier to effective treatment by current topical therapies is the difficulty of formulating the drug product to penetrate through the nail plate and reach the site of infection.

    Our Solution: Tavaborole

        By addressing the limitations of current therapies, we believe tavaborole can potentially offer significant improvements over the standards of care for onychomycosis by combining the safety of a topical drug, efficacy without debridement and ease of use. Due to its unique boron chemistry, tavaborole has demonstrated enhanced nail penetration properties, a novel mechanism of action with potent antifungal activity and, due in part to its topical administration and low systemic exposure, clinically significant systemic side effects in human dosing have not been observed.

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        We designed tavaborole with three distinguishing characteristics:

    Enhanced nail penetration properties.  We utilized our expertise in medicinal chemistry to design tavaborole with enhanced nail penetration properties, allowing for improved delivery of the compound through the nail plate to the nail bed, the site of onychomycosis infection. A preclinical study utilizing human nails indicated that tavaborole, 5% solution is able to penetrate the nail plate approximately 40 times more effectively than Penlac.

    Novel mechanism of action with potent antifungal activity.  We have utilized our expertise in boron-based chemistry to design tavaborole with potent antifungal activity. Tavaborole inhibits an essential fungal enzyme, LeuRS, required for protein synthesis. The inhibition of protein synthesis terminates cell growth and leads to cell death, eliminating the fungal infection. We have shown that this inhibitory activity requires the presence of boron within the compound, as the replacement of the boron atom with a carbon atom in tavaborole inactivated the molecule. The unique boron-based mechanism of action underlying tavaborole was detailed in the June 22, 2007 issue of the journal Science.

    No detected systemic side effects after topical dosing.  We have conducted clinical trials to assess systemic absorption of tavaborole. The results of these trials found that topical treatment with tavaborole resulted in low or no detectable levels of the drug in the blood or urine. No clinically significant treatment-related systemic side effects have been observed in any of our clinical trials, and we believe it is unlikely that treatment of onychomycosis with tavaborole will result in significant systemic side effects.

    Tavaborole Phase 3 Clinical Development Program

        In 2013, we completed two Phase 3 studies under a Special Protocol Assessment (SPA), in which tavaborole achieved a high degree of statistical significance on all primary and secondary endpoints. Enrolled subjects were randomized to receive tavaborole topical solution 5% or vehicle solution once daily for 48 weeks. No debridement was performed and proper nail trimming was limited to within 1 mm of the distal groove. In the first study (known as Study 301), 6.5% of patients treated with tavaborole met the primary endpoint of "complete cure" vs. 0.5% of patients treated with vehicle (p=0.001) at week 52. "Complete cure" is a composite endpoint that requires both a mycological cure and a completely clear nail and is consistent with the FDA endpoint requirement for Lamisil. Among the secondary endpoints at week 52, 26.1% of patients treated with tavaborole achieved a "completely clear" or "almost clear" (£10% clinical involvement) nail vs. 9.3% in the vehicle-treated arm (p<0.001); 31.1% of patients treated with tavaborole achieved mycologic cure vs. 7.2% in the vehicle-treated arm (p<0.001)); and 15.3% of patients treated with tavaborole achieved "completely clear" or "almost clear" nail with mycological cure vs. 1.5% in the vehicle-treated arm (p<0.001). In addition to the primary and secondary endpoints noted above, 87.0% of patients treated with tavaborole had a negative fungal culture vs. 47.9% in the vehicle-treated arm (p<0.001) at week 52, and 24.6% of patients treated with tavaborole achieved "completely clear" or "almost clear" nail and negative fungal culture vs. 5.7% in the vehicle-treated arm (p<0.001) at week 52.

        In the second study (known as Study 302), 9.1% of patients treated with tavaborole met the primary endpoint of "complete cure" vs. 1.5% of patients treated with vehicle (p<0.001) at week 52. Among the secondary endpoints at week 52, 27.5% of patients treated with tavaborole achieved a "completely clear" or "almost clear" nail vs. 14.6% in the vehicle-treated arm (p<0.001); 35.9% of patients treated with tavaborole achieved mycologic cure vs. 12.2% in the vehicle-treated arm (p<0.001)); and 17.9% of patients treated with tavaborole achieved "completely clear" or "almost clear" nail with mycological cure vs. 3.9% in the vehicle-treated arm (p<0.001). In addition to the primary and secondary endpoints noted above, 85.4% of patients treated with tavaborole had a negative fungal culture vs. 51.2% in the vehicle-treated arm (p<0.001) at week 52, and 25.3% of patients treated

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with tavaborole achieved "completely clear" or "almost clear" nail and negative fungal culture vs. 9.3% in the vehicle-treated arm (p<0.001) at week 52.

        In both studies, tavaborole was safe and well-tolerated across study subjects, and there were no serious adverse events related to the study drug.

    AN2718 for Topical Fungal Infections

        AN2718 is our second topical antifungal in clinical development for onychomycosis and fungal infections of the skin and utilizes the same mechanism as tavaborole. AN2718 appears to be well-suited to target organisms that cause common skin and topical fungal infections, including Trichophyton and Candida fungi. Based on preclinical studies and in comparison to tavaborole, we believe that AN2718 has greater potency against the dermatophytes T. mentagrophytes and T. rubrum and results in similar nail penetration. These studies suggest that, like tavaborole, AN2718 also has significantly greater nail penetration than Penlac.

        Our Phase 1 data for AN2718 indicated that AN2718 has a low skin irritation profile across multiple doses and that it would thus be suitable for the treatment of skin fungal infection. This Phase 1 data, which we announced in March 2009, was from a 21-day skin irritation trial. In the trial, we compared AN2718 gel at 1.5%, 2.5%, 5.0% and 7.5%, and AN2718 cream at 0.3% and 1.0% to their respective vehicles. All doses of AN2718 gel, cream and vehicle were applied to the skin of normal volunteers for 21 days using semi-occlusive, or semi-air and water-tight, adhesive patches. Application sites were then evaluated daily for signs of irritation. The irritation indices for all AN2718 doses were very low and comparable to vehicle.

Our Topical Anti-Inflammatory Programs

    AN2728 for Mild-to-Moderate Atopic Dermatitis and Psoriasis

        AN2728 is our lead topical anti-inflammatory product candidate for the treatment of atopic dermatitis and psoriasis, chronic inflammatory skin diseases that affect millions of people worldwide. To date, AN2728 has demonstrated initial tolerability and activity against atopic dermatitis in four clinical studies and against psoriatic lesions in seven clinical studies. We had an End of Phase 2 meeting with the FDA for AN2728 in atopic dermatitis in the first quarter of 2014 and expect to initiate Phase 3 studies in atopic dermatitis in the first half of 2014. In October 2011, we held an End of Phase 2 meeting with the FDA to discuss the design of Phase 3 trials of AN2728 in psoriasis and in November 2011, we filed a SPA, and reached agreement with the FDA on the major parameters associated with the design and conduct of the Phase 3 trials of AN2728 in psoriasis.

        Given the safety profile exhibited by AN2728, the positive outcome from the Phase 2 atopic dermatitis trials and the large unmet medical need in atopic dermatitis relative to psoriasis, we are focusing AN2728 development activities on atopic dermatitis and will evaluate initiating Phase 3 trials in psoriasis after the completion of the Phase 3 studies in atopic dermatitis.

    Atopic Dermatitis Market

        Atopic dermatitis is a chronic rash characterized by inflammation and itching, often occurring in the folds of skin with symptoms lasting up to 14 days or more. Lesions of atopic dermatitis are commonly red, elevated, scaly, excoriated and oozing patches and are often accompanied by intense, unrelenting pruritus (itching). The lesions lichenification, a thickening of the skin with exaggerated skin lines, is considered to be an atrophic response to chronic rubbing. According to the National Eczema Association, almost 18 million people in the United States have atopic dermatitis. An article published in the Journal of Allergy and Clinical Immunology reports that surveys indicate that greater than 70% of patients have mild disease, 20% have moderate disease and only 2% have severe disease. The condition most commonly appears in childhood, with up to 20% of children in the United States affected, and it

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can persist into adulthood. Atopic dermatitis is the eighth most common disease in persons under 25 years of age and is a common cause for pediatric healthcare visits, nonetheless, it continues to be frequently misdiagnosed, misunderstood and ineffectively treated. While the exact cause of atopic dermatitis is not known, patients have a number of characteristics, including: a family tendency towards atopy, i.e., asthma, hay fever and atopic dermatitis; an impaired skin barrier function; dry skin; a lower than normal threshold for itching; increased susceptibility to bacterial as well as viral, fungal and yeast skin infections and abnormal immune and/or inflammatory responses. The secondary infections and/or greater than normal levels of bacterial colonization may be due to deficiencies in these patients' innate immunity. At least some of the inflammatory responses are driven by host responses to the super antigens of Staphylococcus aureus.

    Limitations of Current Therapies for Mild-to-Moderate Atopic Dermatitis

        No currently available therapy is curative for atopic dermatitis. Topical corticosteroids are the mainstay of treatment, aimed at preventing pruritus and subsequent scratching, which exacerbates the condition. Local side effects include skin thinning, acne and stretch marks and systemic side effects include HPA axis suppression. In addition, the safety of long-term corticosteroid treatment in pediatric patients is of concern. The most recently approved non-steroidal topical therapies for atopic dermatitis were Protopic and Elidel, topical immunomodulators, which received Black Box warnings for potential cancer risk from the FDA in 2005. In the year prior to receiving a Black Box warning, 4.9 million prescriptions were written for Protopic and Elidel in the United States. Since the Black Box warning, Protopic and Elidel are only recommended for use as second line therapy for short-term and non-continuous chronic treatment in patients over the age of 2 years who have failed to respond to other treatments. Antibiotics, antihistamines, topical corticosteroids and topical immunomodulators may also be used in combination, however, these can be limited in utility due to insufficient efficacy or unwanted side effects.

    Psoriasis Market

        Psoriasis is a chronic inflammatory skin disease that affects approximately 7.5 million people in the U.S. and over 100 million people worldwide. Patients can be categorized as mild, moderate or severe, with approximately 80% of patients having mild to moderate forms of the disease. Psoriasis is characterized by thickened patches of inflamed, red skin covered with thick, silvery scales typically found at the elbows, knees, scalp and genital area. The disorder ranges from a single, small, localized lesion in some patients to a severe generalized eruption. Patients with mild-to-moderate psoriasis are typically treated with a combination of topical therapies, while patients with moderate-to-severe psoriasis are typically treated with a combination of topical and systemic therapies. The recent introductions of new systemic biologic therapies have provided new treatment options for patients with moderate to severe disease and have greatly expanded amounts spent on drugs to treat psoriasis. According to LeadDiscovery, sales of psoriasis drugs in the seven major pharmaceutical markets (United States, Japan, France, Germany, Italy, Spain and the United Kingdom) were $2.5 billion in 2008. In 2009, over 4.5 million prescriptions were written for patients with psoriasis in the United States, with approximately 3.9 million of these prescriptions written for topical therapies.

    Limitations of Current Psoriasis Therapies

        Most psoriasis patients use more than one type of treatment at any given time and may rotate treatments over time as their disease severity changes or they develop complications. Although current treatments attempt to decrease the severity of the disease, none of them cures the disease. Currently available treatments can be classified as topical, oral, injectable or phototherapy. According to IMS Health, 84% of all prescriptions for psoriasis within the United States in 2009 were for topical treatments. The most common topical treatments are corticosteroids, vitamin D derivatives, such as Dovonex (calcipotriene), topical retinoids, such as Tazorac (tazarotene), and crude coal tar

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preparations. Taclonex is also a treatment for psoriasis and is a combination of calcipotriene and the high potency corticosteroid betamethasone dipropionate. The most common oral treatments are the immunosuppressive drug methotrexate and the oral retinoid acitretin. A number of injectable biologic drugs in the market include Enbrel, Humira, Remicade, Stelara and Simponi. The majority of these drugs are monoclonal antibodies, complex protein molecules, some of which act by the inhibition of TNF-alpha. In addition to topicals, orals and injectables, psoriasis is also treated with ultraviolet light exposure. Typically, physicians initiate treatment by prescribing topical therapies to treat mild or moderate forms of psoriasis, followed by light therapy or oral treatments if the patient's disease does not improve. For patients who do not respond to oral treatments or light therapy, or for those who have moderate-to-severe psoriasis, physicians often consider prescribing injectable biologic treatments.

        Current topical therapies have demonstrated varying levels of efficacy. However, their use has been limited due to issues of safety and tolerability. Long-term use of topical corticosteroids is associated with atrophy, or thinning, of the skin and has the potential to suppress the body's ability to make normal amounts of endogenous corticosteroids, which limit the duration of safe treatment with these therapies. Vitamin D derivatives can cause skin irritation, and some patients report burning sensations associated with their use. Topical retinoids can also cause skin irritation and have been shown to cause birth defects. Thus, their use must be avoided during pregnancy. Oral and injectable drugs have greater activity than topical therapies, but also have well-documented and significant systemic side effects, such as liver toxicity, increase in blood fats and suppression of the immune system. In addition, injectable biologic drugs are very expensive, costing tens of thousands of dollars annually. Ultraviolet light treatments can be effective, but require multiple visits to the doctor's office each week and may increase patients' risk of developing skin cancer.

    Our Solution: AN2728 for Mild-to-Moderate Atopic Dermatitis and Psoriasis

        We believe that AN2728 will have comparable efficacy to that of topical mid-potency corticosteroids and topical immunomodulators in treating mild-to-moderate atopic dermatitis and comparable efficacy to that of topical mid-potency corticosteroids and vitamin D analogs in treating mild-to-moderate psoriasis, but with a better safety and tolerability profile. AN2728 is a novel boron-containing small molecule that inhibits PDE-4 and reduces the production of pro-inflammatory cytokines thought to be associated with atopic dermatitis and psoriasis. If approved, AN2728 would be the first topical non-steroidal treatment for atopic dermatitis since the approval of Elidel in 2002.

    AN2728 Clinical Development Programs

        To date, AN2728 has demonstrated tolerability and activity against mild-to-moderate atopic dermatitis in four clinical studies, and against psoriatic lesions in seven clinical studies. In the first quarter of 2014, we held an End of Phase 2 meeting with the FDA to discuss the design of Phase 3 trials of AN2728 in atopic dermatitis and plan to initiate the Phase 3 trials in the first half of 2014. In October, 2011 we held an End of Phase 2 meeting with the FDA to discuss the design of Phase 3 trials of AN2728 in psoriasis and, in November, 2011, we filed a SPA and reached agreement with the FDA on the major parameters associated with the design and conduct of the Phase 3 trials of AN2728 in psoriasis.

        Given the safety profile exhibited by AN2728 in 18 clinical studies, the positive outcome from the four clinical trials in atopic dermatitis and the large unmet medical need in atopic dermatitis relative to psoriasis, we are focusing AN2728 development activities on atopic dermatitis and will reconsider Phase 3 trials in psoriasis after the completion of the Phase 3 trials in atopic dermatitis.

    AN2728 Clinical Development Program in Mild-to-Moderate Atopic Dermatitis

        In December 2011, we announced the results of our first Phase 2 trial of AN2728 for the treatment of atopic dermatitis. In this six-week, double-blind, bilateral trial, 25 patients were

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randomized 1:1 to treat their atopic dermatitis lesions twice daily (BID) with AN2728 ointment, 2% or vehicle. The primary endpoint was the improvement in lesions treated with AN2728 ointment, 2% compared to lesions treated with vehicle at 28 days. Improvement was defined as a decrease in Atopic Dermatitis Severity Index (ADSI) score, which is the sum of the severity scores of five clinical features (erythema, pruritis, exudation, excoriation and lichenification) from 0 (none) to 3 (severe) for each feature, for a total score of 0 to 15. AN2728 met the primary endpoint with 68% of patient lesions treated with AN2728 showing improvement in ADSI score from baseline compared to 20% of lesions treated with vehicle (P = 0.017). The proportion of lesions achieving total or partial clearance (ADSI score < 2.0) at day 28 was 52% for lesions treated with AN2728 compared to 16% for lesions treated with vehicle.

        In December 2012, we announced results from our second Phase 2 study of AN2728 for the treatment of atopic dermatitis. It was our first study in adolescents with atopic dermatitis, and the first study in which we have evaluated the effect of treating all of a patient's atopic dermatitis and measured the improvement using the Investigator Static Global Assessment (ISGA). The ISGA is a 5-point scale from 0 (clear) to 4 (severe) and is the same scale used by the FDA to evaluate the most recently approved topical treatments for atopic dermatitis. 35% of patients achieved an ISGA score of 'clear' or 'almost clear' with a minimum 2-grade improvement. In addition, AN2728 demonstrated a promising safety profile when treating adolescents. The Phase 2 open-label study enrolled 23 adolescent patients, with mild-to-moderate atopic dermatitis involving 10-35% of treatable body surface area (BSA). Mild-to-moderate atopic dermatitis was defined as an ISGA score of 2 (mild) or 3 (moderate). Patients were instructed to apply AN2728 ointment, 2% BID for 28 days. The primary endpoints were an assessment of safety and tolerability based on the frequency and severity of systemic and local adverse events (AEs) as well as the pharmacokinetic profile. Secondary endpoints included assessment of change in ISGA score as well as individual signs and symptoms of atopic dermatitis.

        In March 2013, we reported the results of a Phase 2 dose-ranging study in 86 adolescents (ages 12 - 17) with mild-to-moderate atopic dermatitis. Patients were randomized 1:1 to either once daily (QD) or BID application for 28 days. Patients were instructed to apply AN2728 ointment, 2.0% to one target lesion and AN2728 ointment, 0.5% to a comparable target lesion. The primary endpoint was the change from baseline ADSI score. A clear dose response was demonstrated in this study, with AN2728 ointment, 2.0% BID yielding the greatest improvement. Lesions treated with AN2728 ointment, 2.0% BID for 28 days achieved a 71% improvement from baseline in their ADSI score, with 62% of lesions in this treatment group achieving total or partial clearance. Most adverse events were mild and largely unrelated to the study drug.

        In November 2013, we reported the results of a Maximal Use Systemic Exposure (MUSE) study in children. The multi-center, open label study enrolled 34 patients, ages two to 17 years with mild-to-moderate atopic dermatitis with a mean involvement of 49% of total body surface area (BSA). Mild-to-moderate atopic dermatitis was defined as an ISGA score of 2 (mild) or 3 (moderate). In the MUSE study, patients (or their caregivers) were instructed to apply AN2728 ointment, 2% BID for 28 days. The results of this study demonstrated that AN2728 ointment, 2% appears to be safe, well-tolerated, and efficacious when applied twice daily to patients, ages two to 17 years with atopic dermatitis affecting a very large percentage of their body surface area. 65% of patients achieved an ISGA score of 0 (clear) or 1 (almost clear) after four weeks of treatment; 47% of patients achieved an ISGA score of 0 (clear) or 1 (almost clear) with a minimum 2-grade improvement after four weeks of treatment; mean pruritus scores improved by 63% after four weeks of treatment; and patients demonstrated an average 78% reduction in affected body surface area. Overall blood levels in pediatrics and adolescents were low and were similar to those previously observed in adults after adjusting for percent BSA treated.

        In December 2013, we completed a thorough QT (TQT) study in approximately 180 healthy volunteers. The primary endpoint of this study was the assessment of change from baseline

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electrocardiogram (ECG), specifically QT/QTc interval following multiple doses of AN2728 ointment, 2% as compared to vehicle ointment at Day 9. Study results indicate that AN2728 ointment, 2% did not have any significant effect on the primary endpoint and was therefore deemed safe from a cardiac safety perspective. In addition, in February 2014, we completed a voluntary drug-drug interaction(DDI) study.

        We held an End of Phase 2 Meeting with the FDA the first quarter of 2014 and currently plan to initiate Phase 3 studies of AN2728 in atopic dermatitis in the first half of 2014.

    AN2728 Clinical Development Program in Psoriasis

        Psoriasis is often bilateral and symmetrical, meaning that patients with psoriasis commonly have similar areas of psoriasis on opposing sides of their body. Three of our Phase 2 studies of AN2728 for the treatment of psoriasis were designed as bilateral studies in which patients treat one of their plaques with one treatment and a similar plaque or the other side of the body with a comparison treatment. This allowed patients to serve as their own control.

        In March 2008, we completed a Phase 2a bilateral trial of AN2728 to characterize the safety profile and to assess efficacy. In this trial, patients, in a double-blinded fashion, treated one of their areas of psoriasis with AN2728 ointment,5.0% and a matching area on the opposite side of the body with the vehicle alone. The trial treated 35 patients with mild-to-moderate psoriasis. The primary endpoint was the proportion of patients in whom the AN2728-treated area improved more than the vehicle-treated area based on the overall target plaque severity score (OTPSS). The OTPSS is a scoring system used by investigators that characterizes severity of disease, which ranges from zero (no evidence of disease) to eight (very severe). Based on the OTPSS after four weeks, the trial achieved its primary endpoint, with 69% of the AN2728 treated plaques demonstrating a lower score than the vehicle treated plaques as compared to 6% of the vehicle treated plaques (p-value less than 0.001). Significant differences were also noted after two weeks and three weeks and in all secondary endpoints, including scaling, erythema and plaque elevation. In addition to no serious adverse events, there were no treatment-related adverse reactions or application site reactions.

        In December 2008, we completed a Phase 2 double-blind bilateral trial comparing AN2728 ointment,5.0% and vehicle using a design similar to our Phase 2a study but using a longer treatment duration. In this Phase 2 study, patients with mild-to-moderate psoriasis applied AN2728 and vehicle BID for 12 weeks in order to define the optimal duration of therapy. Results showed statistically significant reductions in the OTPSS, as well as in the individual signs of psoriasis, such as erythema, scale and plaque thickness at several time points. Compared to those treated with vehicle, psoriasis plaques treated with AN2728 achieved a lower OTPSS in a significantly greater proportion of patients after as few as two weeks of treatment, with optimal responses seen at six and eight weeks (p-value less than 0.001 and 0.01, respectively). Thirteen percent of the treated plaques cleared completely and 43% of the plaques achieved (clear) or (almost clear) with a two-grade improvement from baseline. Treatments were generally well-tolerated with the most common side effect being irritation at the application site. During the course of the trial, one serious adverse event was reported in a patient who developed a rash after receiving an injection of penicillin outside of the trial for a sore throat and needed to be hospitalized for this non-life threatening reaction.

        In June 2010, we completed a 145-patient randomized, double-blind, vehicle-controlled, multicenter, Phase 2b bilateral dose-ranging trial to evaluate the safety and efficacy of AN2728 ointment,0.5% and 2.0%, applied QD or BID for 12 weeks for the treatment of mild-to-moderate psoriasis. Compared to those treated with vehicle, psoriasis plaques treated with AN2728 achieved greater improvement in the OTPSS in a significantly higher proportion of patients after six weeks in the AN2728 ointment,2.0% BID dosing group (p-value less than 0.001), which was the primary endpoint of the trial. A dose response was also observed across the four dosing groups for this outcome. Additionally, of those plaques treated for 12 weeks with AN2728 ointment,2.0% BID, 54%

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achieved complete or near complete clearance with at least a two-grade improvement from their baseline severity score.

        In June 2011, we completed the final Phase 2b trial to evaluate the safety and efficacy of AN2728 in patients with mild-to-moderate psoriasis under the anticipated conditions of expected Phase 3 trials to provide preliminary indications of efficacy and local tolerability and systemic safety when treating all or nearly all of the plaques on each subject. In this trial, 68 subjects were randomized in a 2:1 ratio, AN2728 to vehicle. Subjects treated with AN2728 showed improvement over vehicle at each of the recorded timepoints during the 12-week study period with peak efficacy (defined by proportion of subjects achieving complete or near complete clearance of treated psoriasis plaques) of 26% occurring after six weeks of treatment with AN2728.

        In October 2011, we completed an End of Phase 2 meeting with the FDA. We also filed a SPA and reached agreement with the FDA on the major parameters associated with the design and conduct of the Phase 3 trials in psoriasis, which we will reconsider after the completion of the Phase 3 trials of AN2728 in atopic dermatitis.

    AN2898 for Mild-to-Moderate Atopic Dermatitis and Psoriasis

        AN2898 is our second anti-inflammatory product candidate for atopic dermatitis and psoriasis. Like AN2728, AN2898 is a novel boron-containing small molecule that inhibits PDE-4 and reduces the production of pro-inflammatory cytokines believed to be associated with atopic dermatitis and psoriasis.

        In February 2009, we initiated a Phase 1b study evaluating AN2898 in 12 patients with plaque-type psoriasis for 12 days. Achieving its primary endpoint, this study demonstrated that AN2898 caused a significant reduction in the thickness of psoriatic lesions compared to vehicle, at a p-value less than 0.0001. The mean percent reduction in infiltrate thickness on day 12 for AN2898 was 39%, as compared to 60% for Betnesol-V, the positive control. The results relative to the secondary endpoint (clinical response) paralleled those of the primary endpoint.

        In a cumulative irritation trial completed in the first quarter of 2009, AN2898 ointment,5.0% and its vehicle were applied QD to the skin of normal volunteers under occlusive, adhesive patches for four consecutive days. Application sites were evaluated daily for signs of irritation. No irritation potential was seen for AN2898 ointment,5.0% or the vehicle.

        In December 2011, we completed a Phase 2a study of AN2898 in atopic dermatitis. In this multicenter, randomized, double-blind, vehicle-controlled, bilateral comparison study, 46 patients with mild-to-moderate dermatitis were randomized (1:1) to receive either AN2728 ointment, 2% vs. ointment vehicle or AN2898 ointment, 1% vs. ointment vehicle, applied BID to two similar target lesions on the trunk or extremities for six weeks. The primary endpoint for both compounds was successfully achieved after 28 days of BID treatment.

Our Gram-Negative Antibiotic Program

    AN3365 for Gram-Negative Infections

        AN3365 is our lead antibiotic product candidate for the treatment of infections caused by Gram-negative bacteria. In July 2010, GSK exercised its option to obtain an exclusive license to develop and commercialize AN3365 and assumed responsibility for further development of the product candidate and any resulting commercialization. In June 2011, GSK initiated two Phase 2b trials for complicated urinary tract infections (cUTI) and complicated intra-abdominal infections (cIAI). In March 2012, GSK voluntarily discontinued certain of its current clinical trials of AN3365 due to a microbiological finding in a small number of patients in the Phase 2b trial for the treatment of cUTI. In October 2012, GSK advised us that it had discontinued further development of AN3365 and all rights to this compound reverted to us. We are currently considering our options for further development, if any, of this compound.

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    Limitations of Current Gram-Negative Antibiotics

        Traditionally, Gram-negative infections have been treated with antibiotics, particularly beta-lactams, including penicillins, cephalosporins and carbapenems, and quinolones, including flouroquinolones. However, the effectiveness of existing antibiotics has been declining due to increasingly prevalent drug resistance. Bacteria develop resistance to drugs through genetic mutations or by acquiring genes from other bacteria that have become resistant. For example, in a recent survey of resistance rates of Gram-negative bacteria to current therapies in the United States, the resistance of E. coli to fluoroquinolones has been dramatically increasing. For example, resistance of E. coli to ciprofloxacin increased from 4% in 1999 to 30% in 2008 and resistance of E. coli to levofloxacin increased from 10% in 2003 to 30% in 2008. Over the same period, resistance of another Gram-negative bacteria, Klebsiella pneumoniae, to third generation cephalosporins, such as ceftriaxone and ceftazidime, increased from virtually no resistance to 15%. The same survey also showed that by 2008, 17% - 19% of Pseudomonas aeruginosa were resistant to fluoroquinolones, 10% - 70% were resistant to third generation cephalosporins and 7% - 15% were resistant to carbapenems, such as meropenem and imipenem. Therefore, there is an ongoing need for novel antibiotics to combat the widespread proliferation of antibiotic resistance, particularly for Gram-negative bacteria. Additionally, currently-marketed products have side effect profiles that can include nausea, diarrhea, vomiting, rash, insomnia, and potential liver toxicity. Also, currently-approved antibiotics specifically targeting infections caused by Gram-negative bacteria are only available in either IV or oral formulations, but not both, so patients cannot continue on the same antibiotic therapy they received in the hospital once they are discharged.

    Our Solution: AN3365

        AN3365 is a novel, boron-based, small molecule product candidate that targets the bacterial enzyme LeuRS. The inhibition of protein synthesis leads to termination of cell growth and cell death, eliminating the bacterial infection. Preclinical studies suggest that AN3365 could be a novel approach for the treatment of infections caused by Gram-negative bacteria, including E. coli, Klebsiella pneumoniae, Citrobacter spp., S. marcescens, P. vulgaris, Providentia spp., Pseudomonas aeruginosa and Enterobacter spp. AN3365 has demonstrated a favorable profile in preclinical safety and toxicology studies. Results from a Phase 1 proof-of-concept trial showed that AN3365 demonstrated a promising safety profile and linear dose-proportional pharmacokinetic properties, reaching blood levels that were multiple times higher than the anticipated efficacious dose.

    AN3365 Development Program

        In November 2009, we initiated a Phase 1 dose-escalating clinical study for AN3365, to evaluate the safety, tolerability and pharmacokinetics of AN3365 in healthy volunteers. The randomized, double-blind, placebo-controlled, dose-escalation study enrolled 72 subjects. Participants in this study received AN3365 in single or multiple doses for treatment durations of up to 14 days and included doses that achieve blood levels that are approximately four times the expected efficacious blood levels based on our preclinical studies. In June 2010, we reported Phase 1 results showing that AN3365 appeared to be safe and well-tolerated. In July 2010, GSK exercised its option to obtain an exclusive license to develop and commercialize AN3365. Upon exercise of the option, we received a fee of $15.0 million. In June 2011, GSK initiated two Phase 2b trials for cUTI and cIAI.

        In March 2012, GSK voluntarily discontinued its current clinical trials of AN3365 due to a microbiological finding in a small number of patients in the Phase 2b trial of AN3365 for the treatment of cUTI. In October 2012, GSK advised us that it had discontinued further development of AN3365 and all rights to this compound reverted to us. We are currently considering our options for further development, if any, of this compound.

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Our Animal Health Program

    Animal Health

        In August 2010, we established a four-year research and development agreement with Lilly to create and develop new therapeutics for animal health. In August 2011, Lilly selected its first development candidate and, in December 2012, Lilly selected a second development candidate, each for undisclosed indications in animal health. We received a $1.0 million milestone payment for each candidate selection. Lilly halted further development of the first compound and returned all rights to Anacor. Lilly is currently developing the second development candidate selected. In January 2014, we received notice that Lilly will terminate further funded research efforts under the collaboration, which will terminate Lilly's obligation to make the final two research payments under the agreement to us. The remainder of the agreement remains in effect, and potential payments and royalties related to the compound under development by Lilly pursuant to the agreement remain unaffected by the termination of the research term.

    Animal Health Market

        The animal health market is focused on providing a quality life to animals that are generally categorized as companion animals or food animals. The market is driven primarily by two main factors: pet owners in the United States and Europe demanding more advanced and expensive treatments for companion animals, and the growing world population has increased the demand for food animals requiring improvements in livestock health care and feeding in food animal production. Pharmaceutical products in animal health include vaccines, antibiotics, antifungals, anti-parasitics and medical feed additives. The market for animal health products is approximately $20 billion a year with an annual growth rate averaging over 6% in the last 10 years. The top-selling animal health products are anti-parasitics for companion animals and generate annual sales of almost a $1 billion a year.

    Our Animal Health Development Candidate

        Our boron chemistry platform has demonstrated the potential to treat a number of diseases caused by bacteria, fungi and parasites, some of the leading causes of diseases in animals. As a result of some of our work in human neglected diseases, we identified the opportunity to address unmet medical needs in animals as well. Lilly funded the research that resulted in the discovery of the candidate currently in development and is responsible for its future development and commercialization. Anacor is eligible to receive additional development and regulatory payments as well as tiered royalties from percentages in the high single digits to in-the-tens on future sales.

Our Neglected Diseases Initiatives

    AN5568 for Sleeping Sickness

        AN5568 is a boron-based compound currently in Phase 1 clinical trials for sleeping sickness. In December 2007, we established a partnership with DNDi to develop new therapeutics for sleeping sickness, visceral leishmaniasis and Chagas disease. In March 2012, DNDi commenced Phase 1 human clinical trials of AN5568 in sleeping sickness. AN5568 is a product of Anacor's boron chemistry and the first oral drug candidate for this indication.

    Sleeping Sickness

        Sleeping sickness threatens millions of people in 36 countries in sub-Saharan Africa and is fatal if left untreated. The disease is caused by parasites transmitted by the bite of a tsetse fly and is often asymptomatic for years until the infection reaches "stage 2" where it crosses into the central nervous system and brain. Without effective treatment, sleeping sickness is usually fatal.

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    Limitations of Current Sleeping Sickness Treatments

        Currently available treatments are limited to drugs developed decades ago that are either highly toxic, difficult to administer in resource-limited settings or only effective in one stage of the disease. In addition, prior to being treated, the stage of the disease must be determined using a diagnostic spinal tap to extract cerebrospinal fluid from the patient. Two-thirds of all reported sleeping sickness cases are found in the Democratic Republic of the Congo (DRC), where healthcare is often inaccessible to large parts of the population due to violent conflict, great distances patients must travel to health facilities and extreme poverty.

    Our Solution: AN5568

        In pre-clinical studies, AN5568 demonstrated safety and the ability to cross the blood-brain barrier making it efficacious against stage 1 and stage 2 of the disease. In addition, its oral formulation, short duration of therapy and excellent pre-clinical safety profile suggest that it could change the way sleeping sickness is treated, reduce its incidence in humans, and contribute to elimination of the disease. DNDi is solely responsible for clinical development of AN5568 in this indication.

Research Activities

    Internal Research Activities

        Our internal research activities include follow-on research to our existing compounds as well as investigation of novel activity of our boron chemistry platform in multiple therapeutic applications. Key efforts currently include the further development of topical and systemic PDE-4 inhibitors for the treatment of inflammatory diseases, new approaches to the therapy of acne and rosacea, the development of novel anti-infectives against targets not covered in our existing GSK collaboration and work on novel kinase inhibitors.

    Neglected Diseases Initiatives

        Neglected diseases are defined as diseases that disproportionately affect the world's poorest people, including TB, malaria, visceral leishmaniasis, Chagas disease, sleeping sickness and filarial worms. Despite the fact that these diseases cause significant morbidity and mortality worldwide, and that the current standards of care are difficult to administer, have significant toxicities and are increasingly becoming less effective due to resistance, there has been little investment in developing new therapies for these diseases due to the absence of a reasonable expectation of a financial return.

        Our boron chemistry platform appears to be particularly well suited for the treatment of these types of infectious diseases, and we feel a responsibility to apply our technology to the development of new treatments. Until such time as we are consistently profitable, however, we are committed to doing that research only when we can use grants and other non-dilutive sources of funding in as close to a cash-neutral manner as possible.

        In recent years, a number of foundations and governments have created public-private partnerships to address this gap by funding promising technologies that may result in new drugs. In December 2007, we established a partnership with DNDi to develop new therapeutics for sleeping sickness, visceral leishmaniasis and Chagas disease. In March 2012, DNDi initiated the first Phase 1 clinical trial of AN5568 in humans for sleeping sickness. In May 2009, we established a collaboration with the Global Alliance for TB Drug Development. In April 2010, we entered into a research collaboration with MMV to identify lead compounds for the treatment of prophylaxis of malaria and, in March 2011, we also entered into a development agreement with MMV to develop compounds for the treatment of malaria. In December 2010, we entered into a collaboration with the Sandler Center for Drug Discovery (now the Center for Discovery and Innovation in Parasitic Diseases) at UCSF to discover new drug therapies

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for the treatment of river blindness, a parasitic disease that is the second leading cause of infectious blindness worldwide.

        In April 2013, we signed a research agreement with the Gates Foundation to discover drug candidates intended to treat two filarial worm diseases and TB. Additionally, Anacor will create an expanded library of boron compounds to screen for additional potential drug candidates to treat neglected diseases and will provide access to the expanded library compounds for neglected disease research to the Gates Foundation, and others, including academic, governmental and other non-profit institutions or equivalent entities. Under the agreement, the Gates Foundation agreed to pay up to $17.7 million in research funding over a three-year term and also invested $5.0 million in Anacor common stock.

        Our work in this area also allows us the potential benefits of expanding the chemical diversity of our boron compounds, understanding new properties of our boron compounds, receiving future incentives, such as the potential grant of a priority review voucher by the FDA, and, ultimately if a drug is approved, potential revenue in some regions.

    New Classes of Systemic Antibiotics

        In October 2013, we entered into a research agreement with DTRA to design and discover new classes of systemic antibiotics. A drug discovery consortium formed by Colorado State University, the University of California at Berkeley and us will conduct the research over a three and a half year period. The work is funded by a $13.5 million award from DTRA's R&D Innovation and Systems Engineering Office, which was established to search for and execute strategic investments in innovative technologies for combating weapons of mass destruction. Under this award, we will apply our boron chemistry to discover rationally designed novel antibiotics that target DTRA-priority pathogens known to exhibit resistance to existing antibiotics. The $13.5 million award is available to the consortium to fund $2.7 million of research reimbursements for the eleven-month period through September 30, 2014, and an additional $5.0 million and $5.7 million will become available upon DTRA exercising their options to fund the subsequent twelve- and nineteen-month periods, respectively.

Collaboration with GSK

        In October 2007, we entered into a research and development collaboration, option and license agreement with GSK for the discovery, development and worldwide commercialization of boron-based systemic anti-infectives. Under the agreement, we are currently working to identify and develop product candidates in an identified target-based project areas. The collaborative research term of the agreement will expire in 2014 unless extended by the parties.

        Pursuant to the agreement, GSK paid us a $12.0 million non-refundable, non-creditable upfront fee in October 2007. In addition, GSK invested $30.0 million in a preferred stock financing completed in December 2008. Subsequently, in November 2010, GSK invested an additional $5.0 million in our common stock in connection with our initial public offering.

        In July 2010, GSK exercised its option to obtain an exclusive license to develop and commercialize AN3365 for the treatment of infections caused by Gram-negative bacteria. Upon exercise of the option, we received a licensing fee of $15.0 million. GSK assumed responsibility for further development of the product candidate and any resulting commercialization. In June 2011, GSK initiated two Phase 2b trials for complicated urinary tract infections and complicated intra-abdominal infections. In March 2012, GSK voluntarily discontinued certain of its current clinical trials of AN3365 due to a microbiological finding in a small number of patients in the Phase 2b trial of AN3365 for the treatment of cUTI. In October 2012, GSK advised us that it had discontinued further development of AN3365 and all rights to this compound reverted to us. If we choose to further develop AN3365, we may be required to make

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certain milestone payments beginning upon filing for regulatory approval of up to $8.0 million and royalty payments from percentages in the low single digits to GSK.

        In September 2011, we amended and expanded our agreement with GSK and received a $5.0 million amendment fee. The amendment added a new program for tuberculosis (TB), under which GSK is funding Anacor's TB research activities through to candidate selection. Upon meeting candidate selection criteria, GSK has the option to license TB compounds and would be responsible for all further development and commercialization. In September 2013, GSK selected and licensed a candidate for further development in TB. Anacor is eligible for up to $75.0 million in milestones and royalties from percentages in the low to mid single digits on sales of resulting products.

        To date, in addition to the $12.0 million upfront payments, $5.0 amendment fee and $15.0 million option exercise fee, we have received $10.1 million for achievement of performance milestones, including milestones for lead declaration, candidate selection and first patient dosing in a Phase 1 clinical trial of AN3365. We have also received milestone payments for lead declarations in two other GSK programs.

        The agreement provides for a joint research committee to oversee the research collaboration, and a joint patent subcommittee responsible for coordination of intellectual property developed by the collaboration, including patent application filing. We and GSK have appointed an equal number of members to each such committee and decisions are made on a consensus basis. Unless earlier terminated, the agreement will continue in effect until expiration of all payment obligations under the agreement. GSK retains the unilateral right to terminate the TB project under the agreement upon written notice to us. Either party may also terminate the agreement for any uncured material breach of the agreement by the other party. Either party may also terminate the agreement upon specified actions relating to insolvency of the other party. In the event of unilateral termination by GSK, all rights granted by us to GSK with respect to the project to which such termination applies would terminate and we would retain the rights to any compounds relating to such project. In the event of termination by GSK for cause, GSK would have a perpetual exclusive license under our intellectual property to develop and commercialize any project compounds to which such termination applies, subject to GSK's payment to us of specified royalties on sales of such compounds. In the event of termination by us for cause, we would have a perpetual exclusive license under GSK's intellectual property to develop and commercialize any project compound to which such termination applies.

        For a specified period following the effective date of the agreement, subject to certain exceptions, we may not research, optimize, develop or commercialize outside of the collaboration any compounds that we progressed through the project Under certain circumstances and for a specified period, we are restricted from developing or commercializing TB compounds for other indications. Upon a change of control of either party, the agreement would remain in effect. Upon a change of control of Anacor, GSK has the right to elect to exercise any remaining options to license and commercialize compounds then under development pursuant to the research collaboration.

Collaboration with Lilly

        In August 2010, we entered into a four-year research agreement with Lilly under which we collaborated to discover products for a variety of animal health applications. The collaboration combined our boron-based technology platform and drug research capabilities with Lilly's expertise in the area of animal health. To date, we have received over $16.0 million in milestones and research funding. Lilly is currently developing one of the candidates discovered under this collaboration. We are eligible to receive payments upon Lilly's achievement of development and regulatory milestones, as well as tiered royalties, escalating from percentages in the high single digits to in-the-tens, on sales. Such royalties continue through the later of expiration of our patent rights or six years from the first commercial sale on a country-by-country basis.

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        In January 2014, Anacor received notice that Lilly is terminating the research term effective March 2014, five months earlier than the expiration in August 2014 as specified in the agreement, which will terminate Lilly's obligation to make the final two research payments under the agreement to us. The remainder of the agreement remains in effect, and potential payments and royalties related to the compound under development by Lilly pursuant to the agreement remain unaffected by the termination of the research term.

        Unless earlier terminated, the agreement continues in effect until the termination of royalty payment obligations. The agreement allows for termination by Lilly upon written notice, with certain additional payments to us and a notice period that has a duration dependent on whether the notice is delivered prior to the first regulatory approval of a product under the agreement or thereafter. In addition, either party may terminate for the other party's uncured material breach of the agreement. In the event of termination by us for material breach by Lilly or termination upon written notice by Lilly, Lilly would assign to us certain trademarks and regulatory materials used in connection with the products under the agreement and grant to us an exclusive license under Lilly's patent rights covering such products, and we would pay to Lilly a reasonable royalty on sales of such products should we desire an exclusive license. In the event of termination for material breach by us, Lilly will be entitled to a return of all research funding payments for expenses we have not incurred or irrevocably committed.

Collaboration with Medicis

        In February 2011, we entered into a research and development option and license agreement with Medicis to discover and develop boron-based small molecule compounds directed against a target for the potential treatment of acne.

        On November 28, 2012, we filed for arbitration with JAMS for breach of contract by Medicis seeking damages related to payment for the achievement of certain preclinical milestones under the agreement. On December 11, 2012, apparently in reaction to our filing the arbitration demand, Medicis filed a complaint for breach of the agreement and a motion for preliminary injunction in the Delaware Court of Chancery seeking to enjoin us from prosecuting our claims through arbitration and to require us to continue to use diligent efforts to conduct research and development under the agreement. On October 27, 2013, we entered into a settlement agreement with Valeant related to all outstanding litigation, including the dispute with Medicis, which was acquired by Valeant in December 2012. Under the terms of the settlement, the Medicis agreement was terminated effective October 27, 2013 and all rights and licenses to intellectual property under the agreement reverted back to us.

Sales and Marketing

        Our strategy is to develop, or enter into a partnership to develop, a sales force targeting podiatrists, dermatologists and other specialty markets in the United States and to collaborate with other companies for sales into primary care markets. In addition, we plan to enter into agreements with third parties to commercialize our products outside of the United States.

        We expect that if tavaborole is approved, podiatrists and dermatologists would write a significant portion of prescriptions in the United States, and we expect the majority of overall sales will be within the United States. We believe that this specialty market in the United States can be addressed by us or a partner with a relatively small sales force. If AN2728 is approved, dermatologists and pediatricians would write a significant number of the prescriptions, which we could potentially address by expanding the tavaborole sales force in the United States. In any event, we anticipate licensing commercialization rights to these product candidates to third parties for sales outside of the United States.

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Intellectual Property

        Previous efforts to produce boron-based drugs have been centered largely on boronic acids as serine protease inhibitors, such as the oncology treatment Velcade. Our research concentrates on different biological targets and uses novel boron-based compounds where we believe there is little existing intellectual property held by others. Some of our intellectual property related to our product candidates was initially developed by us or our subcontractors. In the course of our development and commercialization collaborations, intellectual property relating to our product candidates may be developed by us and/or our collaborators, such as GSK or Lilly.

        As of February 1, 2014, we were the owner of record, either solely or with a collaborator, of 23 issued U.S. patents (U.S. Pat. No. 7,390,806; U.S. Pat. No. 7,465,836; U.S. Pat. No. 7,582,621; U.S. Pat. No. 7,652,000; U.S. Pat. No. 7,767,657; U.S. Pat. No. 7,816,344; U.S. Pat. No. 7,888,356; U.S. Pat. No. 7,968,752; U.S. Pat. No. 8,039,450; U.S. Pat. No. 8,039,451; U.S. Pat. No. 8,106,031; U.S. Pat. No. 8,115,026; U.S. Pat. No. 8,168,614; U.S. Pat. No. 8,343,944; U.S. Pat. No. 8,440,642; U.S. Pat. No. 8,461,134; U.S. Pat. No. 8,461,135; U.S. Pat. No. 8,461,336; U.S. Pat. No. 8,461,364; U.S. Pat. No. 8,470,803; U.S. Pat. No. 8,501,712; U.S. Pat. No. 8,546,357; and U.S. Pat. No. 8,623,911) and 37 non-U.S. patents (6 New Zealand patents, 5 Australian patents, 3 South African patents, 2 Japanese patents, 2 South Korean patents, 2 Mexican patents, 1 Chinese patent, 1 German patent, 1 French patent, 1 United Kingdom patent, 1 Spanish patent, 1 Italian patent, 1 Turkish patent, 1 Polish patent, 1 Portuguese patent, 1 Czech Republic patent, 1 Hungarian patent, 1 Hong Kong patent, 1 Israeli patent, 1 Russian patent, 1 Singaporean patent, 1 Moroccan patent, and 1 Algerian patent). We are actively pursuing, either solely or with a collaborator, 24 U.S. patent applications (6 provisional and 18 non-provisional), 4 international (PCT) patent applications and 127 non-U.S. patent applications in at least 30 jurisdictions, including Australia, Brazil, Canada, China, Europe, Hong Kong, India, Israel, Japan, Mexico, New Zealand, Russia, South Africa and South Korea. Of these actively pursued applications, 1 non-provisional U.S. patent application and 16 non-U.S. patent applications are solely owned by a collaborator as of February 1, 2014.

        Our patent filings seek to protect innovations created by us and/or our collaborators, such as composition of matter (compound or pharmaceutical formulation), method of use and method of making. As of February 1, 2014, claims have issued in the United States (U.S. Pat. No. 7,582,621 and U.S. Pat. No. 7,767,657), Australia, Czech Republic, France, Germany, Hong Kong, Hungary, Israel, Italy, Japan, Mexico, New Zealand, Poland, Portugal, Russia, South Africa, South Korea, Spain, Turkey, and the United Kingdom that cover the use of tavaborole to treat onychomycosis and/or pharmaceutical formulations containing tavaborole. As of February 1, 2014, claims have issued in the United States (U.S. Pat. No. 8,115,026), which cover a method of making tavaborole. As of February 1, 2014, claims have issued in Australia, Czech Republic, France, Germany, Hong Kong, Hungary, Israel, Italy, Mexico, New Zealand, Poland, Portugal, Russia, South Africa, South Korea, Spain, Turkey, and the United Kingdom that cover the use of AN2718 to treat onychomycosis and/or pharmaceutical formulations containing AN2718. Due to the existence of an expired U.S. patent relating to a non-pharmaceutical use of the compounds, we are not pursuing a claim solely covering tavaborole or AN2718 as a compound. As of February 1, 2014, claims have issued in the United States (U.S. Pat. No. 8,039,451), Australia, New Zealand, and South Korea that cover AN2728 as a compound and/or as part of a pharmaceutical formulation. As of February 1, 2014, claims have issued in the United States (U.S. Pat. No. 8,168,614 and U.S. Pat. No. 8,501,712), Australia, China, Japan, Mexico, and New Zealand that cover the use of AN2728 to treat psoriasis and/or atopic dermatitis. As of February 1, 2014, claims have issued in the United States (U.S. Pat. No. 8,440,642), Australia, New Zealand, and South Korea that cover AN2898 as a compound and/or as part of a pharmaceutical formulation. As of February 1, 2014, claims have issued in the United States (U.S. Pat. No. 8,168,614 and U.S. Pat. No. 8,501,712), Australia, China, Japan, Mexico, and New Zealand that cover the use of AN2898 to treat psoriasis and/or atopic dermatitis. U.S. Pat. No. 7,816,344 claims AN3365 as a compound as well

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as part of a pharmaceutical formulation. U.S. Pat. No. 8,461,364 claims a crystalline polymorph of AN3365 as a composition, as part of a pharmaceutical formulation, and in a method of use. U.S. Pat. No. 7,390,806, U.S. Pat. No. 7,465,836, U.S. Pat. No. 7,968,752, U.S. Pat. No. 8,106,031, U.S. Pat. No. 8,039,450, U.S. Pat. No. 8,343,944, U.S. Pat. No. 8,461,134, U.S. Pat. No. 8,461,135, U.S. Pat. No. 8,461,336, U.S. Pat. No. 8,470,803, U.S. Pat. No. 8,546,357, and U.S. Pat. No. 8,623,911 claim compounds that do not relate to our current product candidates. U.S. Pat. No. 7,465,836, U.S. Pat. No. 7,888,356, U.S. Pat. No. 8,039,450, U.S. Pat. No. 8,343,944, U.S. Pat. No. 8,461,134, U.S. Pat. No. 8,461,135, U.S. Pat. No. 8,461,336, U.S. Pat. No. 8,470,803, U.S. Pat. No. 8,546,357, and U.S. Pat. No. 8,623,911 claim pharmaceutical formulations that do not relate to our current product candidates. U.S. Pat. No. 7,465,836, U.S. Pat. No. 7,652,000, U.S. Pat. No. 7,888,356, U.S. Pat. No. 7,968,752, U.S. Pat. No. 8,343,944, U.S. Pat. No. 8,461,134, U.S. Pat. No. 8,546,357, and U.S. Pat. No. 8,623,911 claim methods of using compounds that do not relate to our current product candidates.

        Our agreement with GSK provides that we will retain all of our right, title and interest in intellectual property for which we possess the right to license or sublicense as of the effective date of the agreement and throughout the term of the agreement. Each party will remain the sole owner of intellectual property developed by its personnel under the research collaboration. Intellectual property that is jointly developed by GSK and us under the collaboration will be jointly owned by GSK and us, subject to exclusive licenses that may be granted to GSK or us pursuant to the terms of the agreement.

        Our agreement with Lilly provides that we will retain all of our right, title and interest in intellectual property for which we possess the right to license or sublicense as of the effective date of the agreement and throughout the term of the agreement. Each party will remain the sole owner of intellectual property developed by its personnel under the research collaboration. Intellectual property that is jointly developed by Lilly and us under the collaboration will be jointly owned by Lilly and us, subject to exclusive licenses that may be granted to Lilly or us pursuant to the terms of the agreement.

        Our commercial success will depend, in part, on obtaining and maintaining patent protection and trade secret protection of our current and future product candidates and the methods used to manufacture them, as well as successfully defending these patents against third-party challenges. Our ability to stop third parties from making, using, selling, offering to sell or importing our products depends on the extent to which we have rights under valid and enforceable patents or trade secrets that cover these activities. There can be no assurance that our pending patent applications will result in issued patents.

Manufacturing and Supply

        Our current product candidates are low molecular weight molecules that are synthesized chemically and, therefore, we believe they are easier to manufacture at a relatively lower cost than biologic drugs from cell-based sources. All of our current clinical drug product manufacturing activities are in compliance with current Good Manufacturing Practices (cGMP) and are outsourced to qualified third parties with oversight by our employees. We have limited in-house, non-GMP manufacturing capacity for research activities. We rely on third-party cGMP manufacturers for scale-up of the active ingredient, process development work and to produce sufficient quantities of product candidates for use in clinical trials. We intend to continue to rely on third-party cGMP manufacturers for any future clinical trials and commercialization of all of our compounds for which we have manufacturing responsibility. We have established multiple sources of supply for the reagents necessary for the manufacture of our compounds. We believe this manufacturing strategy will enable us to direct financial resources to the development and commercialization of products rather than diverting resources to establishing a manufacturing infrastructure.

        We have transferred tavaborole active pharmaceutical ingredients (API) and drug product manufacturing to third parties that operate in compliance with cGMP regulations. We outsource global process development work and product manufacturing to third parties for AN2728 and our other product candidates.

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Competition

    Onychomycosis

        If approved for the treatment of onychomycosis, we anticipate tavaborole would compete with other approved onychomycosis therapeutics including:

    Systemic treatments:  Lamisil, also known by its generic name, terbinafine, is marketed by Novartis. Terbinafine is available from several generic manufacturers. Sporanox, also known by its generic name, itraconazole, is marketed by Johnson & Johnson and is available as a generic as well. Onmel, a once-daily formulation of itraconazole, approved in 2010, is manufactured and marketed by Merz Pharmaceuticals.

    Topical treatments:  Penlac, also known by its generic name, ciclopirox, is marketed by Valeant. Several versions of ciclopirox are available as generics.

        In addition to approved onychomycosis therapeutics, the marketing of several over-the-counter products is directed toward persons suffering from onychomycosis, even though none of these products is FDA-approved for onychomycosis treatment.

        There are also several pharmaceutical product candidates under development that could potentially be used to treat onychomycosis and compete with tavaborole. The latest-stage development candidate is efinaconazole (also known as Jublia and IDP-108) a novel topical triazole that completed Phase 3 development in December 2011 and was developed by DPS, a wholly-owned subsidiary of Valeant. DPS licensed the triazole (also known as KP-103) from Kaken Pharmaceuticals in 2006. Valeant reported the results of its Phase 3 studies in November 2012. In its first study, 17.8% of patients treated with efinaconazole reached the endpoint of "complete cure," compared to 3.3% of patients treated with vehicle. In the second study, 15.2% of patients treated with efinaconazole reached the endpoint of "complete cure," compared to 5.5% of patients treated with vehicle. Valeant filed an NDA with the FDA in July 2012 and on May 28, 2013, Valeant announced the receipt of a Complete Response Letter from the FDA. According to Valeant, the questions raised by the FDA pertain only to Chemistry, Manufacturing and Controls (CMC) related areas of the container closure apparatus. In January 2014, Valeant announced that it had resubmitted the application for efinaconazole to the FDA in December 2013 and is anticipating approval in mid-2014. Efinaconazole received Health Canada regulatory approval in October 2013.

        On October 24, 2012, we filed a demand for arbitration with JAMS regarding a breach of contract dispute between Valeant and us, arising out of a master services agreement entered into by Anacor and DPS in March 2004 related to certain development services provided by DPS in connection with our efforts to develop our topical antifungal product candidate for the treatment of onychomycosis. We asserted claims for breach of contract, breach of contract, breach of implied covenant of good faith and fair dealing, misappropriation of trade secrets and unfair competition. On October 17, 2013, the arbitrator appointed to resolve our dispute with Valeant related to DPS issued an Interim Final Award in our favor, awarding us $100 million in damages as well as all costs of the arbitration and reasonable attorney's fees. On October 27, 2013, Anacor and Valeant agreed that Valeant would pay us $142.5 million to settle all existing and future claims as well as the damages awarded in that October 17, 2013 ruling, as well as resolve its dispute with Medicis and all other disputes between Anacor, Valeant and DPS related to Anacor's intellectual property, confidential information and contractual rights. Valeant paid Anacor $142.5 million on November 7, 2013.

        The next most advanced topical in late-stage development is 10% Luliconazole Solution from Topica Pharmaceuticals, Inc., currently in a Phase 2b/3 clinical trial to evaluate efficacy and safety of two different dosing regimens.

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        There are also several companies pursuing various devices for onychomycosis, including laser technology. At least four lasers have received FDA clearance for the treatment of onychomycosis—Nuvolase's PinPointe FootLaser, Cutera's GenesisPlus, CoolTouch's VARIA and Light Age's Q-Clear—but they have not been proven effective in randomized controlled clinical trials. In addition, there are a number of earlier stage therapeutics and devices in various stages of development for the treatment of onychomycosis.

    Atopic Dermatitis

        If approved for the treatment of mild-to-moderate atopic dermatitis, we anticipate AN2728 would compete with other marketed topical atopic dermatitis therapeutics, primarily low- and mid-potency steroids and topical calcineurin inhibitors such as Elidel (pimecrolimus) and Protopic (tacrolimus). These topical treatments attempt to reduce inflammation and itch. Other treatments include antibiotics and antihistamines. In addition, while the use of ultraviolet light is not approved by the FDA for the treatment of atopic dermatitis, it is occasionally applied. In addition to the marketed therapeutics, there are a number of topical, oral and injectable product candidates in various stages of development for the treatment of atopic dermatitis that could compete with AN2728.

    Psoriasis

        If approved for the treatment of mild-to-moderate psoriasis, we anticipate AN2728 would compete with other marketed topical therapeutics for mild-to-moderate psoriasis including:

    Prescription topical treatments:  Several branded products exist for the topical treatment of mild-to-moderate psoriasis. Taclonex, a combination of calcipotriene and the high potency corticosteroid betamethasone dipropionate, and Dovonex, also known by its generic name, calcipotriene, are currently marketed by LEO Pharma. Tazorac, also known by its generic name, tazarotene, is currently marketed by Allergan. Vectical, also known by its generic name, calcitriol, is currently marketed by Galderma. Generic products for the treatment of mild-to-moderate psoriasis include corticosteroids, such as triamcinolone and betamethasone, as well as the natural product derivative anthralin.

    Systemic treatments:  Among the product prescribed for the treatment of moderate-to-severe psoriasis are the following: oral products, such as methotrexate, cyclosporine and acitretin; injected biologic products, such as Enbrel, marketed by Amgen; Remicade, Stelara and Simponi, marketed by Janssen Biotech; and Humira, marketed by Abbott.

    Other treatments:  Various light-based treatments are also used to treat psoriasis, including the 380 nanometer excimer laser and pulsed dye lasers. In addition, there are several non-prescription or over-the-counter topical treatments utilized to treat psoriasis, including salicylic acid and coal tar, as well as bath solutions and moisturizers.

        In addition to the marketed psoriasis therapeutics, there are product candidates in Phase 3 development that could potentially be used to treat psoriasis and compete with AN2728, including an injectable therapy from Abbott, and oral therapies from Pfizer, Celgene and Isotechnika. In addition to these, a number of topical, oral and injectable product candidates are in various stages of development for the treatment of psoriasis.

    Gram-Negative Infections

        Any product approved for the treatment of infections caused by Gram-negative bacteria would compete with other marketed broad spectrum and Gram-negative antibiotics.

    Marketed antibiotics:  There are a variety of marketed broad spectrum as well as Gram-negative antibiotics targeting Gram-negative infections. Current marketed products for Gram-negative

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      infections include piperacillin/tazobactam (Pfizer's Zosyn/Tazocin), imipenem/cilastatin (Merck's Primaxin/Tienam), meropenem (Cubist Pharmaceuticals/AstraZeneca's Merrem/Meronem), levofloxacin (Johnson & Johnson's Levaquin, sanofi-aventis's Tavanic and Daiichi Sankyo's Cravit) and ciprofloxacin (cipro), marketed under multiple brand names. Next-generation cephalosporins, carbapenems, quinolones and beta-lactam/beta-lactamase inhibitors, include Johnson & Johnson's Doribax and Pfizer's Tygacil, Forest and AstraZeneca's Fortaz (ceftazidime) and Forest Labs' Teflaro (ceftaroline fosamil).

    Gram-negative antibiotics in development:  The need for new antibiotics will continue to grow due to evolving resistance to existing antibiotics. There are several compounds currently in late-stage clinical development for the treatment of gram-negative infections including Achaogen's plazomicin, Cubist's ceftolozane (formerly known as CXA-201), and Tetraphase's eravacycline.

Government Regulation

    Federal Food, Drug and Cosmetic Act

        Prescription drug products are subject to extensive pre- and post-market regulation by the FDA, including regulations that govern the testing, manufacturing, safety, efficacy, labeling, storage, record keeping, advertising and promotion of such products under the Federal Food, Drug and Cosmetic Act (FFDCA) and its implementing regulations. The process of obtaining FDA approval and achieving and maintaining compliance with applicable laws and regulations requires the expenditure of substantial time and financial resources. Failure to comply with applicable FDA or other requirements may result in refusal to approve pending applications, a clinical hold, warning letters, civil or criminal penalties, recall or seizure of products, partial or total suspension of production or withdrawal of the product from the market. FDA approval is required before any new drug or dosage form, including a new use of a previously approved drug, can be marketed in the United States. All applications for FDA approval must contain, among other things, information relating to safety and efficacy, pharmaceutical formulation, stability, manufacturing, processing, packaging, labeling and quality control.

    New Drug Applications

        The FDA's new drug approval process generally involves:

    completion of preclinical laboratory and animal safety testing in compliance with the FDA's Good Laboratory Practice (GLP) regulations and the International Conference on Harmonisation (ICH) guidelines;

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

    performance of adequate and well-controlled human clinical trials to establish the safety and efficacy of the proposed drug product for each intended use;

    satisfactory completion of an FDA pre-approval inspection of the facility or facilities at which the product is manufactured to assess compliance with the FDA's cGMP regulations; and

    submission to and approval by the FDA of an NDA.

        The preclinical and clinical testing and approval process requires substantial time, effort and financial resources, and we cannot guarantee that any approvals for our product candidates will be granted on a timely basis, if at all. Preclinical tests include laboratory evaluation of product chemistry, formulation and stability, as well as studies to evaluate toxicity in animals. The results of preclinical tests, together with manufacturing information and analytical data, are submitted as part of an IND application to the FDA. The IND automatically becomes effective 30 days after receipt by the FDA, unless the FDA raises concerns or questions about the submission, including concerns that human

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research subjects will be exposed to unreasonable health risks. In such a case, the IND sponsor and the FDA must resolve any outstanding concerns before clinical trials can begin. Our submission of an IND may not result in FDA authorization to commence clinical trials. A separate submission to an existing IND must also be made for each successive clinical trial conducted during product development. Further, an independent institutional review board (IRB) covering each medical center proposing to conduct clinical trials must review and approve the plan for any clinical trial before it commences at that center and it must monitor the study until completed. The FDA, the IRB or the Sponsor may suspend a clinical trial at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk. As a separate amendment to an IND, a sponsor may submit a request for a SPA from the FDA. Under the SPA procedure, a sponsor may seek the FDA's agreement on the design and size of a clinical trial intended to form the primary basis of an effectiveness and safety claim. If the FDA agrees in writing, the study design may not be changed after the trial begins, except in limited circumstances, such as when a substantial scientific issue essential to determining the safety and effectiveness of a product candidate is identified. If the outcome of the trial is successful, the sponsor will ordinarily be able to rely on it as the primary basis for approval with respect to effectiveness and safety. Clinical testing also must satisfy extensive Good Clinical Practice (GCP) regulations, which include requirements that all research subjects provide informed consent and that all clinical studies be conducted under the supervision of one or more qualified investigators.

        For purposes of an NDA submission and approval, human clinical trials are typically conducted in the following sequential phases, which may overlap:

    Phase 1:  Trials are initially conducted in a limited population to test the product candidate for safety, dose tolerance, absorption, metabolism, distribution and excretion, generally in healthy humans.

    Phase 2:  Trials are generally conducted in a limited patient population to identify possible adverse effects and safety risks, to determine the initial efficacy of the product for specific targeted indications and to determine dose tolerance and optimal dosage. Multiple Phase 2 clinical trials may be conducted by the sponsor to obtain information prior to beginning larger and more extensive Phase 3 clinical trials. In some cases, a sponsor may decide to run what is referred to as a "Phase 2b" evaluation, which is a second, confirmatory Phase 2 clinical trial that could, if positive and accepted by the FDA, serve as a pivotal trial in the approval of a product candidate.

    Phase 3:  These are commonly referred to as pivotal studies. When Phase 2 evaluations demonstrate that a dose range of the product is effective and has an acceptable safety profile, Phase 3 clinical trials are undertaken in large patient populations to further evaluate dosage, to provide substantial evidence of clinical efficacy and to further test for safety in an expanded and diverse patient population at multiple, geographically-dispersed clinical trial sites. Generally, replicate evidence of safety and effectiveness needs to be demonstrated in two adequate and well-controlled Phase 3 clinical trials of a product candidate for a specific indication. These studies are intended to establish the overall risk/benefit ratio of the product and provide an adequate basis for product labeling.

    Phase 4:  In some cases, the FDA may condition approval of an NDA for a product candidate on the sponsor's agreement to conduct additional clinical trials to further assess the drug's safety and/or efficacy after NDA approval. Such post-approval trials are typically referred to as Phase 4 clinical trials.

        Progress reports detailing the results of the clinical studies must be submitted at least annually to the FDA and safety reports must be submitted to the FDA and the investigators for serious and unexpected adverse events. Concurrent with clinical studies, sponsors usually complete additional animal safety studies and must also develop additional information about the chemistry and physical

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characteristics of the product and finalize a process for manufacturing the product in commercial quantities in accordance with cGMP requirements. The manufacturing process must be capable of consistently producing quality batches of the product candidate and, among other things, the manufacturer must develop methods for testing the identity, strength, quality and purity of the final product. Moreover, appropriate packaging must be selected and tested and stability studies must be conducted to demonstrate that the product candidate does not undergo unacceptable deterioration over its shelf life.

        The results of product development, preclinical studies and clinical trials, along with the aforementioned manufacturing information, are submitted to the FDA as part of an NDA. NDAs must also contain extensive manufacturing information. Under PDUFA the FDA agrees to specific goals for NDA review time through a two-tiered classification system, Standard Review and Priority Review. Standard Review is applied to a drug that offers at most, only minor improvement over existing marketed therapies. Standard Review NDAs have a goal of being completed within a ten-month timeframe, although a review can take a significantly longer amount of time. A Priority Review designation is given to drugs that offer major advances in treatment, or provide a treatment where no adequate therapy exists. A Priority Review means that the time it takes the FDA to review an NDA is reduced such that the goal for completing a Priority Review initial review cycle is six months. It is likely that our product candidates will be granted Standard Reviews. The review process is often significantly extended by FDA requests for additional information or clarification. The FDA may refer the application to an advisory committee for review, evaluation and recommendation as to whether the application should be approved. The FDA is not bound by the recommendation of an advisory committee, but it generally follows such recommendations.

        The FDA may deny approval of an NDA if the applicable regulatory criteria are not satisfied, or it may require additional clinical data or additional pivotal Phase 3 clinical trials. Even if such data are submitted, the FDA may ultimately decide that the NDA does not satisfy the criteria for approval. Data from clinical trials are not always conclusive and the FDA may interpret data differently than we do. Once issued, product approval may be withdrawn by the FDA if ongoing regulatory requirements are not met or if safety problems occur after the product reaches the market. In addition, the FDA may require testing, including Phase 4 clinical trials, Risk Evaluation and Mitigation Strategies (REMS) and surveillance programs to monitor the effect of approved products that have been commercialized, and the FDA has the power to prevent or limit further marketing of a product based on the results of these post-marketing programs. Drugs may be marketed only for the approved indications and in accordance with the provisions of the approved label. Further, if there are any modifications to the drug, including changes in indications, labeling or manufacturing processes or facilities, approval of a new or supplemental NDA may be required, which may involve conducting additional preclinical studies and clinical trials.

    Drug Price Competition and Patent Term Restoration Act of 1984

        Under the Drug Price Competition and Patent Term Restoration Act of 1984, known as the Hatch-Waxman Amendments, a portion of a product's patent term that was lost during clinical development and application review by the FDA may be restored. The Hatch-Waxman Amendments also provide for a statutory protection, known as nonpatent market exclusivity, against the FDA's acceptance or approval of certain competitor applications.

        Patent term restoration can compensate for time lost during product development and the regulatory review process by returning up to five years of patent life for a patent that covers a new product or its use. This period is generally one-half the time between the effective date of an IND (falling after issuance of the patent) and the submission date of an NDA, plus the time between the submission date of an NDA and the approval of that application. Patent term restorations, however, cannot extend the remaining term of a patent beyond a total of 14 years. The application for patent

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term extension is subject to approval by the United States Patent and Trademark Office in conjunction with the FDA. It takes at least six months to obtain approval of the application for patent term extension. Up to five years of interim one year extensions are available if a product is still undergoing development or FDA review at the time of its expiration.

        The Hatch-Waxman Amendments also provide for a period of statutory protection for new drugs that receive NDA approval from the FDA. If a new drug receives NDA approval as a new chemical entity, meaning that the FDA has not previously approved any other new drug containing the same active moiety, then the Hatch-Waxman Amendments prohibit submission of an Abbreviated New Drug Application (ANDA) or a 505(b)(2) NDA (each as described below) by another company for a generic version of such drug, or modification to the previously approved version, with some exceptions, for a period of five years from the date of approval of the NDA. The statutory protection provided pursuant to the Hatch-Waxman Amendments will not prevent the filing or approval of a full NDA. In order to gain approval of a full NDA, however, a competitor would be required to conduct its own preclinical investigations and clinical trials. If NDA approval is received for a new drug containing an active ingredient that was previously approved by the FDA but the NDA is for a drug that includes an innovation over the previously approved drug and if such NDA approval was dependent upon the submission to the FDA of new clinical investigations, other than bioavailability studies, then the Hatch-Waxman Amendments prohibit the FDA from making effective the approval of an ANDA or a 505(b)(2) NDA for a generic version of such drug or modification of the previously approved version for a period of three years from the date of the NDA approval. This three year exclusivity, however, only covers the innovation associated with the NDA to which it attaches. Thus, the three year exclusivity does not prohibit the FDA, with limited exceptions, from approving ANDAs or 505(b)(2) NDAs for drugs containing the same active ingredient but without the new innovation.

        While the Hatch-Waxman Amendments provide certain patent term restoration and exclusivity protections to innovator drug manufacturers, it also permits the FDA to approve ANDAs for generic versions of their drugs. The ANDA process permits competitor companies to obtain marketing approval for a drug with the same active ingredient for the same uses but does not require the conduct and submission of clinical trials demonstrating safety and effectiveness for that product. Instead of safety and effectiveness data, an ANDA applicant needs only to submit data demonstrating that its product is bioequivalent to the innovator product as well as relevant chemistry, manufacturing and product data. The Hatch-Waxman Amendments also instituted a third type of drug application that requires the same information as an NDA including full reports of clinical and preclinical studies except that some of the information from the reports required for marketing approval comes from studies that the applicant does not own or for which the applicant does not have a legal right of reference. This type of application, a 505(b)(2) NDA, permits a manufacturer to obtain marketing approval for a drug without needing to conduct or obtain a right of reference for all of the required studies.

        Finally, the Hatch-Waxman Amendments require, in some circumstances, an ANDA or a 505(b)(2) NDA applicant to notify the patent owner and the holder of the approved NDA of the factual and legal basis of the applicant's opinion that the patent listed by the holder of the approved NDA in FDA's Approved Drug Products with Therapeutic Equivalence Evaluations manual is not valid or will not be infringed (the patent certification process). Upon receipt of this notice, the patent owner and the NDA holder have 45 days to bring a patent infringement suit in federal district court and obtain a 30-month stay against the company seeking to reference the NDA. The NDA or patent holder could still file a patent suit after the 45 days, but if they did, they would not have the benefit of a 30-month stay. Alternatively, after this 45-day period, the applicant may file a declaratory judgment action, seeking a determination that the patent is invalid or will not be infringed. The discovery, trial and appeals process in such suits can take several years. If such a suit is timely commenced, the Hatch-Waxman Amendments provide a 30-month stay on the approval of the competitor's ANDA or 505(b)(2) NDA. If the litigation is resolved in favor of the competitor or the challenged patent expires

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during a 30-month stay period, unless otherwise extended by court order, the stay is lifted and the FDA may approve the application. The patent owner and the NDA holder have the opportunity to trigger only a single 30-month stay per ANDA or 505(b)(2) NDA. Once the ANDA or 505(b)(2) NDA applicant has notified the patent owner and the NDA holder of the infringement, the applicant cannot be subjected to another 30-month stay, even if the applicant becomes aware of additional patents that may be infringed by its product.

    International Regulation

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

        Under European Union regulatory systems, marketing authorizations may be submitted either under a centralized or a mutual recognition procedure. The centralized procedure provides for the grant of a single marketing authorization that is valid for all European Union member states. The mutual recognition procedure provides for mutual recognition of national approval decisions. Under this procedure, the holder of a national marketing authorization may submit an application to the remaining member states. Within 90 days of receiving the applications and assessment report, each member state must decide whether to recognize approval.

    Healthcare Payor Coverage and Reimbursement

        Although none of our product candidates has been commercialized for any indication, if they are approved for marketing, commercial success of our product candidates will depend, in part, upon the availability of coverage and reimbursement from healthcare payors at the federal, state and private levels. Government payor programs, including Medicare and Medicaid, private health care insurance companies and managed-care plans have attempted to control costs by limiting coverage and the amount of reimbursement for particular drug treatments. The United States Congress and state legislatures from time to time propose and adopt initiatives aimed at cost-containment. Ongoing federal and state government initiatives directed at lowering the total cost of health care will likely continue to focus on health care reform, the cost of prescription pharmaceuticals and on the reform of the Medicare and Medicaid payment systems. Examples of how limits on drug coverage and reimbursement in the United States may cause reduced payments for drugs in the future include:

    changing healthcare payors', such as government payors and commercial payors, reimbursement methodologies;

    fluctuating decisions on which drugs to include in formularies;

    revising drug rebate calculations under the Medicaid program; and

    reforming drug importation laws.

        Indeed, the Patient Protection and Affordable Care Act (PPACA) as amended by the Health Care and Education Reconciliation Act of 2010, or collectively, the Healthcare Reform Act, which was signed into law in March of 2010, substantially changes the way health care is financed by both

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governmental and private insurers, and significantly impacts pharmaceutical manufacturers. The Healthcare Reform Act includes, among other things, the following measures:

    Annual, non-deductible fees on any entity that manufactures or imports certain prescription drugs;

    Increases in Medicaid rebates owed by manufacturers under the Medicaid Drug Rebate Program for both branded and generic drugs;

    A new Patient-Centered Outcomes Research Institute to oversee, identify priorities in and conduct comparative clinical effectiveness research;

    New requirements for manufacturers to discount drug prices to eligible patients by 50% at the pharmacy level and for mail order services in order for their outpatient drugs to be covered under Medicare Part D; and

    An increase in the number of entities eligible for discounts under the Public Health Service pharmaceutical pricing program.

        Additionally, some healthcare payors also require pre-approval of coverage for new or innovative drug therapies before they will reimburse health care providers who use such therapies. While we cannot predict whether any proposed cost-containment measures will be adopted or otherwise implemented in the future, the announcement or adoption of these proposals could have a material adverse effect on our ability to obtain adequate prices for our product candidates and operate profitably.

    Manufacturing Requirements

        We rely, and expect to continue to rely, on third parties for the production of clinical and commercial quantities of our products. We and our third-party manufacturers must comply with applicable FDA regulations relating to FDA's cGMP regulations. The cGMP regulations include requirements relating to organization of personnel, buildings and facilities, equipment, control of components and drug product containers and closures, production and process controls, packaging and labeling controls, holding and distribution, laboratory controls, records and reports and returned or salvaged products. The manufacturing facilities for our products must meet cGMP requirements to the satisfaction of the FDA pursuant to a pre-approval inspection before we can use them to manufacture our products. We and our third-party manufacturers are also subject to periodic inspections of facilities by the FDA and other authorities, including procedures and operations used in the testing and manufacture of our products to assess our compliance with applicable regulations. Failure to comply with statutory and regulatory requirements subjects a manufacturer to possible legal or regulatory action, including warning letters, the seizure or recall of products, injunctions, consent decrees placing significant restrictions on or suspending manufacturing operations and civil and criminal penalties. Adverse experiences with the product must be reported to the FDA and could result in the imposition of market restriction through labeling changes or in product removal. Product approvals may be withdrawn if compliance with regulatory requirements is not maintained or if problems concerning safety or efficacy of the product occur following approval.

    Other Regulatory Requirements

        With respect to post-market product advertising and promotion, the FDA imposes a number of complex regulations on entities that advertise and promote pharmaceuticals, which include, among others, standards for direct-to-consumer advertising, off-label promotion, industry-sponsored scientific and educational activities and promotional activities involving the internet. The FDA has very broad enforcement authority under the FFDCA, and failure to abide by these regulations can result in penalties, including the issuance of a warning letter directing entities to correct deviations from FDA

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standards, a requirement that future advertising and promotional materials be pre-cleared by the FDA and state and federal civil and criminal investigations and prosecutions. We are also subject to various laws and regulations regarding laboratory practices, the experimental use of animals and the use and disposal of hazardous or potentially hazardous substances in connection with our research. In each of these areas, as above, the FDA has broad regulatory and enforcement powers, including the ability to levy fines and civil penalties, suspend or delay issuance of approvals, seize or recall products and withdraw approvals, any one or more of which could have a material adverse effect on us.

Legal Proceedings

        On October 24, 2012, we provided notice to Valeant, successor in interest to DPS, seeking to commence arbitration with JAMS of a breach of contract dispute under a master services agreement dated March 26, 2004 between DPS and us related to certain development services provided by DPS in connection with our efforts to develop our topical antifungal product candidate for the treatment of onychomycosis. We asserted claims for breach of contract, breach of implied covenant of good faith and fair dealing, misappropriation of trade secrets and unfair competition. We were seeking injunctive relief and damages of at least $215.0 million. On November 28, 2012, we filed for arbitration with JAMS for breach of contract by Medicis seeking damages related to payment for the achievement of certain preclinical milestones under the research and development option and license agreement with Medicis dated February 9, 2011. On December 11, 2012, apparently in reaction to our filing the arbitration demand, Medicis filed a complaint for breach of the agreement and a motion for preliminary injunction in the Delaware Court of Chancery seeking to enjoin us from prosecuting our claims through arbitration and to require us to continue to use diligent efforts to conduct research and development under the agreement.

        On October 17, 2013, the arbitrator appointed to resolve our dispute with Valeant related to DPS issued an Interim Final Award in our favor, awarding us $100.0 million in damages as well as all costs of the arbitration and reasonable attorney's fees. On October 27, 2013, Valeant agreed to pay us $142.5 million to settle all existing and future claims as well as the damages awarded in that arbitration and resolve our dispute with Medicis and all other disputes between Anacor, Valeant and DPS related to Anacor's intellectual property, confidential information and contractual rights. We agreed to provide Valeant a paid-up, irrevocable, non-exclusive, worldwide license to all patents that contain claims covering efinaconazole. Valeant paid us $142.5 million on November 7, 2013.

        We are not a party to any material legal proceedings at this time. From time to time, we may be involved in litigation relating to claims arising out of our ordinary course of business.

Employees

        As of December 31, 2013, we had 79 employees, of which 25 held Ph.D. or M.D. degrees and 68 were engaged in research and development activities. We plan to continue to expand our product development programs and initiate commercialization activities for tavaborole. To support this growth and to support public company requirements, we will need to expand our managerial, development, finance, marketing, sales and other functions. None of our employees are represented by a labor union and we consider our employee relations to be good.

Facilities

        Our corporate headquarters are located in Palo Alto, California, where we lease a 36,960 square-foot building with laboratory and office space. The lease will terminate in March 2018, subject to the Landlord's option to terminate the lease as early as June 2016 with twelve (12) months' notice, in exchange for $0.7 million reduction in lease payments.

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        We also have a lease for a 15,300 square-foot building consisting of office and laboratory space in Palo Alto, California, which we extended through December 2014, and have one (1) one-year option to extend the lease through 2015. We may terminate the lease by providing four months' written notice.

Corporate and Available Information

        Our principal corporate offices are located at 1020 East Meadow Circle, Palo Alto, California 94303-4230 and our telephone number is (650) 543-7500. We were incorporated in Delaware in December 2000 and began business operations in March 2002. Our internet address is www.anacor.com. We make available on our website, free of charge, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). Our SEC reports can be accessed through the Investors section of our internet website. Further, a copy of this Annual Report on Form 10-K is located at the SEC's Public Reference Rooms at 100 F Street, N.E., Washington, D. C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy and information statements and other information regarding our filings at http://www.sec.gov. The information found on our internet website is not incorporated by reference into this Annual Report on Form 10-K or any other report we file with or furnish to the SEC.

ITEM 1A.    RISK FACTORS

        Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this Annual Report on Form 10-K, before deciding whether to invest in shares of our common stock. The occurrence of any of the following adverse developments described in the following risk factors could harm our business, financial condition, results of operations or prospects. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.

Risks Relating to Our Financial Position and Need for Additional Capital

Currently, we have no products approved for commercial sale, and to date we have not generated any revenue from product sales. As a result, our ability to curtail our losses and reach profitability is unproven, and we may never achieve or sustain profitability.

        In 2013, we generated $84.8 million of net income, primarily due to the Valeant settlement, but do not expect to be profitable in the foreseeable future. Prior to 2013, we had incurred net losses in each year since our inception, including net losses of approximately, $56.1 million and $47.9 million for 2012 and 2011, respectively.As of December 31, 2013, we had an accumulated deficit of approximately $130.4 million. We have devoted most of our financial resources to research and development, including our preclinical development activities and clinical trials, and commenced planning for commercialization of tavaborole. We have not completed development of any product candidate and we have therefore not generated any revenues from product sales. We expect that both sales and marketing and research and development expenses will increase in the future as we progress our product candidates through clinical development into the commercialization stage, conduct our research and development activities under our various current and potential collaborations, including those related to our neglected diseases initiatives, advance our discovery research projects into the preclinical stage and continue our early-stage research. As a result of the foregoing, after generating net income in 2013 from the Valeant settlement, we expect to continue to experience net losses and negative cash flows for the foreseeable future. These losses and negative cash flows have had, and will continue to have, an adverse effect on our stockholders' equity and working capital.

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        Because of the numerous risks and uncertainties associated with pharmaceutical product development, we are unable to accurately predict the timing or amount of our expenses or when, or if, we will be able to maintain profitability. In addition, our expenses could increase if we are required by the United States Food and Drug Administration (FDA) to perform studies in addition to, or that are larger than, those that we currently expect. To date, we have financed our operations primarily through the sale of equity securities, debt arrangements, government contracts and grants and payments under our agreements with GlaxoSmithKline LLC (GSK), Schering Corporation (Schering), Eli Lilly and Company (Lilly), Medicis Pharmaceutical Corporation (Medicis), the Bill and Melinda Gates Foundation (the Gates Foundation) and the United States Department of Defense, Defense Threat Reduction Agency (DTRA) and our arbitration settlement with Valeant. The size of our future net losses will depend, in part, on our future expenses and our ability to generate revenues. Revenues from our collaborations and research agreements with GSK, Lilly, the Gates Foundation and DTRA are uncertain because milestones or other contingent payments under our agreements with them may not be achieved or received. In addition, we may not be able to enter into other collaborations that will generate significant cash. If we are unable to develop and commercialize one or more of our product candidates, or if revenues from any product candidate that receives marketing approval are insufficient, we will not achieve profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability.

We have a limited operating history and we expect a number of factors to cause our operating results to fluctuate on a quarterly and annual basis, which may make it difficult to predict our future performance.

        Our operations to date have been primarily limited to developing our technology and undertaking preclinical studies and clinical trials of our product candidates and we are reliant on collaborators for certain of our other products. We have not yet obtained regulatory approvals for any of our product candidates. Consequently, any predictions you make about our future success or viability may not be as accurate as they could be if we had a longer operating history and/or approved products on the market. Our financial condition and operating results have varied significantly in the past and will continue to fluctuate from quarter-to-quarter or year-to-year due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these fluctuations include the following risk factors, as well as other factors described elsewhere in this Annual Report on Form 10-K:

    the need to obtain and maintain regulatory approval for tavaborole, for which we filed a New Drug Application (NDA) in July 2013, and which was accepted for filing by the FDA in September 2013 with a Prescription Drug User Fee Act (PDUFA) V goal date of July 29, 2014, AN2728 or any of our other product candidates;

    competition from existing products or new products that may emerge. For example, in January 2014, Valeant announced that it had resubmitted its NDA for efinaconazole, a potential treatment for onychomycosis, to the FDA in December 2013 and anticipates approval in mid-2014. Efinaconazole received Health Canada regulatory approval in October 2013;

    our dependency on third-party manufacturers to supply or manufacture our products;

    our ability to establish an effective sales, marketing and distribution infrastructure in a timely manner;

    market acceptance of our product candidates;

    delays in the commencement, enrollment and the timing of clinical testing for our product candidates, including our planned Phase 3 trials of AN2728 in mild-to-moderate atopic dermatitis, for which we held an End of Phase 2 meeting with the FDA in the first quarter of 2014 and expect to initiate Phase 3 studies in the first half of 2014;

    the success of our clinical trials through all phases of clinical development;

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    any delays in regulatory review and approval of product candidates in clinical development;

    potential side effects of our product candidates that could delay or prevent commercialization or cause an approved drug to be taken off the market;

    our ability to develop systemic product candidates;

    the ability of patients or healthcare providers to obtain coverage of or sufficient reimbursement for our products;

    our ability to obtain additional funding to develop our product candidates;

    our ability to receive approval and commercialize our product candidates outside of the United States;

    our ability to establish or maintain collaborations, licensing or other arrangements;

    our ability and third parties' abilities to protect intellectual property rights;

    costs related to and outcomes of potential litigation;

    our ability to adequately support future growth;

    our ability to attract and retain key personnel to manage our business effectively;

    our ability to maintain our accounting systems and controls;

    potential product liability claims;

    potential liabilities associated with hazardous materials; and

    our ability to maintain adequate insurance policies.

        Due to the various factors mentioned above, and others, the results of any quarterly or annual periods should not be relied upon as indications of future operating performance.

We may continue to require substantial additional capital and if we are unable to raise capital when needed, we would be forced to delay, reduce or eliminate our product development programs.

        Developing and obtaining approval for pharmaceutical products, including conducting preclinical studies and clinical trials and obtaining sufficient data for regulatory approval and commencing commercialization is expensive. If the FDA requires that we perform additional studies beyond those that we currently expect, our expenses could increase beyond what we currently anticipate and the timing of any potential product approval may be delayed. We raised $21.5 million, $24.0 million and $23.0 million in February 2012, October 2012 and May 2013, respectively, through public offerings of our common stock. The net proceeds from these offerings were approximately $19.9 million, $22.6 million and $21.3 million, respectively, after deducting the underwriting discounts and other offering costs. Under our January 2013 "at-the-market" stock offering, through December 31, 2013, we sold shares of our common stock for net proceeds of approximately $1.3 million and we currently have approximately $23.6 million potentially remaining available for sale under this offering. In April 2013, we sold shares of our common stock for net proceeds of approximately $5.0 million to the Gates Foundation as part of our research collaboration with Gates. Beyond the $5.0 million of additional debt drawdowns under our debt facility with Hercules Technology Growth Capital, Inc. and Hercules Technology III, L.P (together, Hercules), which is available upon the FDA approval of tavaborole, we have no other commitments or arrangements for any additional financing to fund our research and development programs other than through the research agreement with DTRA; reimbursements from our various collaborations related to our neglected diseases initiatives, including from our Gates Foundation collaboration; and contingent milestone or royalty payments from GSK or Lilly, which we may not receive. In October 2013, we signed a settlement agreement with Valeant in which we received

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$142.5 million in November 2013. We believe that our existing capital resources will be sufficient to meet our anticipated operating requirements for at least the next twelve months. While we believe that we currently have sufficient resources to fund our operations for at least the next twelve months, we may need to raise additional capital to complete the development and potential commercialization of tavaborole, fund our other research and development activities and meet our operating requirements beyond the next twelve months. Furthermore, any delays in, or unanticipated costs for, our development and regulatory efforts could significantly increase the amount of additional capital required for us to conduct these research, development and commercialization activities and meet our operating requirements beyond the next twelve months. However, our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results, including the costs to maintain our currently planned operations, could vary materially.

        Until we can generate a sufficient amount of revenue from our products, if ever, we expect to finance future cash needs through public or private equity offerings, debt financings or corporate collaborations and licensing arrangements. Additional funds may not be available when we need them on terms that are acceptable to us, or at all. If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate some of our research or development programs or our commercialization efforts and may not be able to make scheduled debt payments on a timely basis or at all. To the extent that we raise additional funds by issuing equity securities, our stockholders may experience additional dilution, and debt financing, if available, may involve restrictive covenants. To the extent that we raise additional funds through collaborations and licensing arrangements, it may be necessary to relinquish some rights to our technologies or our product candidates or grant licenses on terms that may not be favorable to us. We may seek to access the public or private capital markets whenever conditions are favorable, even if we do not have an immediate need for additional capital at that time.

        Our forecasts regarding the period of time that our existing capital resources will be sufficient to meet our operating requirements, the timing of our future capital resource requirements, both near and long-term, will depend on many factors, including, but not limited to:

    the outcome, timing and cost of regulatory approvals, including the tavaborole NDA that we filed in July 2013, which was accepted for filing by the FDA in September 2013 with a PDUFA V goal date of July 29, 2014;

    the effects of competing technological and market developments. For example, in January 2014, Valeant announced that it had resubmitted its NDA for efinaconazole, a potential treatment for onychomycosis, to the FDA in December 2013 and anticipates approval in mid-2014. Efinaconazole received Health Canada regulatory approval in October 2013;

    the cost and timing of completion of commercial-scale outsourced manufacturing activities;

    the cost of establishing sales, marketing and distribution capabilities for tavaborole and any other product candidates for which we may receive regulatory approval;

    the initiation, progress, timing, costs and results of preclinical studies and clinical trials for our product candidates and potential product candidates, including the planned Phase 3 clinical trials for AN2728;

    the success of our collaborations and research agreements with GSK, Lilly, the Gates Foundation and DTRA and the attainment of milestones and royalty payments, if any, under those agreements;

    the number and characteristics of product candidates that we pursue;

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    the terms and timing of any future collaboration, licensing or other arrangements that we may establish;

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

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

Raising funds through lending arrangements may restrict our operations or produce other adverse results.

        Our current loan and security agreement with Hercules, which we entered into in June 2013, contains a variety of affirmative and negative covenants, including required financial reporting, limitations on certain dispositions of assets, limitations on the incurrence of additional debt and other requirements. To secure our performance of our obligations under this loan and security agreement, we granted a security interest in substantially all of our assets, other than intellectual property assets, to the lenders. Our failure to comply with the covenants in the loan and security agreement, the occurrence of a material impairment in our prospect of repayment or in the perfection or priority of the lenders' lien on our assets, as determined by the lenders, or the occurrence of certain other specified events could result in an event of default that, if not cured or waived, could result in the acceleration of all or a substantial portion of our debt, potential foreclosure on our assets and other adverse results.

Risks Relating to the Development, Regulatory Approval and Commercialization of Our Product Candidates

We cannot be certain that tavaborole, AN2728 or any of our other wholly-owned or partnered product candidates will receive regulatory approval, and without regulatory approval our product candidates will not be able to be marketed.

        We have invested a significant portion of our efforts and financial resources in the development of our most advanced product candidates, especially tavaborole. Our ability to generate significant revenue related to product sales will depend on the successful development and regulatory approval of our product candidates.

        In August 2010, we filed a Special Protocol Assessment request with the FDA and reached agreement on the major parameters associated with the design and conduct of the Phase 3 trials for tavaborole. We commenced Phase 3 clinical trials of tavaborole in the fourth quarter of 2010, and completed enrollment in December 2011. In the first quarter of 2013, we announced the results from two clinical trials in which tavaborole met all primary and secondary endpoints with a high degree of statistical significance. We filed an NDA for tavaborole in July 2013, which was accepted for filing by the FDA in September 2013 with a PDUFA V goal date of July 29, 2014. We had an End of Phase 2 meeting with the FDA for AN2728 in atopic dermatitis in the first quarter of 2014 and expect to initiate Phase 3 studies in atopic dermatitis in the first half of 2014. We may conduct lengthy and expensive Phase 3 clinical trials of AN2728 only to learn that this drug candidate is not a safe or effective treatment, in which case these clinical trials may not lead to regulatory approval. Similarly, GSK's development of our partnered product candidate in TB and Lilly's development program for our partnered animal health product candidate may be subject to delays in development and not lead to regulatory approval from the FDA and similar foreign regulatory agencies. Such failure to timely develop and obtain regulatory approvals would prevent our product candidates from being marketed and would have a material and adverse effect on our business.

        We currently have no products approved for sale and we cannot guarantee that we will ever have marketable products. The development of a product candidate, including preclinical and clinical testing, manufacturing, quality systems, labeling, approval, record-keeping, selling, promotion, marketing and

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distribution of products, is subject to extensive regulation by the FDA in the United States and regulatory authorities in other countries, with regulations differing from country to country. We are not permitted to market our product candidates in the United States until we receive approval of an NDA from the FDA. Obtaining approval of an NDA is a lengthy, expensive and uncertain process. An NDA must include extensive preclinical and clinical data and supporting information to establish the product candidate's safety and effectiveness for each indication. The approval application must also include significant information regarding the chemistry, manufacturing and controls for the product. The regulatory development and review process typically takes years to complete and approval is never guaranteed. If a product is approved, the FDA may limit the indications for which the product may be used, include extensive warnings on the product labeling or require costly ongoing requirements for post-marketing clinical studies and surveillance or other risk management measures to monitor the safety or efficacy of the product candidate. Markets outside of the United States also have requirements for approval of drug candidates with which we must comply prior to marketing. Obtaining regulatory approval for marketing of a product candidate in one country does not ensure we will be able to obtain regulatory approval in other countries but a failure or delay in obtaining regulatory approval in one country may have a negative effect on the regulatory process in other countries. Any regulatory approval of any of our products or product candidates, once obtained, may be withdrawn. If tavaborole, AN2728 or any of our other wholly-owned or partnered product candidates do not receive regulatory approval, we may not be able to generate sufficient revenue to become profitable or to continue our operations. Moreover, the filing of our NDA or the receipt of regulatory approval does not assure commercial success of any approved product.

Delays in the commencement, enrollment and completion of clinical trials could result in increased costs to us and delay or limit our ability to obtain regulatory approval for our product candidates.

        Delays in the commencement, enrollment and completion of clinical trials could increase our product development costs or limit the regulatory approval of our product candidates. We had an End of Phase 2 meeting with the FDA for AN2728 in atopic dermatitis in the first quarter of 2014 and expect to initiate Phase 3 studies in atopic dermatitis in the first half of 2014. We do not know whether clinical trials of AN2728 or other product candidates will begin on time or, if commenced, will be completed on schedule or at all. The commencement, enrollment and completion of clinical trials can be delayed for a variety of reasons, including:

    inability to reach agreements on acceptable terms with prospective clinical research organizations (CROs) and trial sites, the terms of which can be subject to extensive negotiation and may vary significantly among different CROs and trial sites;

    regulatory objections to commencing a clinical trial;

    inability to identify and maintain a sufficient number of trial sites, many of which may already be engaged in other clinical trial programs, including some that may be for the same indication as our product candidates;

    withdrawal of clinical trial sites from our clinical trials as a result of changing standards of care or the ineligibility of a site to participate in our clinical trials;

    inability to obtain institutional review board (IRB) approval to conduct a clinical trial at prospective sites;

    difficulty recruiting and enrolling patients to participate in clinical trials for a variety of reasons, including meeting the enrollment criteria for our study and competition from other clinical trial programs for the same indication as our product candidates; and

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    inability to retain patients in clinical trials due to the treatment protocol, personal issues, side effects from the therapy or lack of efficacy, particularly for those patients receiving either a vehicle without the active ingredient or a placebo.

        In addition, a clinical trial may be suspended or terminated by us, our current or any future partners, the FDA or other regulatory authorities due to a number of factors, including:

    failure to conduct the clinical trial in accordance with regulatory requirements or our clinical protocols;

    failed inspection of the clinical trial operations or trial sites by the FDA or other regulatory authorities;

    unforeseen safety or efficacy issues or any determination that a clinical trial presents unacceptable health risks; or

    lack of adequate funding to continue the clinical trial due to unforeseen costs resulting from enrollment delays, requirements to conduct additional trials and studies, increased expenses associated with the services of our CROs and other third parties or other reasons.

        If we are required to conduct additional clinical trials or other testing of our product candidates beyond those currently contemplated, we may be delayed in obtaining, or may not be able to obtain, marketing approval for these product candidates.

        In addition, if our current or any future partners assume development of our product candidates, they may suspend or terminate their development and commercialization efforts, including clinical trials for our product candidates, at any time. For example, in September 2013, Lilly notified us that it was ceasing further development of the development compound licensed in August 2011for an animal health indication and has granted us a fully paid, sublicenseable, perpetual, irrevocable, exclusive license to the related technology and patents. Similarly, GSK discontinued clinical development of AN3365 in October 2012 and all rights to AN3365 have reverted to us. We have not yet determined if we will proceed with any further development of these molecules.

        Changes in regulatory requirements and guidance may occur and we or any partners may be required by appropriate regulatory authorities to amend clinical trial protocols to reflect these changes. Amendments may require us or any partners to resubmit clinical trial protocols to IRBs for re-examination, which may impact the costs, timing or successful completion of a clinical trial. If we or any of our partners experience delays in the completion of, or if we or our partners terminate clinical trials, the commercial prospects for our product candidates will be harmed, and our ability to generate revenue from sales of our products will be prevented or delayed. In addition, many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials ultimately may lead to the denial of regulatory approval of a product candidate.

Clinical failure can occur at any stage of clinical development. Because the results of earlier clinical trials are not necessarily predictive of future results, any product candidate we, GSK, Drugs for Neglected Diseases initiative (DNDi) the Gates Foundation, DTRA or our potential future partners advance through clinical trials may not have favorable results in later clinical trials or receive regulatory approval.

        Clinical failure can occur at any stage of our clinical development. Clinical trials may produce negative or inconclusive results, and we or our partners may decide, or regulators may require us, to conduct additional clinical or preclinical testing. In addition, data obtained from tests are susceptible to varying interpretations, and regulators may not interpret our data as favorably as we do, which may delay, limit or prevent regulatory approval. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will generate the same results or otherwise provide adequate data to demonstrate the efficacy and safety of a product candidate. Frequently, product candidates that have

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shown promising results in early clinical trials have subsequently suffered significant setbacks in later clinical trials. In addition, the design of a clinical trial can determine whether its results will support approval of a product and flaws in the design of a clinical trial may not become apparent until the clinical trial is well advanced. We have limited experience in designing clinical trials and may be unable to design and execute a clinical trial to support regulatory approval. Further, clinical trials of potential products often reveal that it is not practical or feasible to continue development efforts. If tavaborole, AN2728, AN5568, also referred to as SCYX-7158 for human African trypanosomiasis (HAT, or sleeping sickness), or our other product candidates are found to be unsafe or lack efficacy, we or our collaborators will not be able to obtain regulatory approval for them and our business would be harmed. For example, if the results of planned Phase 3 clinical trials of AN2728 do not achieve the primary efficacy endpoints and demonstrate an acceptable safety level, the prospects for approval of AN2728 would be materially and adversely affected. A number of companies in the pharmaceutical industry, including those with greater resources and experience than us, have suffered significant setbacks in Phase 3 clinical trials, even after seeing promising results in earlier clinical trials.

        In some instances, there can be significant variability in safety and/or efficacy results between different trials of the same product candidate due to numerous factors, including changes in trial protocols, differences in size and type of the patient populations, adherence to the dosing regimen, particularly for self-administered topical drugs, and the rate of dropout among clinical trial participants. We do not know whether any Phase 2, Phase 3 or other clinical trials we or any partners may conduct will demonstrate consistent and/or adequate efficacy and safety to obtain regulatory approval to market our product candidates.

We have limited experience in conducting Phase 3 clinical trials and while our first NDA for tavaborole was accepted for filing in September 2013, we may be unable to do so for AN2728 and other product candidates we are developing.

        We are planning to conduct Phase 3 clinical trials of AN2728 in atopic dermatitis in the first half of 2014. The conduct of successful Phase 3 clinical trials is essential in obtaining regulatory approval and the submission of a successful NDA is a complicated process. We have limited experience in preparing, submitting and prosecuting regulatory filings. We submitted our first NDA for tavaborole in July 2013, which was accepted for filing by the FDA in September 2013 with a PDUFA V goal date of July 29, 2014. Consequently, we may be unable to obtain timely approval of our NDA or successfully and efficiently execute and complete additional planned clinical trials in a way that leads to an NDA submission, acceptance and approval of AN2728 or other product candidates we are developing. We may require more time and incur greater costs than our competitors and may not succeed in obtaining regulatory approvals of products that we develop. In addition, failure to commence or complete, or delays in, our planned clinical trials would prevent us from or delay us in commercializing AN2728 and other product candidates we are developing.

Our product candidates may have undesirable side effects that may delay or prevent marketing approval, or, if approval is received, require them to be taken off the market or otherwise limit their sales.

        Unforeseen side effects from any of our product candidates could arise either during clinical development or, if approved, after the approved product has been marketed. For example, a small number of patients who received tavaborole treatment experienced some skin irritation around their toenails during clinical trials of tavaborole for onychomycosis. In addition, a small number of patients who received AN2728 treatment experienced some skin irritation during clinical trials of AN2728. The range and potential severity of possible side effects from systemic therapies is greater than for topically administered drugs. The results of future clinical trials may show that our product candidates cause undesirable or unacceptable side effects, which could interrupt, delay or halt clinical trials, resulting in delay of, or failure to obtain, marketing approval from the FDA and other regulatory authorities.

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        If any of our product candidates receives marketing approval and we or others later identify undesirable or unacceptable side effects caused by such products:

    regulatory authorities may require the addition of labeling statements, specific warnings, a contraindication or field alerts to physicians and pharmacies;

    we may be required to change the way the product is administered, conduct additional clinical trials or change the labeling of the product;

    we may have limitations on how we promote the product;

    sales of the product may decrease significantly;

    regulatory authorities may require us to take our approved product off the market;

    we may be subject to litigation or product liability claims; and

    our reputation may suffer.

        Any of these events could prevent us, GSK, Lilly, the Gates Foundation, DTRA or our potential future partners from achieving or maintaining market acceptance of the affected product or could substantially increase commercialization costs and expenses, which in turn could delay or prevent us from generating significant revenues from the sale of our products.

All of our product candidates require regulatory review and approval prior to commercialization. Any delay in the regulatory review or approval of any of our product candidates will harm our business.

        All of our product candidates require regulatory review and approval prior to commercialization. Any delays in the regulatory review or approval of our product candidates would delay market launch, increase our cash requirements and result in additional operating losses. In July 2013, we filed an NDA for tavaborole, which was accepted for filing by the FDA in September 2013 with a PDUFA V goal date of July 29, 2014, and our financial plans currently relate to timely approval of such NDA. Any delay in approval of our NDA may place tavaborole at a competitive disadvantage and may increase our need for additional resources, which may result in increased difficulty in raising necessary capital to support our future operations. Our success in filing the NDA for tavaborole does not mean that we will be able to submit NDAs for our other products.

        The process of obtaining FDA and other required regulatory approvals, including foreign approvals, often takes many years and can vary substantially based upon the type, complexity and novelty of the products involved. Furthermore, this approval process is extremely complex, expensive and uncertain. GSK, Lilly, the Gates Foundation, DTRA or our potential future partners may be unable to submit NDAs in the United States or any marketing approval application or other foreign applications for any of our products. Upon submitting an NDA, including any amended NDA or supplemental NDA, to the FDA seeking marketing approval for any of our product candidates, the FDA must decide whether to either accept or reject the submission for filing. We cannot be certain that these submissions will be accepted for filing and review by the FDA, or that the marketing approval application submissions to any other regulatory authorities will be accepted for filing and review by those authorities. We cannot be certain that we or our partners will be able to respond to any regulatory requests during the review period in a timely manner without delaying potential regulatory action. We also cannot be certain that any of our product candidates will receive favorable recommendations from any FDA advisory committee or foreign regulatory bodies or be approved for marketing by the FDA or foreign regulatory authorities. In addition, delays in approvals or rejections of marketing applications may be based upon many factors, including regulatory requests for additional analyses, reports, data and studies, regulatory questions regarding data and results, changes in regulatory policy during the period of product development and the emergence of new information regarding our product candidates or other products.

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        Data obtained from preclinical studies and clinical trials are subject to different interpretations, which could delay, limit or prevent regulatory review or approval of any of our product candidates. For example, as a routine part of the evaluation of any potential drug, clinical trials are generally conducted to assess the potential for drug-drug interactions (DDI) that could impact potential product safety. In February 2014, we completed a voluntary DDI study that demonstrated AN2728 does not interact with cytochrome P450 subtype 2C9, although to date, we have not been requested to perform drug-drug interaction studies by the FDA. However, if any DDI studies are required, it may delay any potential product approval and may increase the expenses associated with clinical programs. Furthermore, regulatory attitudes towards the data and results required to demonstrate safety and efficacy can change over time and can be affected by many factors, such as the emergence of new information, including on other products, policy changes and agency funding, staffing and leadership. We do not know whether future changes to the regulatory environment will be favorable or unfavorable to our business prospects.

        In addition, the environment in which our regulatory submissions may be reviewed changes over time. For example, average review times at the FDA for NDAs have fluctuated over the last ten years, and we cannot predict the review time for any of our submissions with any regulatory authorities. Review times can be affected by a variety of factors, including budget and funding levels and statutory, regulatory and policy changes. Moreover, in light of widely publicized events concerning the safety risk of certain drug products, regulatory authorities, members of Congress, the Government Accounting Office, medical professionals and the general public have raised concerns about potential drug safety issues. These events have resulted in the withdrawal of drug products, revisions to drug labeling that further limit use of the drug products and establishment of risk evaluation and mitigation strategies (REMS) that may, for instance, restrict distribution of drug products. The increased attention to drug safety issues may result in a more cautious approach by the FDA to clinical trials. Data from clinical trials may receive greater scrutiny with respect to safety, which may make the FDA or other regulatory authorities more likely to terminate clinical trials before completion, or require longer or additional clinical trials that may result in substantial additional expense, a delay or failure in obtaining approval or approval for a more limited indication than originally sought.

Our use of boron chemistry to develop pharmaceutical product candidates is novel and may not prove successful in producing approved products. Undesirable side effects of any of our product candidates, or of boron-based drugs developed by others, may extend the time period required to obtain regulatory approval or harm market acceptance of our product candidates, if approved.

        All of our product development activities are centered on compounds containing boron. The use of boron chemistry to develop new drugs is largely unproven. If boron-based compounds developed by us or others have significant adverse side effects, regulatory authorities could require additional studies of our boron-based compounds, which could delay the timing of and increase the cost for regulatory approvals of our product candidates. Additionally, adverse side effects for other boron-based compounds could affect the willingness of healthcare payors and medical providers to provide reimbursement for or use our boron-based drugs and could impact market acceptance of our products.

        Additionally, there can be no assurance that boron-based products will be free of significant adverse side effects. During clinical trials, a small number of our patients who received tavaborole experienced some skin irritation around their toenails and a few patients who received AN2728 experienced some skin irritation in the treated areas. If boron-based drug treatments result in significant adverse side effects, they may not be useful as therapeutic agents. If we are unable to develop products that are safe and effective using our boron chemistry platform, our business will be materially and adversely affected.

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If any of our product candidates for which we receive regulatory approval do not achieve broad market acceptance, the revenues that are generated from their sales will be limited.

        The commercial success of tavaborole, AN2728, or our other product candidates will depend upon the acceptance of these products among physicians, patients, and healthcare payors. The degree of market acceptance of our product candidates will depend on a number of factors, including:

    limitations or warnings contained in the FDA-approved labeling for our products;

    changes in the standard of care for the targeted indications for any of our product candidates;

    limitations in the approved indications for our product candidates;

    lower demonstrated clinical safety or efficacy compared to other products;

    occurrence of significant adverse side effects;

    ineffective sales, marketing and distribution support;

    lack of availability of reimbursement from managed care plans and other healthcare payors;

    timing of market introduction and perceived effectiveness of competitive products, including information provided in competitor products' package inserts;

    lack of cost-effectiveness;

    availability of alternative therapies with potentially advantageous results, or other products with similar results at similar or lower cost, including generics and over-the-counter products;

    adverse publicity about our product candidates or favorable publicity about competitive products;

    lack of convenience and ease of administration of our products; and

    potential product liability claims.

        If our product candidates for human use are approved, but do not achieve an adequate level of acceptance by physicians, healthcare payors and patients, sufficient revenue may not be generated from these products, and we may not become or remain profitable. In addition, efforts to educate the medical community and healthcare payors on the benefits of our product candidates may require significant resources and may never be successful. For example, Valeant, filed its NDA for efinaconazole, its topical product candidate for the treatment of onychomycosis, in July 2012, and stated that efinaconazole had a PDUFA goal date of May 24, 2013. On May 28, 2013, Valeant received a Complete Response Letter from the FDA related to its NDA for efinaconazole and estimated that it could receive approval from the FDA in mid-2014. On October 2, 2013, Valeant received one regulatory approval for efinaconazole, under the brand name Jublia, from Health Canada. In January 2014, Valeant announced that it had resubmitted its NDA for efinaconazole, a potential treatment for onychomycosis, to the FDA in December 2013 and anticipates approval in mid-2014.If approved by the FDA, efinaconazole may be the first to market in the United States with data that may be competitive with our data from tavaborole's Phase 3 studies. If efinaconazole reaches the U.S. market prior to tavaborole, the competitive position of tavaborole may be harmed significantly and the diminished value of tavaborole in such event could have a significant adverse effect on our business. Additionally, our product candidates intended for use against neglected diseases, such as AN5568 for sleeping sickness and our product candidate for tuberculosis (TB), are not expected to generate significant revenues, if any.

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We have never marketed a drug before, and if we are unable to establish an effective commercial infrastructure or enter into acceptable third-party sales and marketing or licensing arrangements, we may not be able to commercialize our product candidates successfully.

        We may develop a commercial infrastructure to market and sell our products in certain U.S. specialty markets. We currently do not have any sales, distribution and marketing capabilities, the development of which will require substantial resources and will be time consuming. We are currently evaluating the establishment of these capabilities, either internally or through third-party organizations, and these costs are expected to be incurred in advance of any approval of our product candidates. In addition to the risk and expense of establishing sales capabilities in advance of commercial launch, we may not be able to hire a commercial organization that has adequate expertise in the medical markets that we intend to target. If we are unable to establish our sales force and marketing capability, our operating results may be adversely affected. In addition, we plan to enter into sales and marketing or licensing arrangements with third parties for non-specialty markets in the United States and for international sales of any approved products. If we are unable to enter into any such arrangements on acceptable terms, or at all, we may be unable to market and sell our products in these markets and the potential product revenues for our products would be reduced.

We expect that our existing and future product candidates will face competition and most of our competitors have significantly greater resources than we do.

        The pharmaceutical industry is highly competitive, with a number of established, large pharmaceutical companies, as well as many smaller companies. Most of these companies have significant financial resources, marketing capabilities and experience in obtaining regulatory approvals for product candidates. There are many pharmaceutical companies, biotechnology companies, public and private universities, government agencies and research organizations actively engaged in research and development of products that may target the same markets as our product candidates. We expect any future products we develop to compete on the basis of, among other things, product efficacy, price, lack of significant adverse side effects and convenience and ease of treatment. For example, tavaborole faces potential competition from Valeant's efinaconazole, which is not only potentially ahead of tavaborole in the regulatory approval process, but also would be marketed by a pharmaceutical company with significantly greater resources and commercial experience than we currently possess.

        Compared to us, many of our potential competitors have substantially greater:

    resources, including capital, personnel and technology;

    manufacturing and distribution expertise;

    sales and marketing expertise.

    research and development capability;

    clinical trial expertise;

    regulatory expertise;

    intellectual property prosecution expertise and portfolios; and

    international capabilities;

        As a result of these factors, our competitors may obtain regulatory approval of their products more rapidly than we are able to or may obtain patent protection or other intellectual property rights that limit our ability to develop or commercialize our product candidates. Our competitors also may develop drugs that are more effective, more widely used and less costly than ours and also may be more successful than us in manufacturing and marketing their products.

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The dermatology and podiatry markets are competitive, which may adversely affect our ability to commercialize our dermatological product candidates.

        If tavaborole is approved for the treatment of onychomycosis, we anticipate that it would compete with other marketed nail fungal therapeutics including Lamisil, Sporanox, Onmel, Penlac and generic versions of those compounds. Tavaborole will also compete with lasers, which have received clearance from the FDA for the temporary increase of clear nail in patients with onychomycosis and with over-the-counter products and possibly various other devices under development for onychomycosis. If approved for the treatment of mild-to-moderate atopic dermatitis and/or psoriasis, AN2728 will compete against a number of approved topical treatments. For mild-to-moderate atopic dermatitis, competing treatments would include: combinations of antibiotics, antihistamines, topical corticosteroids and topical immunomodulators, such as Elidel (pimecrolimus) and Protopic (tacrolimus); and, for psoriasis, Taclonex (a combination of calcipotriene and the high potency corticosteroid, betamethasone dipropionate), Dovonex (calcipotriene), Tazorac (tazarotene) and generic versions, where available. AN2728 also would compete against systemic treatments for psoriasis, which include oral products such as Soriatane (acitretin), methotrexate and cyclosporine and injected biologic products such as Enbrel (etanercept), Remicade (infliximab), Stelara (ustekinumab), Simponi (golimumab) and Humira (adalimumab). A number of other treatments are used for psoriasis, including light-based treatments and non-prescription topical treatments.

        There are also several pharmaceutical product candidates under development that could potentially be used to treat onychomycosis and compete with tavaborole. The latest-stage development candidate is efinaconazole, a novel topical triazole that completed Phase 3 development in December 2011 and was developed by DPS, a wholly-owned subsidiary of Valeant. DPS licensed efinaconazole from Kaken Pharmaceuticals in 2006. Valeant reported the results of its Phase 3 studies in November 2012. In its first study, 17.8% of patients treated with efinaconazole reached the primary endpoint of "complete cure," compared to 3.3% of patients treated with vehicle. In the second study, 15.2% of patients treated with efinaconazole reached the primary endpoint of "complete cure," compared to 5.5% of patients treated with vehicle. Valeant filed an NDA with the FDA in July 2012 and had a PDUFA goal date of May 24, 2013. On May 28, 2013, Valeant received a Complete Response Letter from the FDA related to its NDA for efinaconazole, its topical product candidate for the treatment of onychomycosis, and has estimated that it could receive approval from FDA in mid-2014. On October 2, 2013, Valeant received one regulatory approval for efinaconazole, under the brand name Jublia, from Health Canada. In January 2014, Valeant announced that it had resubmitted its NDA for efinaconazole, a potential treatment for onychomycosis, to the FDA in December 2013 and anticipates approval in mid-2014. The success of efinaconazole would be expected to decrease the value of tavaborole.

        There are several companies pursuing various devices for onychomycosis, including laser technology. For example, at least four lasers have received FDA clearance for the treatment of onychomycosis. In addition, there are a number of earlier stage therapeutics and devices in various stages of development for the treatment of onychomycosis. For example, 10% Luliconazole Solution from Topica Pharmaceuticals, Inc., is currently in a Phase 2b/3 clinical trial to evaluate efficacy and safety of two different dosing regimens.

        Even if a generic product or an over-the-counter product is less effective than our product candidates, a less effective generic or over-the-counter product may be more quickly adopted by health insurers and patients than our competing product candidates based upon cost or convenience. In addition, each of our product candidates may compete against product candidates currently under development by other companies.

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Reimbursement decisions by healthcare payors may have an adverse effect on pricing and market acceptance. If there is not sufficient reimbursement for our products, it is less likely that our products will be widely used.

        Successful commercialization of pharmaceutical products usually depends on the availability of adequate coverage and reimbursement from healthcare payors. Patients or healthcare providers who purchase drugs generally rely on healthcare payors to reimburse all or part of the costs associated with such products. Adequate coverage and reimbursement from governmental payors, such as Medicare and Medicaid, and commercial payors, such as HMOs and insurance companies, can be essential to new product acceptance.

        Current treatments for onychomycosis are often not reimbursed by healthcare payors. Only generic formulations of current treatments are generally reimbursed by healthcare payors. We do not know the extent to which tavaborole will be reimbursed if it is approved. Reimbursement decisions by healthcare payors may have an effect on pricing and market acceptance. Our other product candidates, such as AN2728, also will be subject to uncertain reimbursement decisions by healthcare payors. Our products are less likely to be used if they do not receive adequate reimbursement.

        The market for our product candidates may depend on access to healthcare payors' drug formularies, or lists of medications for which healthcare payors provide coverage and reimbursement. Industry competition to be included in such formularies results in downward pricing pressures on pharmaceutical companies. Healthcare payors may refuse to include a particular branded drug in their formularies when a competing generic product is available.

        All healthcare payors, whether governmental or commercial, are developing increasingly sophisticated methods of controlling healthcare costs. In addition, in the United States, no uniform policy of coverage and reimbursement for medicines exists among all these payors. Therefore, coverage of and reimbursement for drugs can differ significantly from payor to payor and can be difficult and costly to obtain.

        Virtually all countries regulate or set the prices of pharmaceutical products, which is a separate determination from whether a particular product will be subject to reimbursement under that government's health plans. There are systems for reimbursement and pricing approval in each country and moving a product through those systems is time consuming and expensive.

Healthcare policy changes, including the Healthcare Reform Act, may have a material adverse effect on us.

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

        In addition to the Healthcare Reform Act, there will continue to be proposals by legislators at both the federal and state levels, regulators and healthcare payors to keep these costs down while

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expanding individual healthcare benefits. Certain of these changes could impose limitations on the prices we will be able to charge for any products that are approved or the amounts of reimbursement available for these products from governmental agencies or healthcare payors or may increase the tax requirements for life sciences companies such as ours. While it is too early to predict what effect the recently enacted Healthcare Reform Act or any future legislation or regulation will have on us, such laws could have a material adverse effect on our business, financial position and results of operations.

We currently expect that a portion of the market for our products will be outside the United States. Our product candidates may never receive approval or be commercialized outside of the United States.

        We plan to enter into sales and marketing arrangements with third parties for international sales of any approved products. To market and commercialize any product candidates outside of the United States, we or any third parties that are marketing or selling our products must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods. The regulatory approval process in other countries may include all of the risks detailed above regarding failure to obtain FDA approval in the United States as well as other risks such as pricing of the product, that will likely require negotiations with foreign governments or agencies of such governments prior to commercialization in these other countries. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may have a negative effect on the regulatory process in others. Failure to obtain regulatory approval in other countries or any delay or setback in obtaining such approval could have the same adverse effects detailed above regarding FDA approval in the United States. In addition, regulatory approval often involves further efforts to obtain adequate pricing or reimbursement from regulatory authorities in foreign jurisdictions. As a result, regulatory and pricing and reimbursement risks include the possibility that our product candidates may not be approved for all indications requested, or at all, which could limit the uses of our product candidates and have an adverse effect on product sales and potential royalties, and that such approval may be subject to limitations on the indicated uses for which the product may be marketed or require costly post-marketing follow-up studies.

Even if our product candidates receive regulatory approval, we may still face future development and regulatory difficulties.

        Even if regulatory approval is obtained for any of our product candidates, regulatory authorities may still impose significant restrictions on a product's indicated uses or marketing or impose ongoing requirements for potentially costly post-approval studies. Given the number of high profile adverse safety events with certain drug products, regulatory authorities may require, as a condition of approval, costly risk evaluation and mitigation strategies, which may include safety surveillance, restricted distribution and use, patient education, enhanced labeling, expedited reporting of certain adverse events, pre-approval of promotional materials and restrictions on direct-to-consumer advertising. For example, any labeling approved for any of our product candidates may include a restriction on the term of its use, or it may not include one or more of our intended indications. Furthermore, any new legislation addressing drug safety issues could result in delays or increased costs during the period of product development, clinical trials and regulatory review and approval, as well as increased costs to assure compliance with any new post-approval regulatory requirements. Any of these restrictions or requirements could force us or our partners to conduct costly studies.

        Our product candidates also will be subject to ongoing regulatory requirements for the labeling, packaging, storage, advertising, promotion, record-keeping and submission of safety and other post-market information on the drug. In addition, approved products, manufacturers and manufacturers' facilities are required to comply with extensive FDA requirements, including ensuring that quality control and manufacturing procedures conform to current Good Manufacturing Practices

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(cGMP). As such, we and our contract manufacturers are subject to continual review and periodic inspections to assess compliance with cGMP. Accordingly, we and others with whom we work must continue to expend time, money and effort in all areas of regulatory compliance, including manufacturing, production and quality control. We also will be required to report certain adverse reactions and production problems, if any, to the FDA and to comply with certain requirements concerning advertising and promotion for our products. Promotional communications with respect to prescription drugs are subject to a variety of legal and regulatory restrictions and must be consistent with the information in the product's approved label. As such, we may not promote our products for indications or uses for which they do not have approval.

        If a regulatory agency discovers previously unknown problems with a product, such as adverse events of unanticipated severity or frequency, or problems with the facility where the product is manufactured or disagrees with the promotion, marketing or labeling of a product, a regulatory agency may impose restrictions on that product or us, including requiring withdrawal of the product from the market. If our product candidates fail to comply with applicable regulatory requirements, a regulatory agency may:

    issue warning letters;

    mandate modifications to promotional materials or require us to provide corrective information to healthcare practitioners;

    require us or our partners to enter into a consent decree, which can include imposition of various fines, reimbursements for inspection costs, required due dates for specific actions and penalties for noncompliance;

    impose other civil or criminal penalties;

    suspend regulatory approval;

    suspend any ongoing clinical trials;

    refuse to approve pending applications or supplements to approved applications filed by us, our partners or our potential future partners;

    impose restrictions on operations, including costly new manufacturing requirements; or

    seize or detain products or require a product recall.

        We are also subject to regulation by regional, national, state and local agencies, including the Department of Justice, the Federal Trade Commission, the Office of Inspector General of the U.S. Department of Health and Human Services and other regulatory bodies, as well as governmental authorities in those foreign countries in which we may commercialize our products. The FFDCA, the Public Health Service Act and other federal and state statutes and regulations govern to varying degrees the research, development, manufacturing and commercial activities relating to prescription pharmaceutical products, including preclinical testing, approval, production, labeling, sale, distribution, import, export, post-market surveillance, advertising, dissemination of information and promotion. These statutes and regulations include Anti-Kickback statutes and false claims statutes.

        The federal Anti-Kickback Statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce or in return for purchasing, leasing, ordering or arranging for the purchase, lease or order of any healthcare item or service reimbursable under Medicare, Medicaid or other federally financed healthcare programs. This statute has been interpreted to apply to arrangements between pharmaceutical companies on the one hand and prescribers, purchasers and formulary managers on the other. Although there are a number of statutory exemptions and regulatory safe harbors protecting identified common activities from prosecution, the exemptions and safe harbors are drawn narrowly, and practices that involve remuneration intended to induce prescribing, purchases or recommendations may be subject to scrutiny if they do not qualify for an exemption or safe harbor.

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        Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government, or knowingly making, or causing to be made, a false statement to get a false claim paid.

        Recently, several pharmaceutical and other healthcare companies have been prosecuted under these laws for allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product. Other companies have been prosecuted for causing false claims to be submitted because of the company's marketing of the product for unapproved, and thus non-reimbursable, uses. Pharmaceutical and other healthcare companies have also been prosecuted on other legal theories of Medicare fraud. The majority of states also have statutes or regulations similar to the federal Anti-Kickback Statute and federal false claims laws that apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payer. Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a company's products from reimbursement under government programs, criminal fines and imprisonment. Several states now require pharmaceutical companies to report expenses relating to the marketing and promotion of pharmaceutical products and prohibit or require reporting of the provision of gifts, meals and entertainment to individual healthcare providers. Other states require the posting of information relating to clinical studies. In addition, California requires pharmaceutical companies to implement a comprehensive compliance program that includes a limit on expenditures for, or payments to, individual medical or health professionals. We have adopted a comprehensive compliance program that we believe satisfies the California law. Several additional states are considering similar proposals. Compliance with these laws is difficult and time consuming, and companies that do not comply with these state laws face civil penalties. Because of the breadth of these laws and the narrowness of available statutory and regulatory exemptions, it is possible that some of our business activities could be subject to challenge under one or more of such laws. Such a challenge could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

        In addition to the federal Anti-Kickback Statute and federal false claims laws, the federal Health Insurance Portability and Accountability Act of 1996 (HIPAA) created new federal criminal statutes that prohibit executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters. HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act of 2009 (HITECH) and its implementing regulations, also imposes certain requirements relating to the privacy, security and transmission of individually identifiable health information. State and foreign laws governing the privacy and security of health information in certain circumstances differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.

        Federal "sunshine" laws require transparency regarding financial arrangements with health care providers, such as the reporting and disclosure requirements imposed by the PPACA on drug manufacturers regarding any "transfer of value" made or distributed to prescribers and other health care providers.

        If we or our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including criminal and significant civil penalties, damages, fines, imprisonment, exclusion of products from reimbursement under United States federal or state healthcare programs, and the curtailment or restructuring of our operations. Any penalties, damages, fines, curtailment or restructuring of our operations could materially adversely affect our ability to operate our business and our financial results. Although compliance programs can mitigate the risk of investigation and prosecution for violations of these laws, the risks cannot be entirely eliminated. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management's attention from the operation of our business. Moreover, achieving and sustaining compliance with these laws may prove costly.

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        We may contract with a contract sales organization that employs the sales representatives who promote our drug products. However, we expect that government and regulatory agencies will hold us responsible for any actions by such sales representatives or sales organizations. If we or our contract sales organization fails to comply with the regulatory requirements of the FDA and other applicable United States. and foreign regulatory authorities or if previously unknown problems with our products, manufacturers or manufacturing processes are discovered, we and our partners could be subject to administrative or judicially imposed sanctions.

Current healthcare laws and regulations and future legislative or regulatory reforms to the healthcare system may affect our ability to profitably sell any products that we may develop.

        The United States and some foreign jurisdictions are considering, or have enacted, a number of legislative and regulatory proposals to change the healthcare system in ways that could affect our ability to sell our products profitably. Among policy makers and payers in the United States and elsewhere, there is significant interest in promoting changes in healthcare systems with the stated goals of containing healthcare costs, improving quality and/or expanding access. In the United States, the pharmaceutical industry has been a particular focus of these efforts and has been significantly affected by major legislative initiatives.

        In March 2010, PPACA became law in the United States. PPACA substantially changes the way healthcare is financed by both governmental and private insurers and significantly affects the pharmaceutical industry. Among the provisions of PPACA of importance to the pharmaceutical industry are the following:

    an annual, nondeductible fee on any entity that manufactures or imports certain branded prescription drugs and biologic agents, apportioned among these entities according to their market share in certain government healthcare programs;

    an increase in the rebates a manufacturer must pay under the Medicaid Drug Rebate Program, retroactive to January 1, 2010, to 23.1% and 13% of the average manufacturer price for branded and generic drugs, respectively;

    a new Medicare Part D coverage gap discount program, in which manufacturers must agree to offer 50% point-of-sale discounts off negotiated prices of applicable brand drugs to eligible beneficiaries during their coverage gap period, as a condition for the manufacturer's outpatient drugs to be covered under Medicare Part D;

    extension of manufacturers' Medicaid rebate liability to covered drugs dispensed to individuals who are enrolled in Medicaid managed care organizations;

    expansion of eligibility criteria for Medicaid programs by, among other things, allowing states to offer Medicaid coverage to additional individuals and by adding new mandatory eligibility categories for certain individuals with income at or below 133% of the Federal Poverty Level beginning in 2014, thereby potentially increasing manufacturers' Medicaid rebate liability;

    expansion of the entities eligible for discounts under the Public Health Service pharmaceutical pricing program;

    new requirements to report certain financial arrangements with physicians and teaching hospitals, as defined in PPACA and its implementing regulations, including reporting any "transfer of value" made or distributed to teaching hospitals, prescribers and other healthcare providers, and reporting any ownership and investment interests held by physicians and their immediate family members and applicable group purchasing organizations during the preceding calendar year, with data collection to be required beginning August 1, 2013 and reporting to the Centers for Medicare & Medicaid Services to be required by March 31, 2014 and by the 90th day of each subsequent calendar year;

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    a new requirement to annually report drug samples that manufacturers and distributors provide to physicians;

    expansion of healthcare fraud and abuse laws, including the False Claims Act and the Anti-Kickback Statute, new government investigative powers and enhanced penalties for noncompliance;

    a licensure framework for follow-on biologic products; and

    a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in and conduct comparative clinical effectiveness research, along with funding for such research.

        In addition, other legislative changes have been proposed and adopted since PPACA was enacted. In August 2011, the Budget Control Act of 2011, among other things, created measures for spending reductions by Congress. A Joint Select Committee on Deficit Reduction, tasked with recommending a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, was unable to reach required goals, thereby triggering the legislation's automatic reduction to several government programs. This includes aggregate reductions to Medicare payments to providers of up to 2% per fiscal year, starting in 2013. In January 2013, President Obama signed into law the American Taxpayer Relief Act of 2012 (ATRA) which, among other things, reduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers, and increased the statute of limitations period for the government to recover overpayments to providers from three to five years. These new laws may result in additional reductions in Medicare and other healthcare funding, which could have a material adverse effect on our customers and accordingly, our financial operations.

        We anticipate that PPACA, as well as other healthcare reform measures that may be adopted in the future, may result in more rigorous coverage criteria and an additional downward pressure on the price that we receive for any approved product, and could seriously harm our business. Any reduction in reimbursement from Medicare or other government programs may result in a similar reduction in payments from private payers. Insurers may also refuse to provide any coverage of uses of approved products for medical indications other than those for which the FDA has granted market approvals. As a result, significant uncertainty exists as to whether and how much third-party payers will reimburse for any newly-approved drugs, which in turn will put pressure on the pricing of drugs.

        We also cannot be certain that tavaborole or any products that may result from our product candidates will successfully be placed on the list of drugs covered by particular health plan formularies, nor can we predict the negotiated price for such products, which will be determined by market factors. Many states have also created preferred drug lists and include drugs on those lists only when the manufacturers agree to pay a supplemental rebate. If tavaborole or other products that may result from our product candidates are not included on these preferred drug lists, physicians may not be inclined to prescribe them to their patients, thereby diminishing the potential market for such products.

Guidelines and recommendations published by various organizations may affect the use of our products.

        Government agencies may issue regulations and guidelines directly applicable to us, our partners or our potential future partners and our product candidates. In addition, professional societies, practice management groups, private health/science foundations and organizations involved in various diseases from time to time publish guidelines or recommendations to the healthcare and patient communities. These various sorts of recommendations may relate to such matters as product usage, dosage, route of administration and use of related or competing therapies. Changes to these recommendations or other guidelines advocating alternative therapies could result in decreased use of our products, which may adversely affect our results of operations.

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Risks Related to Our Dependence on Third Parties

We are dependent on our existing third party collaborations and research agreements to fund additional development opportunities and expect to continue to expend resources in our current collaborations and/or research agreements with GSK, Lilly, the Gates Foundation and DTRA. These research collaborations may fail to successfully identify product candidates, may result in disputes or our partners may elect not to license, develop or commercialize any of the resulting compounds, including, in the case of GSK, the tuberculosis (TB) compounds that GSK licensed from us in September 2013. In the event our collaborator does not elect to exercise its option or elects not to develop or commercialize our collaboration product candidates, our operating results and financial condition could be materially and adversely affected.

        Currently, we have three significant ongoing collaboration and research agreements: an August 2010 collaborative research, license and commercialization agreement with Lilly for the discovery, development and worldwide commercialization of animal health products for specific applications; an April 2013 research collaboration with the Gates Foundation to discover drug candidates intended to treat two filarial worm diseases (onchocerciasis, or river blindness, and lymphatic filariasis, commonly known as elephantiasis) and TB and an October 2013 research agreement with DTRA to design and discover new classes of systemic antibiotics. While the research period under our collaboration agreement with GSK expired in October 2013, GSK selected a compound for further development in TB in September 2013 and will be responsible for all further development and commercialization of this compound under our October 2007 research and development collaboration, option and license agreement with GSK, as amended. In January 2014, Anacor received notice that Lilly is terminating the research term in March 2014, or five months earlier than the August 2014 expiration as specified in the agreement, which will terminate Lilly's obligation to make quarterly research payments under the agreement to us. The remainder of the agreement remains in effect, and potential payments and royalties related to compounds under development by Lilly pursuant to the agreement remain unaffected by the termination of the research term. Under the Gates Foundation research agreement, the Gates Foundation will pay us up to $17.7 million over a three-year research term to conduct research activities directed at discovering potential neglected disease drug candidates and to create an expanded library of boron compounds to screen for additional potential drug candidates to treat neglected diseases, which will be accessible to the Gates Foundation and other third parties. In connection with the research agreement, the Gates Foundation purchased shares of our common stock for net proceeds of approximately $5.0 million. Under the research agreement with DTRA, we will work with a drug discovery consortium formed by Colorado State University, the University of California at Berkeley and us to design and discover new classes of systemic antibiotics. The research will be conducted over a three and a half year period. The work is funded by a $13.5 million award from DTRA's R&D Innovation and Systems Engineering Office, which was established to search for and execute strategic investments in innovative technologies for combating weapons of mass destruction. Under this award, we will apply our boron chemistry to discover rationally designed novel antibiotics that target DTRA-priority pathogens known to exhibit resistance to existing antibiotics.

        During the research terms of the collaborations and research agreements, we and, in some cases, our partner are committed to use our diligent efforts to discover and develop compounds and to provide specified resources, on a project-by-project basis. We are either reimbursed for our research costs, or each party is responsible for its own research costs, but in all cases we expect to continue to expend resources on the collaborations and research agreements. If we fail to successfully identify product candidates or, in some cases, demonstrate proof-of-concept for those product candidates we identify, our operating results and financial condition could be materially and adversely affected. In the case of the DTRA award, after the initial term of eleven months, DTRA has the sole option to fund the research in the subsequent twelve- and nineteen- month periods. In addition, we may mutually agree with our collaboration partner not to pursue all of the research activities contemplated under the applicable agreement. Certain collaboration partners have the option, but are not required, to exclusively license or select for further development certain product candidates under the agreement

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once the product candidate meets specified criteria, subject to continuing obligations to make milestone payments and royalty payments on commercial sales, if any, of such licensed compounds. Certain collaboration partners are obligated to make payments to us upon the achievement of certain initial discovery and developmental milestones, but further, more significant milestone payments are payable only on compounds that the partner chooses to license or develop. If we devote significant resources to a research project and our collaboration partner elects not to exercise its option with respect to any resulting product candidates or elects not to develop such candidates, our financial condition could be materially and adversely affected. In certain cases, if our partner does not exercise a given option or terminates development, we may request a license to develop and commercialize products containing the relevant compounds. If we make such a request, we will be obligated to make certain milestone and royalty payments to the partner upon development and commercialization of such products.

        If our collaboration partner elects to license or develop a compound, like GSK and Lilly have, the partner assumes sole responsibility for further development, regulatory approval and commercialization of such compound. Thus, with respect to compounds that our partner chooses to develop, the timing of development and future payments to us, including milestone and royalty payments, will depend on the extent to which such licensed compounds advance through development, regulatory approval and commercialization by our partner. Additionally, our partner can choose to terminate the agreement with a specified notice period or its license to any compounds at any time with no further obligation to develop and commercialize such compounds. In such event, we would not be eligible to receive further payments for the affected compounds. We would retain rights to develop and market any such product candidates. However, we would be required to fund further development and commercialization ourselves or with other partners if we continue to pursue these product candidates and, in some cases, would owe our previous partner royalties if we succeeded in commercializing any such product candidates. For example, in September 2013, Lilly notified us that it was ceasing further development of the compound licensed in August 2011for an animal health indication. Similarly, in October 2012, GSK discontinued clinical development of AN3365. There can be no assurance that our partners will not terminate development candidates remaining under license in our existing collaboration agreements.

        If our partner does not devote sufficient resources to the research, development and commercialization of compounds identified through our research collaboration, or is ineffective in doing so, our operating results could be materially and adversely affected. In particular, if our partner independently develops products that compete with our compounds, it could elect to advance such products and not develop or commercialize our product candidates, even while complying with applicable exclusivity provisions. We cannot assure you that our collaboration partners will fulfill their obligations under the agreements or develop and commercialize compounds identified by the research collaborations. If our partners fail to fulfill their obligations under the agreements or terminate the agreements, we would need to obtain the capital necessary to fund the development and commercialization of the returned compounds, enter into alternative arrangements with a third party or halt our development efforts in these areas. We also could become involved in disputes with our partners, which could lead to delays in or termination of the research collaborations or the development and commercialization of identified product candidates and time-consuming and expensive litigation or arbitration. If our partners terminate or breach their agreements with us or otherwise do not advance the compounds identified by our research collaborations, our chances of successfully developing or commercializing such compounds could be materially and adversely affected. For example, on November 28, 2012, we filed an arbitration demand alleging breach of contract by Medicis under the Medicis Agreement and seeking damages related to payment for the achievement of certain preclinical milestones under that agreement. On December 11, 2012, Medicis filed a complaint for breach of the Medicis Agreement and a motion for preliminary injunction in the Delaware Court of Chancery seeking to enjoin us from prosecuting our claims through arbitration and to require us to continue to use diligent efforts to conduct research and development under the Medicis Agreement.

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On October 27, 2013, we entered into a $142.5 million settlement agreement with Valeant, parent of Medicis and DPS, which, among other effects, terminated the Medicis Agreement and all rights and licenses to intellectual property reverted back to us. There can be no assurances that we will not have other disputes in the future with our current or future partners with respect to our collaboration agreements.

We may not be successful in establishing and maintaining development and commercialization collaborations, which could adversely affect our ability to develop certain of our product candidates and our financial condition and operating results.

        Developing pharmaceutical products, conducting clinical trials, obtaining regulatory approval, establishing manufacturing capabilities and marketing approved products is expensive. Consequently, we plan to establish collaborations for development and commercialization of product candidates and research programs. For example, if tavaborole, AN2728 or any of our other product candidates receives marketing approval, we intend to enter into sales and marketing arrangements with third parties for non-specialty markets in the United States and for international sales, and to develop our own sales force targeting podiatrists, dermatologists and other specialty markets in the United States. If we are unable to enter into any such arrangements on acceptable terms, or at all, we may be unable to market and sell our products in these markets. We expect to face competition in seeking appropriate collaborators. Moreover, collaboration arrangements are complex and time consuming to negotiate, document and implement and they may require substantial resources to maintain. We may not be successful in our efforts to establish and implement collaborations or other alternative arrangements for the development of our product candidates. When we partner with a third party for development and commercialization of a product candidate, we can expect to relinquish to the third party some or all of the control over the future success of that product candidate. Our collaboration partner may not devote sufficient resources to the commercialization of our product candidates or may otherwise fail in their commercialization. The terms of any collaboration or other arrangement that we establish may not be favorable to us. In addition, any collaboration that we enter into may be unsuccessful in the development and commercialization of our product candidates. In some cases, we may be responsible for continuing preclinical and initial clinical development of a partnered product candidate or research program, and the payment we receive from our collaboration partner may be insufficient to cover the cost of this development. If we are unable to reach agreements with suitable collaborators for our product candidates, we may incur increased costs, we may be forced to limit the number of our product candidates we can commercially develop or the territories in which we commercialize them and we might fail to commercialize products or programs or territories for which a suitable collaborator cannot be found. If we fail to achieve successful collaborations, our operating results and financial condition could be materially and adversely affected.

We depend on third-party contractors for a substantial portion of our operations and may not be able to control their work as effectively as if we performed these functions ourselves.

        We outsource substantial portions of our operations to third-party service providers, including chemical synthesis, biological screening and manufacturing and the conduct of our clinical trials and various preclinical studies. We anticipate outsourcing the distribution of tavaborole, once approved, to a third party logistics provider, as well as certain of our sales and marketing operations. Our agreements with third-party service providers and clinical research organizations are on a study-by-study basis and are typically short-term. In all cases, we may terminate the agreements with notice and are responsible for the service provider's previously incurred costs.

        Because we have relied on third parties, our internal capacity to perform these functions is limited. Outsourcing these functions involves risk that third parties may not perform to our standards, may not produce results in a timely manner, may become troubled financially or may fail to perform at all. In addition, the use of third-party service providers requires us to disclose our proprietary information to

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these parties, which could increase the risk that this information will be misappropriated. There are a limited number of third-party service providers that have the expertise required to achieve our business objectives. Identifying, qualifying and managing performance of third-party service providers can be difficult and time consuming and could cause delays in our development programs. We currently have a small number of employees, which limits the internal resources we have available to identify and monitor our third-party providers. To the extent we are unable to identify, retain and successfully manage the performance of third-party service providers in the future, our business may be adversely affected.

We have limited experience manufacturing our active pharmaceutical ingredients and product candidates on a large clinical or commercial scale, and have no manufacturing facility. As a result, we are dependent on third parties for the manufacture of our product candidates and our supply chain, and if we experience problems with any of these suppliers, the manufacturing of our product candidates or products could be delayed.

        We do not own or operate facilities for the manufacture of our product candidates. We have a small number of personnel with experience in drug product manufacturing. We currently outsource all manufacturing and packaging of our preclinical and clinical product candidates to third parties and intend to continue to do so. If tavaborole is approved, the inability to manufacture sufficient supplies of the active drug ingredient or drug product could adversely affect product commercialization. We also outsource to third parties the active ingredient and drug product manufacturing for AN2728 and our other product candidates. We currently do not have any agreements with third-party manufacturers for the long-term commercial supply of our product candidates, including tavaborole. We may be unable to enter into agreements for commercial supply with third party manufacturers, or may be unable to do so on acceptable terms. We rely on single source suppliers of our current requirements of active pharmaceutical ingredients (API) and drug products for tavaborole and AN2728 under manufacturing services agreements. In the event that the parties cannot agree to the terms and conditions for these suppliers to provide some or all of our clinical and commercial supply needs of API and drug products, we would not be able to manufacture API and drug products until alternative suppliers are identified and qualified, which could delay the further development of, and impair our ability to commercialize, these product candidates. We may not be able to establish additional sources of supply for our products. Such suppliers are subject to regulatory requirements, covering manufacturing, testing, quality control and record keeping relating to our product candidates, as well as for product candidates owned by other companies. These suppliers are also subject to ongoing inspections by the regulatory agencies. Failure by any of our suppliers to comply with applicable regulations may result in long delays and interruptions to our product candidate supply while we seek to secure another supplier that meets all regulatory requirements.

        Reliance on third-party manufacturers entails risks to which we would not be subject if we manufactured the product candidates ourselves, including:

    the possible breach of the manufacturing agreements by the third parties because of factors beyond our control;

    the possibility of termination or nonrenewal of the agreements by the third parties because of our breach of the manufacturing agreement or based on their own business priorities;

    the possibility of encountering difficulties in achieving volume production, quality control and quality assurance or suffer shortages of qualified personnel, which could result in their inability to manufacture sufficient quantities of drugs to meet commercial needs or clinical supplies of our product candidates;

    the possibility of failing to establish and follow FDA-mandated cGMPs which are required for FDA approval of our product candidates, or fail to document their adherence to cGMPs, either of which could require costly recalls of products already having received approval, lead to

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      significant delays in the availability of material for clinical study or delay or prevent marketing approval for our product candidates; and

    the possibility of encountering financial difficulties that would interfere with their obligations to supply our product candidates.

        In addition, the manufacturing facilities of certain of our suppliers are located outside of the United States. This may give rise to difficulties in importing our products or product candidates or their components into the United States or other countries as a result of, among other things, regulatory agency import inspections, incomplete or inaccurate import documentation or defective packaging.

        Any of these factors could result in delays or higher costs in connection with our clinical trials, regulatory submissions, required approvals or commercialization of our products.

If we lose our relationships with contract research organizations, our drug development efforts could be delayed.

        We are substantially dependent on third-party vendors and contract research organizations for preclinical studies and clinical trials related to our drug discovery and development efforts. If we lose our relationship with any one or more of these providers, we could experience a significant delay in both identifying another comparable provider and then contracting for its services, which could adversely affect our development efforts. We may be unable to retain an alternative provider on reasonable terms, or at all. Even if we locate an alternative provider, it is likely that this provider will need additional time to respond to our needs and may not provide the same type or level of services as the original provider. In addition, any contract research organization that we retain will be subject to the FDA's regulatory requirements and similar foreign standards and we do not have control over compliance with these regulations by these providers. Consequently, if these practices and standards are not adhered to by these providers, the development and commercialization of our product candidates could be delayed, which could severely harm our business and financial condition.

Risks Relating to Our Intellectual Property

It is difficult and costly to protect our proprietary rights, and we may not be able to ensure their protection.

        Our commercial success will depend in part on obtaining and maintaining patent protection and trade secret protection of our current and future product candidates and the methods used to manufacture them, as well as successfully defending these patents against third-party challenges. Our ability to stop third parties from making, using, selling, offering to sell or importing our products is dependent upon the extent to which we have rights under valid and enforceable patents or trade secrets that cover these activities.

        The patent positions of pharmaceutical companies can be highly uncertain and involve complex legal and factual questions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in pharmaceutical patents has emerged to date in the United States or in many foreign jurisdictions. Changes in either the patent laws or in interpretations of patent laws in the United States and foreign jurisdictions may diminish the value of our intellectual property. Accordingly, we cannot predict the breadth of claims that may be enforced in the patents that we currently own or that may be issued from the applications we have filed or may file in the future or that we may license from third parties. Further, if any patents we obtain or license are deemed invalid and unenforceable, it could impact our ability to commercialize or license our technology.

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

    others may be able to make compounds that are similar to our product candidates but that are not covered by the claims of our patents;

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    we might not have been the first to make the inventions covered by our pending patent applications;

    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;

    any patents that we obtain may not provide us with any competitive advantages;

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

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

        As of February 1, 2014, we are an owner of record, either solely or with a collaborator, of 23 issued U.S. patents and 37 non-U.S. patents with claims to boron-containing compounds, methods of making these compounds or methods of using these compounds in various indications. We are actively pursuing, either solely or with a collaborator, 24 U.S. patent applications (6 provisional and 18 non-provisional), 4 international (PCT) patent applications and 127 non-U.S. patent applications in at least 30 jurisdictions. Of these actively pursued applications, 1 non-provisional U.S. patent application and 16 non-U.S. patent applications are solely owned by a collaborator.

        Due to the patent laws of a country, or the decisions of a patent examiner in a country, or our own filing strategies, we may not obtain patent coverage for all of the product candidates or methods involving these candidates in the parent patent application. We plan to pursue divisional patent applications and/or continuation patent applications in the United States and many other countries to obtain claim coverage for inventions that were disclosed but not claimed in the parent patent application.

        There have been numerous changes to the patent laws and proposed changes to the rules of the United States Patent and Trademark Office (USPTO), which may have a significant impact on our ability to protect our technology and enforce our intellectual property rights. For example, in September 2011, President Obama signed the America Invents Act that codifies several significant changes to the U.S. patent laws, including, among other things, changing from a "first to invent" to a "first inventor to file" system, limiting where a patent holder may file a patent suit, requiring the apportionment of patent damages, replacing interference proceedings with derivation actions and creating a post-grant opposition process to challenge patents after they have been issued. The effects of these changes are currently unclear as the USPTO must still implement various regulations, the courts have yet to address any of these provisions and the applicability of the act and new regulations on specific patents discussed herein have not been determined and would need to be reviewed. However, this act and its implementation could increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents, all of which could have a material adverse effect on our business and financial condition.

        We also may 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. Although we use reasonable efforts to protect our trade secrets, our employees, consultants, contractors, outside scientific collaborators and other advisors may unintentionally or willfully disclose our information to competitors. Enforcing a claim that a third party illegally obtained and is using any of our trade secrets is expensive and time consuming, and the outcome is unpredictable. In addition, courts outside the United States are sometimes less willing to protect trade secrets. Moreover, our competitors may independently develop equivalent knowledge, methods and know-how. Our patent applications would not prevent others from taking advantage of the chemical properties of boron to discover and develop new therapies, including therapies for the indications we are targeting. If others seek to develop boron-based therapies, their research and development efforts may inhibit our ability to conduct research in certain areas and to expand our intellectual property portfolio.

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We may incur substantial costs as a result of litigation or other proceedings relating to patent and other intellectual property rights and we may be unable to enforce or protect our rights to, or use, our technology.

        If we choose to go to court to stop another party from using the inventions claimed in any patents we obtain, that individual or company has the right to ask the court to rule that such patents are invalid or should not be enforced against that third party. These lawsuits are expensive and would consume time and resources and divert the attention of managerial and scientific personnel even if we were successful in stopping the infringement of such patents. In addition, there is a risk that the court will decide that such patents are not valid and that we do not have the right to stop the other party from using the inventions. There is also the risk that, even if the validity of such patents is upheld, the court will refuse to stop the other party on the grounds that such other party's activities do not infringe our rights to such patents. In addition, the United States Supreme Court has recently modified some tests used by the USPTO in granting patents over the past 20 years, which may decrease the likelihood that we will be able to obtain patents and increase the likelihood of challenge of any patents we obtain or license.

        Furthermore, a third party may claim that we or our manufacturing or commercialization partners are using inventions covered by the third party's patent rights and may go to court to stop us from engaging in our normal operations and activities, including making or selling our product candidates. These lawsuits are costly and could affect our results of operations and divert the attention of managerial and scientific personnel. There is a risk that a court would decide that we or our commercialization partners are infringing the third party's patents and would order us or our partners to stop the activities covered by the patents. In that event, we or our commercialization partners may not have a viable way around the patent and may need to halt commercialization of the relevant product. In addition, there is a risk that a court will order us or our partners to pay the other party damages for having violated the other party's patents. In the future, we may agree to indemnify our commercial partners against certain intellectual property infringement claims brought by third parties.

        The pharmaceutical and biotechnology industries have produced a proliferation of patents, and it is not always clear to industry participants, including us, which patents cover various types of products or methods of use. The coverage of patents is subject to interpretation by the courts, and the interpretation is not always uniform. If we are sued for patent infringement, we would need to demonstrate that our products or methods either do not infringe the patent claims of the relevant patent or that the patent claims are invalid, and we may not be able to do this. Proving invalidity is difficult. For example, in the United States, proving invalidity requires a showing of clear and convincing evidence to overcome the presumption of validity enjoyed by issued patents.

        Because some patent applications in the United States may be maintained in secrecy until the patents are issued, because patent applications in the United States and many foreign jurisdictions are typically not published until eighteen months after filing and because publications in the scientific literature often lag behind actual discoveries, we cannot be certain that others have not filed patent applications for technology covered by our pending applications, or that we were the first to invent the technology. Our competitors may have filed, and may in the future file, patent applications covering technology similar to ours. Any such patent application may have priority over our patent applications, which could further require us to obtain rights to issued patents covering such technologies. If another party has filed a U.S. patent application on inventions similar to ours, we may have to participate in an interference proceeding declared by the USPTO to determine priority of invention in the United States. The costs of these proceedings could be substantial, and it is possible that such efforts would be unsuccessful if, unbeknownst to us, the other party had independently arrived at the same or similar invention prior to our own invention, resulting in a loss of our U.S. patent position with respect to such inventions.

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        Patents covering the composition of matter of tavaborole and AN2718 that were owned by others have expired. Our patent applications and patents include or support claims on other aspects of tavaborole or AN2718, such as pharmaceutical formulations containing tavaborole or AN2718, methods of using tavaborole or AN2718 to treat disease and methods of manufacturing tavaborole or AN2718. Without patent protection on the composition of matter of tavaborole or AN2718, our ability to assert our patents to stop others from using or selling tavaborole or AN2718 in a non-pharmaceutically acceptable formulation may be limited.

        Some of our competitors may be able to sustain the costs of complex patent litigation more effectively than we can because they have substantially greater resources. In addition, any uncertainties resulting from the initiation and continuation of any litigation could have a material adverse effect on our ability to raise the funds necessary to continue our operations. For example, in our legal proceedings with Valeant regarding efinaconazole, we spent considerable resources, including management time, in the proceedings. The final hearing was held in September 2013 and, on October 17, 2013, the arbitrator issued an Interim Final Award in our favor for $100.0 million in damages as well as all costs of the arbitration and reasonable attorneys' fees. On October 27, 2013, we, Valeant and DPS entered into a settlement agreement and Valeant agreed to pay us $142.5 million to settle all existing and future claims, including the damages awarded in the October 17, 2013 arbitration ruling, and, among other things, all other disputes between Valeant, DPS and us related to our intellectual property, confidential information and contractual rights. We agreed to provide Valeant a paid-up, irrevocable, non-exclusive, worldwide license to all patents that contain claims covering efinaconazole.

We do not have exclusive rights to intellectual property we developed under U.S. federally funded research grants and contracts in connection with certain of our neglected diseases initiatives, including our recent research agreements with the Gates Foundation and DTRA, and, in the case of those funded research activities, we could ultimately share or lose the rights we do have under certain circumstances.

        Some of our intellectual property rights related to compounds that are not currently in clinical development were initially developed in the course of research funded by the U.S. government. As a result, the U.S. government may have certain rights to intellectual property embodied in our current or future products pursuant to the Bayh-Dole Act of 1980. Government rights in certain inventions developed under a government-funded program include a non-exclusive, non-transferable, irrevocable worldwide license to use inventions for any governmental purpose. In addition, the U.S. government has the right to require us to grant exclusive licenses to any of these inventions to a third party if they determine that: (i) adequate steps have not been taken to commercialize the invention; (ii) government action is necessary to meet public health or safety needs; or (iii) government action is necessary to meet requirements for public use under federal regulations. The U.S. government also has the right to take title to these inventions if we fail to disclose the invention to the government and fail to file an application to register the intellectual property within specified time limits. In addition, the U.S. government may acquire title in any country in which a patent application is not filed within specified time limits.

        Some of our intellectual property rights related to boron-containing compounds that are currently in clinical development, although not funded by the U.S. government, were developed through collaborations. We receive research funding from DNDi, which requires that we share rights with DNDi. For example, we have a co-exclusive, royalty-free, sublicensable license with DNDi to make, use, import and manufacture products for treatment of sleeping sickness, Chagas disease and cutaneous and visceral leishmaniasis in humans in all countries of the world, specifically excluding Japan, Australia, New Zealand, Russia, China and all countries of North America and Europe (DNDi Territory). We also grant to DNDi an exclusive, royalty-free, sublicensable license to distribute, including uses by, or on behalf of, a public sector agency, products containing molecules synthesized under the research plan

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for treatment of sleeping sickness, Chagas disease and cutaneous and visceral leishmaniasis in humans in the DNDi Territory. As a result of these licenses, we are unlikely to realize any revenue in the DNDi Territory for any human therapeutics that we discover for these diseases. In March 2012, DNDi initiated a Phase 1 clinical trial for AN5568 in France. AN5568 is being developed for the treatment of sleeping sickness. As of February 1, 2014, the boron-containing compounds being studied in this collaboration are structurally distinct from our other clinical product candidates. Currently, none of our existing clinical product candidates under development are being considered for use in the DNDi collaboration. Likewise, some of our intellectual property rights related to boron-containing compounds that are not currently in clinical development were developed through a collaboration with Medicines for Malaria Venture (MMV). We accept research and development funding from MMV, and we provide MMV with a worldwide, royalty-free non-exclusive license (without the right to sublicense, except with our prior written approval) to intellectual property rights arising under the collaboration to develop human therapeutics for the treatment of malaria under our research and development agreements with MMV. The boron-containing compounds under development in our MMV collaboration are currently structurally distinct from our clinical product candidates and none of our existing clinical product candidates are being considered for use in the MMV collaboration.

        Under our Gates Foundation research agreement, our research efforts with respect to project compounds in neglected diseases and Gates Foundation priority areas in identified developing countries are subject to co-ownership or exclusive exploitation rights of the Gates Foundation. While we have a first right to develop and commercialize those project compounds, we are required to implement a global access program for such compounds and we may not be able to further develop or exploit project compounds identified in the collaboration.

        Under our DTRA collaboration, we will design and discover new classes of systemic antibiotics under a drug discovery consortium formed by us, Colorado State University (CSU) and the University of California at Berkeley (UCB), and will conduct the research over a three and a half year period. The total $13.5 million award is available to the consortium to fund $2.7 million of research reimbursement for the eleven month period through September 30, 2014, and $5.0 million and $5.7 million is available upon DTRA exercising their option to fund the subsequent twelve and nineteen-month periods, respectively. The funds will support our internal research as well as research conducted in the labs of CSU and UCB. Our research efforts are subject to co-ownership rights with CSU, UCB and the U.S. Government.

Our existing collaborations may limit our ability to develop collaboration intellectual property and compounds subject to the collaboration.

        Certain of our patents are jointly owned with our collaborator, which may limit our ability to further develop or research related compounds. For example, under an existing collaboration, we jointly own 1 U.S. patent, 2 provisional U.S. patent applications and 1 international (PCT) patent application with a collaborator, and have a license under 1 non-provisional U.S. patent application and 16 non-U.S. patent applications solely owned by the collaborator. The rights of our collaborators to jointly-owned intellectual property and compounds under the collaborations will, in the future, restrict our ability to further develop or generate revenues from those compounds, except through the collaborations.

Risks Related to Employee Matters and Managing Growth

We may need to expand certain of our operations and increase the size of our company, and we may experience difficulties in managing growth.

        As we contemplate commercialization of our lead product candidate, increase the number of product development programs we have underway and advance our product candidates through development and commercialization, we will need to increase our product development, scientific,

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regulatory, marketing, sales and administrative headcount to manage these efforts. Our management, personnel and systems currently in place may not be adequate to support this future growth. Our need to effectively manage our operations, growth and various projects requires that we:

    successfully attract and recruit new employees with the expertise and experience we will require;

    develop a marketing, sales and distribution capability;

    manage our clinical programs effectively, which we anticipate being conducted at numerous clinical sites; and

    continue to develop our operational, financial and management controls, reporting systems and procedures.

        If we are unable to successfully manage this growth, our business may be adversely affected.

We may not be able to manage our business effectively if we are unable to attract and retain key personnel.

        We may not be able to attract or retain qualified management, sales and marketing, finance, scientific and clinical personnel in the future due to the intense competition for qualified personnel among biotechnology, pharmaceutical and other businesses, particularly in Northern California. If we are not able to attract and retain necessary personnel to accomplish our business objectives, we may experience constraints that will significantly impede the achievement of our development objectives, our ability to raise additional capital and our ability to implement our business strategy.

        Our industry has experienced a high rate of turnover of management personnel in recent years. We are highly dependent on the development, regulatory, commercialization and business development expertise of our executive officers and key employees. If we lose one or more of our executive officers or key employees, our ability to implement our business strategy successfully could be seriously harmed. We have entered into change of control and severance agreements with each of our officers as part of our retention efforts. Replacing executive officers and key employees may be difficult and may take an extended period of time because of the limited number of individuals in our industry with the breadth of skills and experience required to develop, gain regulatory approval of and commercialize products successfully. Competition to hire from this limited pool is intense, and we may be unable to hire, train, motivate or retain these additional key personnel. Our failure to retain key personnel could materially harm our business.

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements on a timely basis could be impaired, which would adversely affect our business and our stock price.

        We operate in an increasingly demanding regulatory environment, which requires us to comply with the Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act), the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the related rules and regulations of the Securities and Exchange Commission, expanded disclosure requirements, accelerated reporting requirements and more complex accounting rules. Company responsibilities required by the Sarbanes-Oxley Act include establishing adequate internal control over financial reporting and disclosure controls and procedures. Effective internal controls are necessary for us to produce reliable financial reports and are important to help prevent financial fraud. The growth of our operations and our initial public offering created a need for additional resources within the accounting and finance functions in order to produce timely financial information and to create the level of segregation of duties customary for a U.S. public company.

        Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally

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accepted accounting principles. Our management does not expect that our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within our company will have been detected.

        We were required to comply with Section 404 of the Sarbanes-Oxley Act (Section 404) in connection with the Annual Report on Form 10-K for the year ending December 31, 2013. We have expended significant resources to develop the necessary documentation and testing procedures required by Section 404. We cannot be certain that the actions we have taken to improve our internal control over financial reporting will be sufficient, and if we are unable to produce accurate financial statements on a timely basis, investors could lose confidence in the reliability of our financial statements, which could cause the market price of our common stock to decline and make it more difficult for us to finance our operations and growth.

Other Risks Relating to Our Business

We face potential product liability exposure, and if successful claims are brought against us, we may incur substantial liability for a product candidate and may have to limit its commercialization.

        The use of our product candidates in clinical trials and the sale of any products for which we may obtain marketing approval expose us to the risk of product liability claims. Product liability claims may be brought against us or our partners by participants enrolled in our clinical trials, patients, healthcare providers or others using, administering or selling our products. If we cannot successfully defend ourselves against any such claims, we would incur substantial liabilities. Regardless of merit or eventual outcome, product liability claims may result in:

    withdrawal of clinical trial participants;

    termination of clinical trial sites or entire trial programs;

    costs of related litigation;

    substantial monetary awards to patients or other claimants;

    decreased demand for our product candidates and loss of revenues;

    impairment of our business reputation;

    diversion of management and scientific resources from our business operations; and

    the inability to commercialize our product candidates.

        We have obtained limited product liability insurance coverage for our clinical trials domestically and in selected foreign countries where we are conducting clinical trials. Our insurance coverage may not reimburse us or may not be sufficient to reimburse us for any expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive, and, in the future, we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses due to product liability. We intend to expand our insurance coverage for products to include the sale of commercial products if we obtain marketing approval for our product candidates in development, but we may be unable to obtain commercially reasonable product liability insurance for any products approved for marketing. Large judgments have been awarded in class action lawsuits based on drugs that had unanticipated side effects. A successful product liability claim or series of claims brought against us, particularly if judgments exceed our insurance coverage, could decrease our cash and adversely affect our business.

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Our operations involve hazardous materials, which could subject us to significant liabilities.

        Our research and development processes involve the controlled use of hazardous materials, including chemicals. Our operations produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge or injury from these materials. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these materials. We could be subject to civil damages in the event of exposure of individuals to hazardous materials. In addition, claimants may sue us for injury or contamination that results from our use of these materials and our liability may exceed our total assets. We have general liability insurance coverage of up to $5.0 million per occurrence, with an annual aggregate limit of $6.0 million, which excludes pollution liability. This coverage may not be adequate to cover all claims related to our biological or hazardous materials. Furthermore, if we were to be held liable for a claim involving our biological or hazardous materials, this liability could exceed our insurance coverage, if any, and our other financial resources. Compliance with environmental and other laws and regulations may be expensive and current or future regulations may impair our research, development or production efforts.

        In addition, we may incur substantial costs in order to comply with current or future environmental, health and safety laws and regulations. These current or future laws and regulations may impair our research, development or production efforts. Failure to comply with these laws and regulations also may result in substantial fines, penalties or other sanctions.

Our insurance policies are expensive and protect us only from some business risks, which will leave us exposed to significant uninsured liabilities.

        We do not carry insurance for all categories of risk that our business may encounter. For example, we do not carry earthquake insurance. In the event of a major earthquake in our region, our business could suffer significant and uninsured damage and loss. Some of the policies we currently maintain include general liability, employment practices liability, property, auto, workers' compensation, products liability and directors' and officers' insurance. We do not know, however, if we will be able to maintain existing insurance with adequate levels of coverage. Any significant uninsured liability may require us to pay substantial amounts, which would adversely affect our cash position and results of operations.

Significant disruptions of information technology systems or breaches of data security could adversely affect our business.

        Our business is increasingly dependent on critical, complex and interdependent information technology systems, including Internet-based systems, to support business processes as well as internal and external communications. The size and complexity of our computer systems make them potentially vulnerable to breakdown, malicious intrusion and computer viruses that may result in the impairment of production and key business processes. In addition, our systems are potentially vulnerable to data security breaches—whether by employees or others—that may expose sensitive data to unauthorized persons. Such data security breaches could lead to the loss of trade secrets or other intellectual property, or could lead to the public exposure of personal information (including sensitive personal information) of our employees, clinical trial patients, potential customers and others. Such disruptions and breaches of security could have a material adverse effect on our business, financial condition and results of operations.

Risks Relating to Owning Our Common Stock

Ownership in our common stock is highly concentrated. Our executive officers, directors and principal stockholders have the ability to significantly influence all matters submitted to our stockholders for approval.

        As of February 15, 2014, our executive officers, directors and stockholders who own more than 5% of our outstanding common stock, together beneficially own shares representing approximately 43% of

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our common stock based on reports filed with the SEC. While this does not represent a majority of our outstanding common stock, if these stockholders were to choose to act together, they would be able to significantly influence all matters submitted to our stockholders for approval, as well as our management and affairs. For example, these persons, if they choose to act together, will significantly influence the election of directors and approval of any merger, consolidation, sale of all or substantially all of our assets or other business combination or reorganization. This concentration of voting power could delay or prevent an acquisition of us on terms that other stockholders may desire. The interests of this group of stockholders may not always coincide with your interests or the interests of other stockholders and they may act in a manner that advances their best interests and not necessarily those of other stockholders, including seeking a premium value for their common stock, and might affect the prevailing market price for our common stock.

If we raise additional capital by issuing securities in the future, such as under our existing equity distribution agreement, it will cause dilution to existing stockholders and may cause our share price to decline.

        We may raise additional funds through the issuance and sale of additional shares of our common stock or other securities convertible into or exchangeable for our common stock. For example, in January 2013, we entered into an equity distribution agreement with Wedbush Securities Inc. (Wedbush) pursuant to which we may issue and sell shares of our common stock having an aggregate offering price up to $25.0 million, from time to time. The number of shares ultimately offered for sale by Wedbush is dependent upon the number of shares that we elect to sell through Wedbush under the agreement. Depending upon market liquidity at the time, sales of shares of our common stock through Wedbush under the agreement may cause the trading price of our common stock to decline.

        Additionally, and separate from our equity securities agreement with Wedbush, in April 2013 and May 2013, we sold shares of our common stock for net proceeds of approximately $5.0 million and $21.3 million, respectively. To the extent that we raise additional capital by issuing equity securities under the agreement with Wedbush or otherwise, our stockholders will experience additional dilution, and any such issuances may result in downward pressure on the price of our common stock.

Sales of our common stock in the "at-the-market" offering, or the perception that such sales may occur, could cause the market price of our common stock to fall.

        We may issue shares of our common stock with aggregate sales proceeds of up to $25.0 million from time to time in connection with the "at-the-market" offering. Through December 31, 2013, we sold shares of our common stock for net proceeds of approximately $1.3 million and currently have approximately $23.6 million potentially remaining available for sale under our "at-the-market" offering and the issuance from time to time of these new shares of common stock, or our ability to issue these new shares of common stock in this offering, could have the effect of depressing the market price for our common stock.

We do not anticipate paying cash dividends, and accordingly, stockholders must rely on stock appreciation for any return on their investment.

        We do not anticipate paying cash dividends in the future. As a result, only appreciation of the price of our common stock, which may never occur, will provide a return to stockholders. Investors seeking cash dividends should not invest in our common stock. In addition, our ability to pay cash dividends is currently prohibited by the terms of our loan and security agreement with Hercules.

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Our share price may be volatile and could decline significantly.

        The market price of shares of our common stock could be subject to wide fluctuations in response to many risk factors listed in this section, and others beyond our control, including:

    announcement of FDA approvability, approval or non-approval of tavaborole or our other product candidates, and the timing of the FDA review process;

    actions taken by regulatory agencies with respect to products or drug classes related to tavaborole or our product candidates;

    problems in our manufacturing or supply chain that limit or exhaust the quantity of supplies of tavaborole or other product candidates that are available to patients;

    changes in the structure of healthcare payment systems;

    results or delays of our clinical trials;

    results of clinical trials of our competitors' products;

    regulatory actions with respect to our products or our competitors' products;

    actual or anticipated fluctuations in our financial condition and operating results;

    actual or anticipated changes in our product sales growth rates relative to those of our competitors;

    actual or anticipated fluctuations in our competitors' operating results or changes in their product sales growth rates;

    competition from existing products or new products that may emerge;

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

    issuance of new or updated research or reports by securities analysts;

    fluctuations in the valuation of companies perceived by investors to be comparable to us;

    share price and volume fluctuations attributable to inconsistent trading volume levels of our shares;

    additions or departures of key management or scientific personnel;

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

    announcement or expectation of additional financing efforts;

    sales of our common stock by us, our insiders or our other stockholders;

    market conditions for biopharmaceutical stocks in general; and

    general economic and market conditions.

        Furthermore, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions such as recessions, interest rate changes or international currency fluctuations, may negatively impact the market price of shares of our common stock. You may not realize any return on an investment in us and may lose some or all of your investment.

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We may be subject to securities litigation, which is expensive and could divert management attention.

        Our share price may be volatile, and in the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management's attention from other business concerns, which could seriously harm our business.

A significant portion of our total outstanding shares of common stock is subject to demand registration rights, which could require us to register such shares for public sale at the holders' option.

        Holders of shares of our common stock who are party to an investors' rights agreement and a registration rights agreement with us have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders.

As a public company, we are subject to additional expenses and administrative burden.

        As a public company, we incur significant legal, accounting and other expenses and our administrative staff is required to perform additional tasks, such as adopting additional internal controls, disclosure controls and procedures, retaining a transfer agent and bearing all of the internal and external costs of preparing and distributing periodic public reports in compliance with our obligations under the securities laws.

        In addition, changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act and related regulations implemented by the Securities and Exchange Commission and The NASDAQ Global Market, are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. We are currently evaluating and monitoring these rules and proposed changes to rules, and cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment will result in increased general and administrative expenses and may divert management's time and attention from product development activities. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and our business may be harmed. In the future, it may be more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These factors could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee and compensation committee, and qualified executive officers.

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

        Provisions in our amended and restated certificate of incorporation and our bylaws may delay or prevent an acquisition of us. 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, who are responsible for appointing the members of our

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management team. In addition, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits, with some exceptions, stockholders owning in excess of 15% of our outstanding voting stock from merging or combining with us. Finally, our charter documents establish advance notice requirements for nominations for election to our board of directors and for proposing matters that can be acted upon at stockholder meetings. Although we believe these provisions together 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.

If we commit certain material breaches under the research agreement with the Gates Foundation, and fail to cure them, we may be required to redeem shares of our common stock held by the Gates Foundation and its affiliates.

        In the event of termination of the research agreement by the Gates Foundation for certain specified uncured material breaches by us, we will be obligated, among other remedies, to repurchase the $5 million in common stock purchased by the Gates Foundation in connection with the research agreement, facilitate the purchase of such common stock by a third party or elect to register the resale of such common stock into the public markets unless certain specified conditions are satisfied. If we are required to repurchase such shares of common stock, our financial condition could be materially and adversely affected.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

        None.

ITEM 2.    PROPERTIES

        We lease a 36,960 square-foot building consisting of office and laboratory space in Palo Alto, California, which serves as our corporate headquarters. The lease term commenced in March 2008 and has scheduled annual rent increases through the lease expiration in March 2018. In May 2013, we amended the lease to grant the landlord a right to terminate the lease as early as June 2016, with twelve months' written notice. As consideration for entering into the amendment, we received a rent credit of $0.7 million, which was applied to the monthly base rent under the original lease commencing June 1, 2013 and continued for each successive month until the full amount of the rent credit was applied in November 2013.

        We also have a lease for a 15,300 square-foot building consisting of office and laboratory space in Palo Alto, California, which we extended through December 2014, and have one (1) one-year option to extend the lease through 2015. This lease is cancelable with four months' notice. We believe that the facilities that we currently lease are adequate for our needs for the immediate future and that, should it be needed, additional space can be leased to accommodate any future growth.

ITEM 3.    LEGAL PROCEEDINGS

        On October 24, 2012, we provided notice to Valeant Pharmaceuticals International, Inc. ((Valeant), successor in interest to Dow Pharmaceutical Sciences, Inc. (DPS)) seeking to commence arbitration before JAMS of a breach of contract dispute under a master services agreement dated March 26, 2004 between DPS and us related to certain development services provided by DPS in connection with our efforts to develop our topical antifungal product candidate for the treatment of onychomycosis. Our assertions included breach of contract, breach of implied covenant of good faith and fair dealing, misappropriation of trade secrets and unfair competition. We were seeking injunctive relief and damages of at least $215.0 million. The final hearing was held in September 2013 and, on October 17,

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2013, the arbitrator issued an Interim Final Award in our favor for $100.0 million in damages as well as all costs of the arbitration and reasonable attorney's fees.

        On November 28, 2012, we filed an arbitration demand before JAMS alleging breach of contract by Medicis Pharmaceutical Corporation (Medicis) under the February 9, 2011 research and development option and license agreement between Medicis and us (the Medicis Agreement) and seeking damages in the form of payment for the achievement of certain preclinical milestones under that agreement. On December 11, 2012, Medicis filed a complaint for breach of the Medicis Agreement and a motion for preliminary injunction in the Delaware Court of Chancery seeking to enjoin us from prosecuting our claims through arbitration and to require us to continue to use diligent efforts to conduct research and development under the Medicis Agreement. Medicis was acquired by Valeant in December 2012. On January 16, 2013, we filed a motion requesting that the Delaware Court of Chancery dismiss the Medicis suit and send the dispute back to arbitration. On February 15, 2013, Medicis filed a brief in opposition to our motion to dismiss in favor of arbitration. On March 4, 2013, we filed a reply brief in support of our motion to dismiss. On August 12, 2013, following completion of the oral arguments on the motion to dismiss, we received a ruling on the motion to dismiss that the matter should not be limited to arbitration as the proceeding for resolution of the dispute. On October 11, 2013, the parties filed a stipulation with the Delaware Court of Chancery which permitted Medicis to file an amended complaint.

        On October 27, 2013, we entered into a settlement agreement with Valeant and DPS pursuant to which Valeant agreed to pay us $142.5 million to settle all existing and future claims, including damages awarded in the October 17, 2013 arbitration ruling, and all other disputes between Valeant, DPS and us related to our intellectual property, confidential information and contractual rights. Under the settlement agreement, we agreed to provide Valeant a paid-up, irrevocable, non-exclusive, worldwide license to all patents that contain claims covering efinaconazole. In addition, the settlement agreement provided that both we and Valeant would withdraw all claims and complaints relating to arbitration or litigation in connection with the Medicis Agreement, that the Medicis Agreement would be terminated effective October 27, 2013 and that all rights and intellectual property under the Medicis Agreement would revert back to us. Valeant made the $142.5 million payment to us on November 7, 2013.

        We are not a party to any material legal proceedings at this time. From time to time, we may be involved in litigation relating to claims arising out of our ordinary course of business.

ITEM 4.    MINE SAFETY DISCLOSURES

        None.

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PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

PRICE RANGE OF COMMON STOCK

        Our common stock began trading on the NASDAQ Global Market under the symbol "ANAC" on November 24, 2010. Prior to this date, there was no public market for our common stock. The following table sets forth the high and low closing prices of our common stock for the period indicated as reported on the NASDAQ Global Market.

 
  High   Low  

2013

             

4th Quarter

  $ 17.53   $ 10.66  

3rd Quarter

    10.82     5.41  

2nd Quarter

    8.02     4.99  

1st Quarter

    6.52     3.15  

2012

             

4th Quarter

  $ 6.81   $ 4.60  

3rd Quarter

    6.83     5.63  

2nd Quarter

    6.49     4.60  

1st Quarter

    7.42     5.31  

        The closing price for our common stock as reported by The NASDAQ Global Market on March 10, 2014 was $20.28 per share.

        As of March 10, 2014, there were 41,838,760 shares of our common stock issued and outstanding with approximately 54 stockholders of record. A significantly larger number of stockholders may be in "street name" or beneficial holders, whose shares of record are held by banks, brokers and other financial institutions. The number of record holders does not include shares held in "street name" through brokers.


STOCK PRICE PERFORMANCE GRAPH

        The following stock performance graph compares our total stock return with the total return for (i) the NASDAQ Composite Index and the (ii) the NASDAQ Biotechnology Index for the period from November 24, 2010 (the date our common stock commenced trading on the NASDAQ Global Market) through December 31, 2013. The figures represented below assume an investment of $100 in our common stock at the closing price of $5.09 on November 24, 2010 and in the NASDAQ Composite Index and the NASDAQ Biotechnology Index on November 24, 2010 and the reinvestment of dividends into shares of common stock. The comparisons in the table are required by the Securities and Exchange Commission (SEC) and are not intended to forecast or be indicative of possible future performance of our common stock. This graph shall not be deemed "soliciting material" or be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any of our filings under the Securities Act of 1933, as amended, or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

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Stock Price Performance Graph

GRAPHIC

$100 investment in
stock or index
  Ticker   November 24,
2010
  December 31,
2010
  March 31,
2011
  June 30,
2011
  September 30,
2011
  December 31,
2011
   
   
 

Anacor

    ANAC   $ 100.00   $ 105.50   $ 135.95   $ 126.92   $ 111.98   $ 121.81              

NASDAQ Composite Index

    IXIC   $ 100.00   $ 104.32   $ 109.36   $ 109.06   $ 94.98   $ 102.44              

NASDAQ Biotechnology Index

    NBI   $ 100.00   $ 104.51   $ 112.12   $ 119.40   $ 104.45   $ 116.85              

 

$100 investment in
stock or index
 
Ticker
 
March 31,
2012
 
June 30,
2012
 
September 30,
2012
 
December 31,
2012
 
March 31,
2013
 
June 30,
2013
 
September 30,
2013
 
December 31,
2012
 

Anacor

    ANAC   $ 115.72   $ 127.50   $ 129.27   $ 102.16   $ 126.92   $ 109.82   $ 208.64   $ 329.67  

NASDAQ Composite Index

    IXIC   $ 121.57   $ 115.41   $ 122.54   $ 118.73   $ 128.48   $ 133.82   $ 148.30   $ 164.23  

NASDAQ Biotechnology Index

    NBI   $ 138.00   $ 145.60   $ 160.09   $ 154.13   $ 179.81   $ 195.31   $ 235.79   $ 255.24  


DIVIDEND POLICY

        We have never declared or paid any cash dividends. We currently expect to retain earnings for use in the operation and expansion of our business, and therefore do not anticipate paying any cash dividends in the foreseeable future. In addition, our ability to pay cash dividends is currently prohibited by the terms of our loan and security agreement with Hercules Technology Growth Capital, as a lender and as the collateral agent for Hercules Technology III, L.P., also a lender.


RECENT SALE OF UNREGISTERED SECURITIES

        None.

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ITEM 6.    SELECTED FINANCIAL DATA

        The data in the tables below should be read together with our financial statements and accompanying notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this Annual Report on Form 10-K. The selected financial data in this section is not intended to replace our financial statements and the accompanying notes. Our historical results are not necessarily indicative of our future results.

        The statements of operations data for 2013, 2012 and 2011 and the balance sheet data as of December 31, 2013 and 2012 were derived from our audited financial statements appearing elsewhere in this Annual Report on Form 10-K. The statements of operations data for 2010 and 2009 and the

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balance sheet data as of December 31, 2011, 2010 and 2009 were derived from our audited financial statements that are not included in this Annual Report on Form 10-K.

 
  Year Ended December 31,  
 
  2013   2012   2011   2010   2009  
 
  (in thousands, except share and per share data)
 

Statement of Operations Data:

                               

Revenues:

                               

Contract revenue

  $ 17,228   $ 10,740   $ 20,306   $ 26,357   $ 18,643  

Government contract and grant revenue

                1,467      
                       

Total revenues

    17,228     10,740     20,306     27,824     18,643  

Operating (income) expense:

                               

Research and development(1)

    46,561     52,318     56,097     29,866     34,083  

General and administrative(1)

    20,650     11,614     10,552     7,452     7,054  

Litigation settlement gain

    (142,500 )                
                       

Total operating (income) expenses

    (75,289 )   63,932     66,649     37,318     41,137  
                       

Income (loss) from operations

    92,517     (53,192 )   (46,343 )   (9,494 )   (22,494 )

Interest income

    55     72     148     25     154  

Interest expense

    (4,051 )   (2,914 )   (1,396 )   (2,005 )   (2,434 )

Loss on early extinguishment of debt

    (1,381 )       (313 )        

Other income (expense)

    (669 )   (53 )   (40 )   1,416     (80 )
                       

Income (loss) before income tax expense (benefit)

    86,471     (56,087 )   (47,944 )   (10,058 )   (24,854 )

Provision for (benefit of) income taxes

    1,706                 (15 )
                       

Net income (loss)

  $ 84,765   $ (56,087 ) $ (47,944 ) $ (10,058 ) $ (24,839 )
                       
                       

Net income (loss) per common share—basic

  $ 2.16   $ (1.76 ) $ (1.71 ) $ (2.71 ) $ (17.55 )
                       
                       

Net income (loss) per common share—diluted

  $ 2.10   $ (1.76 ) $ (1.71 ) $ (2.71 ) $ (17.55 )
                       
                       

Weighted-average number of common shares used in calculating net income (loss) per common share—basic(2)

    39,178,289     31,901,966     28,109,302     3,705,505     1,415,083  
                       
                       

Weighted-average number of common shares used in calculating net income (loss) per common share—diluted(2)

    40,320,187     31,901,966     28,109,302     3,705,505     1,415,083  
                       
                       

(1)
Includes the following noncash, stock-based compensation expense:

Research and development

  $ 2,770   $ 1,973   $ 2,594   $ 1,631   $ 1,557  

General and administrative

    1,963     1,629     1,810     1,155     893  
(2)
Please see Note 2 to our audited financial statements for an explanation of the method used to calculate basic and diluted net income (loss) per common share and the number of shares used in the computation of the per share amounts. There is a lack of comparability in the per share amounts between the periods presented above. During the fourth quarter of 2010, we issued 12,000,000 shares of common stock sold in our initial public offering (IPO), 2,000,000 shares of common stock sold in a concurrent private placement and 1,382,651 shares of common stock sold

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    pursuant to an over-allotment option granted to the underwriters of our IPO. Also during that quarter, all convertible preferred stock shares outstanding were converted into 11,120,725 shares of common stock at the closing of our IPO.

 
  As of December 31,  
 
  2013   2012   2011   2010   2009  
 
  (in thousands)
 

Balance Sheet Data:

                               

Cash, cash equivalents and investments(1)

  $ 166,815   $ 45,713   $ 50,879   $ 78,788   $ 14,700  

Working capital

    139,185     23,902     32,020     66,687     3,633  

Total assets

    172,165     51,071     55,789     83,964     17,945  

Notes payable

    28,018     25,667     17,313     7,741     10,724  

Convertible preferred stock

                    87,473  

Redeemable common stock

    4,952                  

Accumulated deficit

    (130,446 )   (215,211 )   (159,124 )   (111,180 )   (101,122 )

Total stockholders' equity (deficit)

    121,432     4,811     13,899     56,393     (95,284 )

(1)
For the year ended December 31, 2013, includes short-term restricted investments of $1,475 and long-term restricted investments of $3,155. For the years ended December 31, 2009 through 2012, includes long-term restricted investments of $197.

ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        You should read the following discussion and analysis together with our financial statements and the notes to those statements included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. We use words such as "may," "will," "expect," "anticipate," "estimate," "intend," "plan," "predict," "potential," "believe," "should" and similar expressions to identify forward-looking statements. These statements appearing throughout this Annual Report on Form 10-K are statements regarding our intent, belief, or current expectations, primarily regarding our operations. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report on Form 10-K. As a result of many factors, such as those set forth under "Risk Factors" and elsewhere in this Annual Report on Form 10-K, our actual results may differ materially from those anticipated in these forward-looking statements.

Overview

        We are a biopharmaceutical company focused on discovering, developing and commercializing novel small-molecule therapeutics derived from our boron chemistry platform. The productivity of our internal discovery capability has enabled us to generate a pipeline of both topical and systemic boron-based compounds. We have discovered, synthesized and developed eight molecules that are currently in development.

        Our lead product candidates include two topically administered dermatologic compounds—tavaborole (formerly referred to as AN2690) and AN2728. Tavaborole is a topical treatment for onychomycosis, a fungal infection of the nail and nail bed. We filed a New Drug Application (NDA) for tavaborole in July 2013, which was accepted for review by the United States Food and Drug Administration (FDA) in October 2013 with a Prescription Drug User Fee Act (PDUFA) V goal date of July 29, 2014. AN2728 is our lead topical anti-inflammatory product candidate for the treatment of atopic dermatitis and psoriasis. We held an End of Phase 2 meeting with the FDA for AN2728 in atopic dermatitis in the first quarter of 2014 and expect to initiate Phase 3 studies in atopic dermatitis in the first half of 2014. In addition, we have three other wholly-owned clinical product candidates—AN2718 and AN2898, which are backup compounds to tavaborole and AN2728, respectively, and

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AN3365 (formerly referred to as GSK2251052, or GSK '052), an antibiotic for the treatment of infections caused by Gram-negative bacteria, which was previously licensed to GlaxoSmithKline, LLC (GSK). In October 2012, GSK advised us that it had discontinued further development of AN3365; substantially all rights to this compound reverted to us. We are currently considering our options for further development, if any, of this compound. We have also discovered three other compounds that we have out-licensed for further development—one is licensed to Eli Lilly and Company (Lilly) for the treatment of an animal health indication, a second compound, AN5568, also referred to as SCYX-7158, is licensed to Drugs for Neglected Diseases initiative (DNDi) for human African trypanosomiasis (HAT, or sleeping sickness) and a third compound is licensed to GSK for development in tuberculosis (TB). We also have a pipeline of other internally discovered topical and systemic boron-based compounds in earlier stages of research and pre-clinical development.

        In October 2007, we entered into a research and development collaboration, option and license agreement with GSK for the discovery, development and worldwide commercialization of boron-based systemic anti-infectives. In September 2011, we amended and expanded the GSK agreement to, among other things, add a new research program using our boron chemistry platform for TB. In September 2013, GSK selected a compound for further development in TB and will be responsible for all further development and commercialization of this compound.

        In August 2010, we entered into a four-year research, license and commercialization agreement with Lilly, under which we collaborated to discover products for a variety of animal health applications. Pursuant to this agreement, Lilly selected the first development compound for an animal health indication in August 2011 and, in December 2012, they selected a second development compound for another animal health indication. In September 2013, Lilly notified us that it was ceasing further development of the first compound; Lilly has granted us a fully paid, sublicenseable, perpetual, irrevocable, exclusive license to the related technology and patents. Lilly will be responsible for all further development and commercialization of the second compound. In January 2014, Lilly notified us of the termination of the research term in March 2014 which is five months earlier than the latest date contemplated in the agreement. The remainder of the agreement, including provisions related to potential future payments and royalties, remains in effect and Lilly retained its exclusive rights to the development of the compound selected.

        In February 2011, we entered into a research and development option and license agreement with Medicis Pharmaceutical Corporation (Medicis) to discover and develop compounds directed against a target for the potential treatment of acne (the Medicis Agreement). On November 28, 2012, we filed for arbitration for breach of contract by Medicis seeking damages in the form of payment for the achievement of certain preclinical milestones under the collaboration. On December 11, 2012, Medicis filed a complaint for breach of the collaboration and a motion for preliminary injunction seeking to enjoin us from prosecuting our claims through arbitration and to require us to continue to use diligent efforts to conduct research and development under the agreement. Medicis was acquired by Valeant Pharmaceuticals International, Inc. (Valeant) in December 2012. On October 27, 2013, as part of a settlement with Valeant related to arbitration on an unrelated matter, we and Valeant agreed to withdraw all claims and complaints relating to arbitration or litigation in connection with the Medicis Agreement, to terminate the Medicis Agreement effective October 27, 2013 and to cause all rights and intellectual property under the Medicis Agreement to revert back to us.

        In April 2013, we entered into a research agreement with the Bill & Melinda Gates Foundation (the Gates Foundation) to discover drug candidates intended to treat two filarial worm diseases (onchocerciasis, or river blindness, and lymphatic filariasis, commonly known as elephantiasis) and TB. Under the agreement, the Gates Foundation will pay us up to $17.7 million over a three-year research term to conduct research activities directed at discovering potential neglected disease drug candidates in accordance with an agreed upon research plan. As part of the funded research activities, we are responsible for creating an expanded library of boron compounds to screen for additional potential

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drug candidates to treat neglected diseases, which will be accessible to the Gates Foundation and other third parties. Under the terms of the agreement, the Gates Foundation will have the exclusive right to commercialize selected drug candidates in specified neglected diseases in specified developing countries. We retain the exclusive right to commercialize any selected drug candidate outside of the specified neglected diseases as well as with respect to the specified neglected diseases in specified developed countries and would be obligated to pay the Gates Foundation royalties on specified license revenue received. The agreement will continue in effect until the later of five years from the effective date or the expiration of our specified obligation to provide access to the expanded library compounds.

        In connection with the Gates Foundation agreement, we issued 809,061 shares of unregistered common stock at a purchase price of $6.18 per share for aggregate gross proceeds of $5.0 million. The shares were subsequently registered with the Securities and Exchange Commission (SEC) under a Form S-3 filed on June 28, 2013, which became effective on July 11, 2013. In the event of termination of the agreement by the Gates Foundation for certain specified uncured material breaches by us, we will be obligated, among other remedies, to either redeem our common stock purchased in connection with the agreement, facilitate the purchase of such common stock by a third party or elect to register the resale of such common stock into the public markets unless certain specified conditions are satisfied. In addition, the Gates Foundation agreement places certain restrictions on our use of the research funding and the redeemable common stock proceeds we receive from the Gates Foundation.

        On October 16, 2013, we entered into a research agreement with the United States Department of Defense, Defense Threat Reduction Agency (DTRA) to design and discover new classes of systemic antibiotics. A drug discovery consortium formed by Colorado State University, the University of California at Berkeley and us will conduct the research over a three and a half year period. The work is funded by a $13.5 million award from DTRA's R&D Innovation and Systems Engineering Office, which was established to search for and execute strategic investments in innovative technologies for combating weapons of mass destruction. Under this award, we will apply our boron chemistry to discover rationally designed novel antibiotics that target DTRA-priority pathogens known to exhibit resistance to existing antibiotics. The $13.5 million award is available to the consortium to fund $2.7 million of research reimbursements for the eleven month period through September 30, 2014, and an additional $5.0 million and $5.7 million will become available upon DTRA exercising their options to fund the subsequent twelve and nineteen month periods, respectively.

        We also have several collaborations with organizations that fund research leveraging our boron chemistry to discover new treatments for neglected diseases. In addition to potentially developing new therapies for such diseases, these collaborations provide us the potential benefits of expanding the chemical diversity of our boron compounds, understanding new properties of our boron compounds, receiving future incentives, such as the potential grant of a priority review voucher by the FDA, and ultimately, if a drug is approved, potential revenue in some regions. Our collaboration partners include DNDi to develop new therapeutics for sleeping sickness, visceral leishmaniasis and Chagas disease, MMV to develop compounds for the treatment of malaria, the Global Alliance for Livestock Veterinary Medicines (GALVMed) for the treatment of sleeping sickness and the Liverpool School of Tropical Medicine for the treatment of river blindness and lymphatic filariasis. In 2011, DNDi completed pre-clinical studies of AN5568 for sleeping sickness and, in March 2012, AN5568 became the first compound from our neglected diseases initiatives to enter human clinical trials.

        In December 2012, we filed a shelf registration statement on Form S-3 with the SEC. The shelf registration was declared effective by the SEC and permits us to sell, from time to time, up to $75.0 million of common stock, preferred stock, debt securities and warrants.

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        In January 2013, we entered into an equity distribution agreement with Wedbush Securities Inc. (Wedbush) under which we may, from time to time, offer and sell common stock having aggregate sales proceeds of up to $25.0 million through Wedbush, or to Wedbush, for resale. Sales of our common stock through Wedbush will be made by means of ordinary brokers' transactions on The NASDAQ Global Market or otherwise at market prices prevailing at the time of sale, in block transactions or as otherwise agreed upon by us and Wedbush and may be made in sales deemed to be "at-the-market" equity offerings. We will pay Wedbush a commission, or allow a discount, as the case may be, in each case equal to 2.0% of the gross sales proceeds of any common stock sold through Wedbush as agent under this agreement. We have also agreed to reimburse Wedbush for certain expenses up to an aggregate of $150,000, of which $45,000 has been incurred through December 31, 2013. Under the terms of this agreement, we also may sell our common stock to Wedbush, as principal for its own account, at a price to be agreed upon at the time of sale. Through December 31, 2013, we have sold 401,500 shares of our common stock under this agreement. The net proceeds from these sales were approximately $1.3 million, after deducting the underwriting discount and other offering costs, and we may sell up to an additional $23.6 million in authorized but unsold shares of our common stock under this agreement.

        In May 2013, we issued and sold 3,599,373 shares of our common stock, including 469,483 shares issuable to the underwriters pursuant to the overallotment option, in connection with an underwriting agreement with Cowen and Company, LLC, as representative of the several underwriters. The price to the public in this offering was $6.39 per share, for gross proceeds of approximately $23.0 million, and the underwriters purchased the shares from us at a price of $6.0066 per share. Our net proceeds from this offering were approximately $21.3 million, after deducting the underwriting discount and other offering costs.

        In June 2013, we entered into a loan and security agreement (Loan Agreement) with Hercules Technology Growth Capital, Inc. as collateral agent and a lender and Hercules Technology III, L.P. as a lender, (together, Hercules), under which we were able to borrow up to $45.0 million. The first $30.0 million tranche was drawn at the closing of the transaction, at which time we repaid $22.6 million in remaining obligations associated with our previous loan. Subject to the terms and conditions of the Loan Agreement, the second tranche of up to $10.0 million was available to us at our discretion, and the third tranche is available to us upon confirmation of the FDA approval of the tavaborole NDA. We elected not to draw the second tranche of $10.0 million and the option to do so expired on December 5, 2013. The third tranche of $5.0 million will be available for drawdown through the earlier to occur of December 15, 2014 or 30 days after the FDA approval of tavaborole. We expect to use the remainder of the proceeds from the first tranche to fund development and commercialization activities related to our product candidates.

        In August 2013, we filed an additional shelf registration statement on Form S-3 with the SEC. The shelf registration was declared effective by the SEC and permits us to sell, from time to time, up to $50.0 million of common stock, preferred stock, debt securities and warrants.

        On October 24, 2012, we provided notice to Valeant, successor in interest to Dow Pharmaceutical Sciences, Inc. (DPS) seeking to commence arbitration before JAMS of a breach of contract dispute under a master services agreement dated March 26, 2004 between DPS and us related to certain development services provided by DPS in connection with our efforts to develop a topical antifungal product candidate for the treatment of onychomycosis. Our assertions included breach of contract, breach of implied covenant of good faith and fair dealing, misappropriation of trade secrets and unfair competition. The final hearing was held in September 2013 and, on October 17, 2013, the arbitrator issued an Interim Final Award in our favor for $100.0 million in damages as well as all costs of the arbitration and reasonable attorney's fees. On October 27, 2013, we entered into a settlement agreement with Valeant and DPS pursuant to which Valeant agreed to pay us $142.5 million to settle all existing and future claims, including damages awarded in the October 17, 2013 arbitration ruling,

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and all other disputes between Valeant, DPS and us related to our intellectual property, confidential information and contractual rights. Under the settlement agreement, we provided Valeant with a paid-up, irrevocable, non-exclusive, worldwide license to all patents that contain claims covering efinaconazole, Valeant's topical antifungal product candidate for the treatment of onychomycosis. In addition, the settlement agreement provided that both we and Valeant would withdraw all claims and complaints relating to arbitration or litigation in connection with the Medicis Agreement, that the Medicis Agreement would be terminated effective October 27, 2013 and that all rights and intellectual property under the Medicis Agreement revert back to us. We received the $142.5 million payment from Valeant on November 7, 2013.

        We began business operations in March 2002. To date, we have not generated any revenue from product sales. As of December 31, 2013, we have an accumulated deficit of $130.4 million. We have funded our operations primarily through the sale of equity securities, payments received under our agreements with Schering Corporation (Schering), GSK, Lilly, Medicis and the Gates Foundation, government contracts and grants, contracts with not-for-profit organizations for neglected diseases, borrowings under debt arrangements and our settlement with Valeant. We expect to incur operating losses in future years as we continue to develop our drug candidates, expand clinical trials for AN2728 and begin commercialization activities in anticipation of FDA approval of tavaborole. The size of our future operating losses will depend, in part, on the rate of growth of our expenses, our ability to enter into additional licensing, research and development agreements and future payments earned under our agreements with GSK, Lilly, the Gates Foundation, DTRA or any such future collaboration partners or research funding providers and our ability to successfully commercialize tavaborole and our other product candidates. Our intent is to enter into additional licensing and development agreements to further develop certain of our product candidates and to fund other areas of our research. If the GSK, Gates Foundation or DTRA agreements are terminated or we are unable to enter into other collaboration or research funding agreements, we may incur additional operating losses and our ability to expand and continue our research and development activities and move our product candidates into later stages of development may be limited. Management believes that we currently have sufficient capital resources to fund our operations for at least the next twelve months.

Financial Operations Overview

Revenues

        Our recent revenues are comprised primarily of collaboration agreement-related revenues and government contract revenues. Collaboration agreement-related revenues have included license fees, development reimbursements and development milestone fees. In addition, we received an amendment fee in 2011 in connection with the modification of our research and development collaboration with GSK (the Amendment Fee). Government contract revenues have included cost plus fixed fee reimbursements for allowable costs.

Research and Development Expenses

        Research and development expenses consist primarily of costs associated with research activities, as well as costs associated with our product development efforts, including preclinical studies and clinical trials. Research and development expenses, including those paid to third parties, are recognized as incurred. Research and development expenses include:

    external research and development expenses incurred pursuant to agreements with third-party manufacturing organizations, contract research organizations and investigational sites;

    employee and consultant-related expenses, which include salaries, benefits, stock-based compensation and consulting fees;

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    third-party supplier expenses; and

    facilities, depreciation and other allocated expenses, which include direct and allocated expenses for rent and maintenance of facilities, amortization or depreciation of leasehold improvements, equipment and laboratory supplies and other expenses.

        Our expenses associated with preclinical studies and clinical trials are based upon the terms of the service contracts, the amount of the services provided and the status of the related activities. We expect that research and development expenses will increase in the future as we progress AN2728 through Phase 3 clinical trials, conduct our research and development activities under our agreements with the Gates Foundation, DTRA and various current and potential collaborations, including those related to our neglected diseases initiatives, advance our discovery research projects into the preclinical stage and continue our early-stage research.

        The table below sets forth our research and development expenses for 2013, 2012 and 2011, and for the period from January 1, 2004 through December 31, 2013, for three of our clinical-stage product candidates, other work conducted under the GSK agreement, work on our Lilly and Gates collaborations and work on neglected diseases and other programs, including programs that are currently inactive. Prior to January 1, 2004, we did not separately record expenses for tavaborole or any other product candidates due to the early stage of their development. A portion of our research and development costs, including indirect costs relating to our product candidates, are not recorded on a program-by-program basis and are allocated based on the personnel resources assigned to each program.

 
   
   
   
  Total from
January 1,
2004 to
December 31,
2013
 
 
  Year Ended December 31,  
 
  2013   2012   2011  
 
  (in thousands)
 

Tavaborole, including NIH grant expenses

  $ 15,279   $ 25,912   $ 22,111   $ 95,475  

AN2728

    15,862     12,415     14,715     63,784  

AN3365 (previously GSK '052)

    250     543     149     14,290  

GSK programs

    1,433     1,427     744     40,327  

Lilly programs

    3,656     3,591     3,048     11,495  

Gates Foundation programs

    5,085             5,085  

Neglected diseases

    3,146     4,418     5,138     17,020  

Other programs

    1,850     4,012     10,192     73,472  
                   

Total research and development expenses

  $ 46,561   $ 52,318   $ 56,097   $ 320,948  
                   
                   

        We expect our research and development expenses for tavaborole to decrease in the near future due to the completion of our tavaborole clinical activities and the filing of our NDA in mid-2013. We expect costs associated with AN2728 to increase as we expand the clinical and preclinical activities for this program. In October 2012, GSK advised us that it had discontinued further development of AN3365 and all rights to this compound reverted to us. We are currently considering our options for further development, if any, of this compound. GSK has selected a compound for further development in our GSK TB program and we expect our future expenses for this program will be reduced. In January 2014, Lilly notified us of the termination of the research term of the contract and, accordingly, our research expenses for Lilly programs will decrease in the near future. For our Gates Foundation programs and our new DTRA contract, expenses should increase due to our contractual obligations under the related agreements. In addition, spending for our early-stage research programs will be dependent upon our success in developing and advancing new product candidates for these programs.

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        We cannot determine with certainty the duration and completion costs of the current or future clinical trials of our product candidates or if, when or to what extent we will generate revenues from the commercialization and sale of any of our product candidates. We or our collaboration partners may never succeed in achieving marketing approval for any of our product candidates. The duration, costs and timing of clinical trials and development of our product candidates will depend on a variety of factors, including the uncertainties of future clinical and preclinical studies, uncertainties in clinical trial enrollment rates and significant and changing government regulation and whether our current or future collaborators are committed to, and make progress in, programs licensed to them. In addition, the probability of success for each product candidate will depend on numerous factors, including competition, manufacturing capability and commercial viability. Consequently, we are unable to provide a meaningful estimate of the period in which material cash inflows will be received. We will determine which programs to pursue and how much to fund each program in response to the scientific and clinical success of each product candidate, as well as an assessment of each product candidate's commercial potential. Our strategy includes entering into additional collaborations with third parties for the development and commercialization of some of our product candidates. To the extent that such third parties have control over preclinical development or clinical trials for some of our product candidates, we will be dependent upon their efforts for the progress of such product candidates. We cannot forecast with any degree of certainty which of our product candidates, if any, will be subject to future collaborations or how such arrangements would affect our development plans or capital requirements.

General and Administrative Expenses

        General and administrative expenses consist primarily of salaries and related costs for our personnel, including stock-based compensation and travel expenses, in executive, finance, business development and other administrative functions. Other general and administrative expenses include facility-related costs not otherwise included in research and development expenses, consulting costs associated with financial services, professional fees for legal services, including patent-related services, marketing expenses and auditing and tax services. We expect that general and administrative expenses will increase in the future as we expand our operating activities, initiate our sales and marketing activities for tavaborole, hire additional staff and incur additional costs associated with operating as a public company.

Critical Accounting Policies and Significant Judgments and Estimates

        Our management's discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments related to revenue recognition, preclinical study and clinical trial accruals, accrued compensation, deferred advance payments and stock-based compensation. We base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances and review our estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.

        While our significant accounting policies are described in more detail in Note 2 of our financial statements included in this Annual Report on Form 10-K, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements.

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Revenue Recognition

        Our contract revenues are generated primarily through research and development collaboration agreements, which typically may include non-refundable, non-creditable upfront fees, funding for research and development efforts, payments for achievement of specified development, regulatory and sales goals and royalties on product sales of licensed products.

        For multiple element arrangements, we evaluate the components of each arrangement as separate elements based on certain criteria. Where multiple deliverables are combined as a single unit of accounting, revenues are recognized based on the performance requirements of the agreements. We recognize revenue when persuasive evidence of an arrangement exists; transfer of technology has been completed, services are performed or products have been delivered; the fee is fixed or determinable; and collection is reasonably assured.

        For arrangements with multiple deliverables, we evaluate each deliverable to determine whether it qualifies as a separate unit of accounting. This determination is generally based on whether the deliverable has stand-alone value to the customer. The selling price used for each unit of accounting will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific nor third-party evidence is available. Our management may be required to exercise considerable judgment in determining whether a deliverable is a separate unit of accounting and in estimating the selling prices of identified units of accounting for new agreements.

        Upfront payments for licensing our intellectual property are evaluated to determine if the licensee can obtain stand-alone value from the license separate from the value of the research and development services to be provided by us. Typically, we have determined that the licenses we have granted to collaborators do not have stand-alone value separate from the value of the research and development services provided. As such, upfront payments are recorded as deferred revenue in the balance sheet and are recognized as contract revenue over the contractual or estimated performance period that is consistent with the term of the research and development obligations contained in the research and development collaboration agreement. When stand-alone value is identified, the related consideration is recorded as revenue in the period in which the license or other intellectual property rights are issued.

        Some arrangements involving the licensing of our intellectual property, the provision of research and development services or both may also include exclusivity clauses whereby we agree that, for a specified period of time, we will not conduct further research on licensed compounds or on compounds that would compete with licensed compounds or that we will do so only on a limited basis. Such provisions may also restrict the future development or commercialization of such compounds. We do not treat such exclusivity clauses as a separate element within an arrangement and any upfront payments received related to the exclusivity clause would be allocated to the identified elements in the arrangement and recognized as described in the preceding paragraph.

        Payments resulting from our efforts under research and development agreements or government grants are recognized as the activities are performed and are presented on a gross basis. Revenue is recorded gross because we act as a principal, with discretion to choose suppliers, bear credit risk and perform part of the services. The costs associated with these activities are reflected as a component of research and development expense in our statements of operations and approximate the revenues recognized from such activities.

        For certain contingent payments under research and development arrangements, we recognize revenue using the milestone method. Under the milestone method, a payment that is contingent upon the achievement of a substantive milestone is recognized in its entirety in the period in which the milestone is achieved. A milestone is an event (i) that can be achieved based in whole or in part on either our performance or on the occurrence of a specific outcome resulting from our performance,

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(ii) for which there is substantive uncertainty at the date the arrangement is entered into that the event will be achieved and (iii) that would result in additional payments being due to us. The determination that a milestone is substantive is judgmental and is made at the inception of the arrangement. Milestones are considered substantive when the consideration earned from the achievement of the milestone is (i) commensurate with either our performance to achieve the milestone or the enhancement of value of the item delivered as a result of a specific outcome resulting from our performance to achieve the milestone, (ii) relates solely to past performance and (iii) is reasonable relative to all deliverables and payment terms in the arrangement. In making the determination as to whether a milestone is substantive or not, we consider all facts and circumstances relevant to the arrangement, including factors such as the scientific, regulatory, commercial and other risks that must be overcome to achieve the respective milestone, the level of effort and investment required to achieve the respective milestone and whether any portion of the milestone consideration is related to future performance or deliverables.

        Other contingent payments received for which payment is either contingent solely upon the passage of time or the results of a collaboration partner's performance (bonus payments) are not accounted for using the milestone method. Such bonus payments will be recognized as revenue when earned and when collectibility is reasonably assured.

        Royalties based on reported sales of licensed products will be recognized based on contract terms when reported sales are reliably measurable and collectibility is reasonably assured. To date, none of our products have been approved and therefore we have not earned any royalty revenue from product sales.

Preclinical Study and Clinical Trial Accruals and Deferred Advance Payments

        We estimate preclinical study and clinical trial expenses based on the services performed pursuant to contracts with research institutions and clinical research organizations that conduct these activities on our behalf. In recording service fees, we estimate the time period over which the related services will be performed and compare the level of effort expended through the end of each period to the cumulative expenses recorded and payments made for such services and, as appropriate, accrue additional service fees or defer any non-refundable advance payments until the related services are performed. If the actual timing of the performance of services or the level of effort varies from our estimate, we will adjust our accrual or deferred advance payment accordingly. If we underestimate or overestimate the level of services performed or the costs of these services, our actual expenses could differ from our estimates. To date, we have not experienced significant changes in our estimates of preclinical study and clinical trial accruals.

Stock-Based Compensation

        Employee stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the employee's requisite service period (generally the vesting period). Stock option awards granted to our nonemployee directors for their board-related services are included in employee stock-based compensation in accordance with current accounting standards. We use the Black-Scholes option-pricing model to estimate the fair value of our stock-based awards and use the straight-line (single-option) method for expense attribution. We estimate forfeitures and recognize expense only for those shares expected to vest.

        We account for equity instruments issued to nonemployees based on their fair values on the measurement dates using the Black-Scholes option-pricing model. The fair values of the options granted to nonemployees are remeasured as they vest. As a result, the noncash charge to operations for nonemployee options with vesting is affected each reporting period by changes in the fair value of our common stock.

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        We recorded noncash stock-based compensation for employee and nonemployee stock option grants and ESPP stock purchase rights of $4.7 million, $3.6 million and $4.4 million during 2013, 2012 and 2011, respectively. As of December 31, 2013, we had outstanding options to purchase 4,493,912 shares of our common stock and had $8.3 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to outstanding stock options and $0.1 million related to ESPP stock purchase rights that will be recognized over weighted-average periods of 2.4 and 0.5 years, respectively. There were 95,373 common shares purchased under the ESPP for the year ended December 31, 2013. We expect to continue to grant stock options and ESPP stock purchase rights in the future, which will increase our stock-based compensation expense in future periods. If any of the assumptions used in the Black-Scholes model change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period.

Results of Operations

Comparison of Years Ended December 31, 2013 and 2012

 
  Year Ended December 31,  
 
  2013   2012   Increase/
(decrease)
 
 
  (in thousands)
 

Contract revenue

  $ 17,228   $ 10,740   $ 6,488  

Research and development expenses(1)

    46,561     52,318     (5,757 )

General and administrative expenses(1)

    20,650     11,614     9,036  

Litigation settlement gain

    142,500         142,500  

Interest income

    55     72     (17 )

Interest expense

    4,051     2,914     1,137  

Loss on early extinguishment of debt

    1,381         1,381  

Other expense

    669     53     616  

Provision for income taxes

    1,706         1,706  

(1)
Includes the following stock-based compensation expenses:

Research and development expenses

  $ 2,770   $ 1,973   $ 797  

General and administrative expenses

    1,963     1,629     334  

        Contract revenue.    For the year ended December 31, 2013, we recognized $4.5 million for research services performed under the Gates Foundation agreement, $0.2 million of which related to an aggregate of $0.8 million of reimbursements for services performed prior to the effective date of the agreement. We also recognized $3.2 million for research funding and $1.0 million of the $3.5 million upfront fee received under our collaboration with Lilly, $1.5 million for research funding and patent reimbursements under our collaboration agreement with GSK, $0.5 million under our research contract with DTRA and $1.8 million for research performed under our agreements with not-for-profit organizations for neglected diseases. In addition, we recognized $4.8 million of revenue remaining under our agreement with Medicis, which was previously classified as deferred revenue. For the year ended December 31, 2012, we recognized revenues of $3.4 million for research funding, $1.0 million for a development milestone earned and $0.9 million of the $3.5 million upfront fee received under the Lilly agreement, $1.2 million of the $7.0 million upfront fee received under the Medicis agreement and $1.3 million primarily for research funding under our collaboration agreement with GSK. We also recognized $2.9 million for research work performed under other research and development agreements, including our agreements with not-for-profit organizations for neglected diseases.

        Research and development expenses.    For the year ended December 31, 2013, research and development expenses decreased by $5.8 million as compared to the same period in the prior year.

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Although expenses for our tavaborole program decreased by $10.6 million during this period, this decrease was partially offset by an increase of $3.4 million in our AN2728 program expenses as compared with the prior year. As our tavaborole Phase 3 and cardiac safety clinical trials were completed in 2013, our costs for this program were lower than in 2012 when we were actively conducting two fully-enrolled Phase 3 trials, the cardiac safety trial and the repeat insult patch test (RIPT) study. Our NDA for tavaborole was filed in July 2013 and our consulting expenses increased in 2013 in comparison with 2012 as we prepared for the filing and potential launch of tavaborole in 2014. Our manufacturing costs also increased in 2013 compared to 2012 as a result of our increased regulatory and pre-commercialization efforts. The $3.4 million increase in AN2728 costs were mainly due to our increased clinical trial activity in 2013, partially offset by less extensive drug development activities for this product candidate as compared to the prior year. During 2013, we were actively conducting our Phase 1 MUSE and cardiac safety trials and planning for our Phase 3 and long-term safety trials, while during 2012, our AN2728 clinical trial activities were limited to planning for, and enrolling patients in, our less costly Phase 2 clinical trials. In 2013, our AN2728 drug development efforts included continuation of some preclinical studies initiated in the prior year and initial manufacturing activities in preparation for our Phase 3 and long-term safety trials and certain regulatory requirements, whereas in 2012 we were conducting multiple preclinical safety studies for AN2728 as well as manufacturing drug supplies for both our preclinical studies and our planned clinical trials.

        During 2013, our research and development expenses increased by $5.1 million and $0.5 million, respectively, as a result of new research activities under our Gates Foundation and DTRA programs. These increases were offset by a $2.0 million decrease in expenses due to the suspension of our research and development activities relating to our Medicis collaboration, a $0.1 million decrease in our research expenses under our collaboration with Lilly and a $2.3 million decrease in our spending on other research activities, including our neglected disease programs.

        General and administrative expenses.    The increase in general and administrative expenses of $9.0 million in 2013 compared to 2012 was primarily due to increases of $7.2 million in legal fees resulting primarily from our legal proceedings with Valeant and Medicis, $0.9 million related to marketing activities for tavaborole, $0.8 million in salaries and stock-based compensation.

        Litigation settlement gain.    In November 2013, we received a $142.5 million payment from Valeant to settle all existing and future claims, including damages awarded in the arbitration ruling, and all other disputes between Valeant, DPS and us related to our intellectual property, confidential information and contractual rights. This award also included approximately $8.1 million for legal fees incurred during the proceedings, the majority of which was incurred during the year ended December 31, 2013 and recorded in general and administrative expenses.

        Interest income.    The decrease in interest income for 2013 compared to 2012 was due to a lower yield partially offset by higher average investment balances.

        Interest expense.    Interest expense increased in 2013 compared to 2012 due to the higher outstanding balance of our debt.

        Loss on early extinguishment of debt.    Upon the early extinguishment of our debt with Oxford and Horizon in June 2013, we incurred a loss of $1.4 million, which consisted of the unaccrued balance of the final payment, the unamortized balances of the debt discount and deferred issuance costs and a prepayment penalty.

        Other expense.    Other expense increased in 2013 compared to 2012 due to higher amortization of deferred financing fees related to our expanded debt facility and the write-off of previously deferred financing costs related to our "at-the-market" equity offerings and a potential debt facility that was terminated.

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        Income tax provision.    The $1.7 million provision for income taxes for the year ended December 31, 2013 resulted solely from Federal alternative minimum taxes on the portion of our 2013 alternative minimum taxable income that could not be offset by prior years' alternative minimum tax loss carryforwards. We had alternative minimum taxable income in 2013 as a result of the income from the $142.5 million settlement with Valeant during the quarter ended December 31, 2013.

Comparison of Years Ended December 31, 2012 and 2011

 
  Year Ended December 31,  
 
  2012   2011   Increase/
(decrease)
 
 
  (in thousands)
 

Contract revenue

  $ 10,740   $ 20,306   $ (9,566 )

Research and development expenses(1)

    52,318     56,097     (3,779 )

General and administrative expenses(1)

    11,614     10,552     1,062  

Interest income

    72     148     (76 )

Interest expense

    2,914     1,396     1,518  

Loss on early extinguishment of debt

        313     (313 )

Other expense

    53     40     13  

(1)
Includes the following stock-based compensation expenses:

Research and development expenses

  $ 1,973   $ 2,594   $ (621 )

General and administrative expenses

    1,629     1,810     (181 )

        Contract revenue.    For the year ended December 31, 2012, we recognized revenues of $3.4 million for research funding, $1.0 million for a development milestone earned and $0.9 million of the $3.5 million upfront fee received under the Lilly agreement, $1.2 million of the $7.0 million upfront fee received under the Medicis agreement and $1.3 million primarily for research funding under our collaboration agreement with GSK. We also recognized $2.9 million for research work performed under other research and development agreements, including our agreements with not-for-profit organizations for neglected diseases. During the year ended December 31, 2011, we recognized $5.5 million of the original upfront fee received from GSK, including $3.5 million as a result of the material modification of our GSK agreement in September 2011, and an additional $5.0 million for the related Amendment Fee. We also recognized $0.3 million for GSK research funding and reimbursement of patent costs by GSK. In addition, for the year ended December 31, 2011, under the Lilly agreement, we recognized $3.1 million for research funding, $1.0 million for a development milestone and $0.9 million of the $3.5 million upfront fee. We also recognized $1.0 million of the upfront fee received under the Medicis agreement and $3.5 million for research work performed under our other research and development agreements, including our agreements with not-for-profit organizations for neglected diseases.

        Research and development expenses.    Research and development expenses decreased by $3.8 million for the year ended December 31, 2012 as compared with the same period in the prior year primarily due to decreases in our AN2898 and AN2728 program costs of $3.4 million and $2.3 million, respectively, partially offset by an increase in our tavaborole program of $3.8 million. Due to our revised near-term focus on developing AN2728 instead of AN2898 for atopic dermatitis, our activities for AN2898 were minimal in 2012 as compared to 2011, when we were conducting and completing our Phase 2 trial in atopic dermatitis, manufacturing clinical supplies and conducting preclinical studies for this compound. Our manufacturing activities and our internal clinical efforts were more extensive for AN2728 in 2011 than they were in 2012. In 2011, we were building up our AN2728 drug product supplies to be used in our 2011 and 2012 long-term toxicology studies and clinical trials, while in 2012 our drug manufacturing activities were more limited. For our tavaborole program, our regulatory and

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pre-commercialization activities, which included preparations for our expected NDA filing in mid-2013, manufacturing of registration batches and start-up activities with a newly selected contract manufacturing organization, were more extensive in 2012 than they were during the same period in 2011 and these increased activities were only partially offset by a decline in our 2012 clinical trial activities for tavaborole versus the prior year as our Phase 3 trials were nearing completion by the end of 2012.

        For the year ended December 31, 2012 compared to the same period in 2011, our research and development spending also decreased by $2.8 million and $0.7 million for our collaborations with Medicis and our other research activities, including our neglected diseases programs, respectively. These decreases were offset by an increase of $1.1 million and $0.5 million in spending under our collaboration with GSK and Lilly, respectively.

        General and administrative expenses.    The increase in general and administrative expenses of $1.1 million in 2012 compared to 2011 was primarily due to increases of $0.5 million in legal fees relating to intellectual property and corporate activities, $0.5 million in our expenses for marketing consulting and other pre-commercialization activities for tavaborole and $0.2 million in salaries and related expenses due to the hiring of additional personnel. These increases were partially offset by decreases in our stock-based compensation expense of $0.2 million in 2012 as compared to 2011.

        Interest income.    The decrease in interest income for the year ended 2012 compared to 2011 was due to a reduction in average investment balances and lower yields.

        Interest expense and loss on early extinguishment of debt.    Interest expense increased in 2012 compared to the same period in 2011 due to the higher outstanding balance of our debt, which was only partially offset by a lower effective interest rate. Upon the early extinguishment of our Lighthouse Capital Partners V, L.P. (Lighthouse) debt in March 2011, we incurred a loss of $0.3 million, which consisted of the unaccrued portion of the final payment, the unamortized portions of the debt discount and deferred issuance costs, plus a prepayment penalty.

        Other expense.    The increase in other expense in the year ended December 31, 2012 compared to the same period in 2011 was a result of the deferred financing fees relating to our debt.

Income Taxes

        At December 31, 2013, we had net operating loss carryforwards for federal income tax purposes of $105.3 million and federal research and development tax credit carryforwards of $9.1 million. Our utilization of the net operating loss and tax credit carryforwards may be subject to annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. The annual limitations may result in the expiration of net operating losses and credits prior to utilization. We have determined that an ownership change, as defined by Internal Revenue Code Section 382, occurred in December 2010 and that there have been no other ownership changes from that date through December 31, 2013. The computed annual limitation that resulted from the 2010 ownership change is not expected to prevent us from utilizing our net operating losses prior to their expiration if we can generate sufficient taxable income to do so in the future.

        We periodically evaluate our prospects of generating future taxable income based on our history of taxable income or losses and our projections for the foreseeable future. Prior to 2013, we had incurred tax losses in every year since our inception and our 2013 taxable income was primarily due to the non-recurring income from our settlement with Valeant. Because we lack a consistent earnings history and currently believe that it is more likely than not that we will be unable to realize the benefits related to our deferred tax assets, we have recorded a valuation allowance at December 31, 2013 to offset in full such benefits.

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        As of December 31, 2013 and 2012, we had approximately $2.9 million and $2.2 million, respectively, of unrecognized tax benefits, none of which would currently affect our effective tax rate if recognized due to our deferred tax assets being fully offset by a valuation allowance. We do not believe there will be any material changes in our unrecognized tax positions over the next twelve months.

Liquidity and Capital Resources

        The following table sets forth the primary sources and uses of cash for each of the periods presented below (in thousands):

 
  Year Ended December 31,  
 
  2013   2012   2011  

Net cash provided by (used in) operating activities

  $ 90,075   $ (54,937 ) $ (35,696 )

Net cash (used in) provided by investing activities

    (17,457 )   (584 )   19,428  

Net cash provided by financing activities

    31,802     50,687     9,694  
               

Net increase (decrease) in cash and cash equivalents

  $ 104,420   $ (4,834 ) $ (6,574 )
               
               

        Net cash provided by operating activities was $90.0 million compared to net cash used in operating activities of $(54.9) million for the years ended December 31, 2013 and 2012, respectively. The net cash provided by operating activities for 2013 primarily reflected our net income, which included our litigation settlement of $142.5 million, adjusted for noncash items, partially offset by the net changes in operating assets and liabilities, including those related to the amortization for the upfront fees received in prior years from Lilly and Medicis. For the same period in 2012, the net cash used in operating activities resulted from our net loss adjusted for noncash items as well as the net changes in operating assets and liabilities, including those related to the amortization of upfront fees received in prior years and the increase in current prepaid expenses for our clinical trials and preclinical studies.

        Net cash used in investing activities was $(17.5) million and $(0.6) million for 2013 and 2012, respectively. The activities for both periods were primarily related to the purchases of investments and property and equipment, net of the proceeds from the maturities of investments. In addition, in 2013, our net transfers of investments to restricted investments, primarily as a result of restrictions placed on our use of the redeemable common stock proceeds and the research funding received from the Gates Foundation under our Gates Foundation agreement, were $4.4 million.

        Net cash provided by financing activities was $31.8 million for 2013 compared with $50.7 million for 2012. The net cash provided by financing activities for 2013 was primarily due to the net proceeds of $21.3 million from the sale of our common stock in May 2013 and net proceeds of $5.0 million received for redeemable common stock we issued in connection with the research agreement with the Gates Foundation. Cash was also provided from the $30.0 million drawdown of the first tranche under our debt facility with Hercules, offset by the $28.5 million paid for the regularly scheduled principal payments and remaining obligations under the Oxford and Horizon debt facility and for the financing fees, debt issuance costs and loan fees associated with the Hercules debt. Stock option exercises and employee stock plan purchases also contributed $2.7 million and the net proceeds of $1.3 million from the sale of common stock related to our "at-the-market" common stock offering in the first quarter of 2013 also increased the net cash provided by financing for 2013. The cash provided by financing activities in 2012 was primarily due to net proceeds of $22.6 million and $19.9 million from the sale of our common stock in October 2012 and February 2012, respectively, $12.0 million in notes payable proceeds from the September 2012 drawdown of the third tranche under our loan facility with Oxford and Horizon, partially offset by $4.3 million in scheduled principal payments related to the loan, and $0.5 million in proceeds from stock option exercises and employee stock plan purchases.

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        We believe that our existing capital resources will be sufficient to meet our anticipated operating requirements for at least the next twelve months. Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially.

        Our future capital requirements are difficult to forecast and will depend on many factors, including:

    the timing of potential approval and initial commercial success of tavaborole;

    the initiation, progress, timing, costs and results of preclinical studies and clinical trials for our product candidates and potential product candidates, including our ongoing and/or planned trials for AN2728;

    the success of our efforts under our contracts with the Gates Foundation and DTRA and the attainment of contingent event-based payments and royalties, if any, and our agreements with GSK and Lilly;

    the number and characteristics of product candidates that we pursue;

    the terms and timing of any future collaboration, licensing or other arrangements that we may establish;

    the outcome, timing and cost of regulatory approvals, including the tavaborole NDA approval;

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

    the effect of competing technological and market developments;

    the cost and timing of completion of commercial-scale outsourced manufacturing activities;

    the cost of establishing sales, marketing and distribution capabilities for any product candidates for which we may receive regulatory approval; and

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

        If, over the next several years, adequate funds are not available, we may be required to delay, reduce the scope of or eliminate some, or all, of the above activities.

        Although we believe that our existing capital resources and the remaining borrowing capacity under our expanded debt facility will be adequate to fund operations for at least the next twelve months, we may elect to finance certain future cash needs through public or private equity offerings, debt financings or a possible license, collaboration or other similar arrangement with respect to commercialization rights to tavaborole or any of our other product candidates, or a combination of the above.

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Contractual Obligations

        Our contractual obligations consist primarily of obligations under lease agreements and our notes payable obligations. The following table summarizes our contractual obligations at December 31, 2013 and the effect such obligations are expected to have on our liquidity and cash flow in future years.

 
  Payments due by period (in thousands)  
 
  Total   Less than
1 year
  1 - 3 years   3 - 5 years(1)  

Contractual obligations:

                         

Operating leases

  $ 7,218   $ 1,830   $ 3,252   $ 2,136  

Notes payable

    38,352     3,543     27,780     7,029  
                   

Total contractual obligations

  $ 45,570   $ 5,373   $ 31,032   $ 9,165  
                   
                   

(1)
There are no obligations greater than 5 years.

    Operating Leases

        We lease a 36,960 square-foot building consisting of office and laboratory space in Palo Alto, California, which serves as our corporate headquarters. The lease commenced in April 2008 and was originally scheduled to teriminate terminate in March 2018. In May 2013, we amended the lease to grant the landlord a right to terminate the lease as early as June 2016, with twelve months' written notice. As consideration for entering into the amendment, we received a rent credit of $0.7 million, which was applied to the monthly base rent under the original lease commencing June 1, 2013 and continued for each successive month until the full amount of the rent credit was applied in November 2013. We also lease a second building in Palo Alto, California, consisting of 15,300 square feet of office and laboratory space. In September 2013, we extended the lease for twelve months through December 2014. We have a one-year option to extend the lease though December 31, 2015. This lease is cancelable with four months' notice.

    Notes Payable

        On June 7, 2013, we entered into a loan and security agreement with Hercules to provide up to $45.0 million, available in three tranches of $30.0 million, $10.0 million and $5.0 million each (see Note 6 to the financial statements). The first $30.0 million tranche was drawn on June 7, 2013, at which time we repaid $22.6 million of the remaining obligations under our previous debt facility with Oxford and Horizon. We elected not to draw the second tranche of $10.0 million and the option to do so expired on December 5, 2013. An additional $5.0 million of debt is available under the Hercules agreement upon FDA approval of tavaborole. The future payments under the new debt facility are included as notes payable in the table of contractual obligations above.

    Contracts

        We enter into contracts in the normal course of business with clinical research organizations for clinical trials and clinical supply manufacturing and with vendors for preclinical research studies, research supplies and other services and products for operating purposes. These contracts generally provide for termination on notice, and therefore we believe that our non-cancelable obligations under these agreements are not material.

Off-Balance Sheet Arrangements

        We currently have no off-balance sheet arrangements, such as structured finance, special purpose entities or variable interest entities.

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Recent Accounting Pronouncements

        In February 2013, a new accounting standard was issued that amended existing guidance to improve the reporting of reclassifications out of accumulated other comprehensive income. The new standard requires the disclosure of significant amounts reclassified from each component of accumulated other comprehensive income and the income statement line items affected by the reclassification. The standard is effective prospectively for interim and annual periods beginning after December 15, 2012. We adopted this guidance as of January 1, 2013 and its adoption did not have an effect on our financial statements.

        In July 2013, a new accounting standard was issued that requires the netting of unrecognized tax benefits against a deferred tax asset for a net operating loss or other carryforward that would apply in the settlement of uncertain tax positions. Under the new standard, unrecognized tax benefits will be netted against all available same-jurisdiction net operating loss or other tax carryforwards that would be utilized, rather than only against carryforwards that are created by the unrecognized tax benefits. The new standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The new standard is not expected to have an impact on our financial statements.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        The primary objective of our investment activities is to preserve our capital for the purpose of funding operations while at the same time maximizing the income we receive from our investments without significantly increasing risk. To achieve these objectives, our investment policy allows us to maintain a portfolio of cash equivalents and investments in a variety of high credit quality securities, including U.S. government instruments, commercial paper, money market funds and corporate debt securities. Our investment policy prohibits us from holding auction rate securities or derivative financial instruments. To the extent that the investment portfolios of companies whose commercial paper is included in our investment portfolio may be subject to interest rate risks, which could be negatively impacted by reduced liquidity in auction rate securities or derivative financial instruments they hold, we may also be subject to these risks. However, our investments as of December 31, 2013 are comprised of U.S treasury securities and federal agency securities with a minimum rating of AAA or AA+ with a remaining average maturity of the entire portfolio of 73 days, and therefore we believe that there is no material exposure to interest rate risk and we are not aware of any material exposure to market risk.

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Financial Statements

Contents

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Anacor Pharmaceuticals, Inc.

        We have audited the accompanying balance sheets of Anacor Pharmaceuticals, Inc. (the Company) as of December 31, 2012 and 2013 and the related statements of operations, comprehensive income (loss), redeemable common stock and stockholders' equity and cash flows for each of the three years in the period ended December 31, 2013. 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 financial statements referred to above present fairly, in all material respects, the financial position of Anacor Pharmaceuticals, Inc. at December 31, 2012 and 2013, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, 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), the Company's internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated March 17, 2014 expressed an unqualified opinion thereon.

    /s/ Ernst & Young LLP

Redwood City, California
March 17, 2014

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Anacor Pharmaceuticals, Inc.

Balance Sheets

(In Thousands, Except Share and Per Share Data)

 
  December 31  
 
  2013   2012  

Assets

             

Current assets:

             

Cash and cash equivalents

  $ 114,755   $ 10,335  

Short-term investments

    35,574     35,181  

Restricted investments, short-term

    1,475      

Contract receivable

    1,324     1,203  

Prepaid expenses and other current assets

    2,286     2,574  
           

Total current assets

    155,414     49,293  

Long-term investments

    11,856      

Restricted investments, long-term

    3,155     197  

Property and equipment, net

    1,458     1,516  

Other assets

    282     65  
           

Total assets

  $ 172,165   $ 51,071  
           
           

Liabilities, redeemable common stock and stockholders' equity

             

Current liabilities:

             

Accounts payable

  $ 4,708   $ 3,019  

Accrued liabilities

    8,431     9,590  

Income taxes payable

    1,706      

Notes payable

        9,826  

Deferred revenue

    1,115     2,886  

Deferred rent

    269     70  
           

Total current liabilities

    16,229     25,391  

Notes payable, less current portion

    28,018     15,841  

Deferred revenue, less current portion

    315     4,192  

Deferred rent, less current portion

    1,219     836  

Redeemable common stock

   
4,952
   
 

Stockholders' equity:

   
 
   
 
 

Preferred stock, $0.001 par value; authorized: 10,000,000 shares as of December 31, 2013 and 2012; issued and outstanding: no shares as of December 31, 2013 and 2012

         

Common stock, $0.001 par value; authorized: 100,000,000 shares as of December 31, 2013 and 2012; issued and outstanding: 41,544,249 shares and 35,590,645 shares as of December 31, 2013 and 2012, respectively

    41     36  

Additional paid-in capital

    251,839     219,983  

Accumulated other comprehensive income (loss)

    (2 )   3  

Accumulated deficit

    (130,446 )   (215,211 )
           

Total stockholders' equity

    121,432     4,811  
           

Total liabilities, redeemable common stock and stockholders' equity

  $ 172,165   $ 51,071  
           
           

   

See accompanying notes.

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Anacor Pharmaceuticals, Inc.

Statements of Operations

(In Thousands, Except Share and Per Share Data)

 
  Year Ended December 31  
 
  2013   2012   2011  

Revenues:

                   

Contract revenue

  $ 17,228   $ 10,740   $ 20,306  
               

Total revenues

    17,228     10,740     20,306  

Operating (income) expenses:

                   

Research and development

    46,561     52,318     56,097  

General and administrative

    20,650     11,614     10,552  

Litigation settlement gain

    (142,500 )        
               

Total operating (income) expenses

    (75,289 )   63,932     66,649  
               

Income (loss) from operations

    92,517     (53,192 )   (46,343 )

Interest income

    55     72     148  

Interest expense

    (4,051 )   (2,914 )   (1,396 )

Loss on early extinguishment of debt

    (1,381 )       (313 )

Other expense

    (669 )   (53 )   (40 )
               

Income (loss) before provision for income taxes

    86,471     (56,087 )   (47,944 )

Provision for income taxes

    1,706          
               

Net income (loss)

  $ 84,765   $ (56,087 ) $ (47,944 )
               
               

Net income (loss) per common share:

                   

Basic

  $ 2.16   $ (1.76 ) $ (1.71 )

Diluted

  $ 2.10   $ (1.76 ) $ (1.71 )

Weighted-average number of common shares and common equivalent shares:

   
 
   
 
   
 
 

Basic

    39,178,289     31,901,966     28,109,302  

Diluted

    40,320,187     31,901,966     28,109,302  

   

See accompanying notes.

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Anacor Pharmaceuticals, Inc.

Statements of Comprehensive Income (Loss)

(In Thousands)

 
  Year Ended December 31  
 
  2013   2012   2011  

Net income (loss)

  $ 84,765   $ (56,087 ) $ (47,944 )

Change in unrealized gain (loss) on investments

    (5 )   3     14  
               

Comprehensive income (loss)

  $ 84,760   $ (56,084 ) $ (47,930 )
               
               

   

See accompanying notes.

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Anacor Pharmaceuticals, Inc.

Statements of Redeemable Common Stock and Stockholders' Equity

(In Thousands, Except Share Data)

 
  Redeemable
Common Stock
   
   
   
   
   
   
 
 
  Common Stock    
  Accumulated
Other
Comprehensive
Income (Loss)
   
   
 
 
  Additional
Paid-In
Capital
  Accumulated
Deficit
  Total
Stockholders'
Equity
 
 
  Shares   Amount   Shares   Amount  

Balance as of December 31, 2010

            27,996,878     28     167,559     (14 )   (111,180 )   56,393  

Issuance of common stock upon exercise of stock options

            152,369         100             100  

Issuance of common stock under employee stock purchase plan

            44,897         193             193  

Stock-based compensation on options issued to nonemployee advisors

                    250             250  

Employee stock-based compensation expense

                    4,154             4,154  

Issuance of warrants to purchase common stock

                    739             739  

Net loss

                            (47,944 )   (47,944 )

Change in unrealized gain/loss on available for sale securities

                        14         14  
                                   

Balance as of December 31, 2011

            28,194,144     28     172,995         (159,124 ) $ 13,899  

Issuance of common stock pursuant to common stock offerings, net of issuance costs

            7,250,000     7     42,509             42,516  

Issuance of common stock upon exercise of stock options

            49,917         50             50  

Issuance of common stock under employee stock purchase plan

            96,584     1     432             433  

Stock-based compensation on options issued to nonemployee advisors

                    291             291  

Employee stock-based compensation expense

                    3,311             3,311  

Issuance of warrants to purchase common stock

                    395             395  

Net loss

                            (56,087 )   (56,087 )

Change in unrealized gain/loss on available for sale securities

                        3         3  
                                   

Balance as of December 31, 2012

            35,590,645     36     219,983     3     (215,211 ) $ 4,811  

Issuance of common stock pursuant to common stock offerings, net of issuance costs

            3,599,373     4     21,325             21,329  

Issuance of common stock upon exercise of stock options

            686,302     1     2,369             2,370  

Issuance of common stock under employee stock purchase plan

            95,373         336             336  

Issuance of common stock in an at-the-market offering, net of issuance costs

            401,500         1,278             1,278  

Issuance of redeemable common stock in a private offering, net of issuance costs

    809,061     4,952                          

Issuance of common stock from cashless exercise of common stock warrants

            361,995                      

Stock-based compensation on options issued to nonemployee advisors

                    242             242  

Employee stock-based compensation expense

                    4,491             4,491  

Issuance of warrants to purchase common stock

                    1,815             1,815  

Net income

                            84,765     84,765  

Change in unrealized gain/loss on available for sale securities

                        (5 )       (5 )
                                   

Balance as of December 31, 2013

    809,061   $ 4,952     40,735,188   $ 41   $ 251,839   $ (2 ) $ (130,446 ) $ 121,432  
                                   
                                   

   

See accompanying notes.

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Anacor Pharmaceuticals, Inc.

Statements of Cash Flows

(In Thousands)

 
  Year Ended December 31  
 
  2013   2012   2011  

Operating activities

                   

Net income (loss)

  $ 84,765   $ (56,087 ) $ (47,944 )

Adjustments to reconcile net income (loss) to net cash used in operating activities:

                   

Depreciation and amortization

    507     667     652  

Amortization of debt discount and debt issuance costs

    822     552     342  

Stock-based compensation

    4,733     3,602     4,404  

Amortization of premium on investments

    321     479     1,370  

Accrual of final payment on notes payable

    318     534     231  

Noncash loss on early extinguishment of debt

    1,175         263  

Changes in assets and liabilities:

                   

Contract receivable

    (121 )   (67 )   (52 )

Government grant receivable

            108  

Prepaid and other current assets

    412     (1,347 )   335  

Other assets

    (27 )   714     (152 )

Accounts payable

    1,689     1     880  

Income taxes payable

    1,706          

Accrued liabilities

    (1,159 )   (972 )   3,474  

Deferred revenue

    (5,648 )   (2,994 )   370  

Deferred rent

    582     (19 )   23  
               

Net cash provided by (used in) operating activities

    90,075     (54,937 )   (35,696 )

Investing activities

   
 
   
 
   
 
 

Transfers to restricted investments, net

    (4,432 )        

Purchases of investments

    (67,196 )   (65,074 )   (58,763 )

Maturities of investments

    54,621     64,930     78,742  

Acquisition of property and equipment

    (450 )   (440 )   (551 )
               

Net cash (used in) provided by investing activities

    (17,457 )   (584 )   19,428  

Financing activities

   
 
   
 
   
 
 

Proceeds from the sale of redeemable common stock, net of issuance costs

    4,952          

Proceeds from the sale of common stock, net of issuance costs

    22,607     42,516      

Proceeds from employee stock plan purchases and the exercise of stock options by employees and nonemployee advisors

    2,706     482     293  

Proceeds from the issuance of notes payable

    30,000     12,000     18,000  

Principal payments on notes payable

    (25,716 )   (4,285 )   (6,689 )

Final payment on notes payable

    (1,650 )       (1,455 )

Payment of financing fee, debt issuance costs and loan restructuring fee

    (1,097 )   (26 )   (455 )
               

Net cash provided by financing activities

    31,802     50,687     9,694  
               

Net increase (decrease) in cash and cash equivalents

    104,420     (4,834 )   (6,574 )

Cash and cash equivalents at beginning of year

    10,335     15,169     21,743  
               

Cash and cash equivalents at end of year

  $ 114,755   $ 10,335   $ 15,169  
               
               

Supplemental schedule of noncash financing activities

                   

Fair value of warrants to purchase common stock issued in connection with notes payable

  $ 1,815   $ 395   $ 739  
               
               

Supplemental disclosure of cash flow information

                   

Interest paid, including payment of loan restructuring fee

  $ 4,736   $ 1,755   $ 2,601  
               
               

   

See accompanying notes.

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Anacor Pharmaceuticals, Inc.

Notes to Financial Statements

1. The Company

Nature of Operation

        Anacor Pharmaceuticals, Inc. (the Company) is a biopharmaceutical company focused on discovering, developing and commercializing novel small-molecule therapeutics derived from its boron chemistry platform. The Company has discovered, synthesized and developed eight molecules that are currently in development. Its two lead product candidates are topically administered dermatologic compounds—tavaborole, formerly known as AN2690, and AN2728. Tavaborole is a topical treatment for onychomycosis, a fungal infection of the nail and nail bed. The Company filed a New Drug Application (NDA) for tavaborole in July 2013, which was accepted for review by the United States Food and Drug Administration (FDA) in September 2013 with a Prescription Drug User Fee Act (PDUFA) V goal date of July 29, 2014. AN2728 is the Company's lead topical anti-inflammatory product candidate for the treatment of atopic dermatitis and psoriasis. The Company held an End of Phase 2 meeting with the FDA for AN2728 in atopic dermatitis in the first quarter of 2014 and expects to initiate Phase 3 studies in atopic dermatitis in the first half of 2014. In addition to its two lead programs, the Company has three other wholly-owned clinical product candidates—AN2718 and AN2898, which are backup compounds to tavaborole and AN2728, respectively, and AN3365 (formerly referred to as GSK2251052, or GSK '052), an antibiotic for the treatment of infections caused by Gram-negative bacteria, which previously was licensed to GlaxoSmithKline, LLC (GSK). In October 2012, GSK advised the Company that it had discontinued further development of AN3365 and substantially all rights to this compound reverted to the Company. The Company is currently considering its options for further development, if any, of AN3365. The Company has discovered three other compounds that it has out-licensed for further development—one is licensed to Eli Lilly and Company (Lilly) for the treatment of an animal health indication, a second compound, AN5568, also referred to as SCYX-7158, is licensed to Drugs for Neglected Diseases initiative for the treatment of human African trypanosomiasis (HAT, or sleeping sickness) and the third compound is licensed to GSK for development in tuberculosis (TB). The Company also has a pipeline of other internally discovered topical and systemic boron-based compounds in earlier stages of research and pre-clinical development.

        Since inception, the Company has not generated revenue from product sales and, as of December 31, 2013, has an accumulated deficit of $130.4 million. The Company may require substantial additional capital to fund research and development activities, including clinical trials for its development programs and preclinical activities for its product candidates, expansion of clinical trials for AN2728 and preparation for commercialization activities in anticipation of FDA approval of tavaborole. The Company believes that its existing capital resources will be sufficient to meet its anticipated operating requirements for at least the next twelve months. While management believes that the Company currently has sufficient resources to fund its operations, the Company may also elect to finance its future cash needs through public or private equity offerings, debt financings or a possible license, collaboration or other similar arrangement to complete the development and potential commercialization of tavaborole and fund its other research and development activities.

2. Summary of Significant Accounting Policies

Use of Estimates

        The preparation of the financial statements in accordance with U.S. generally accepted accounting principles (GAAP) requires the Company to make estimates and judgments in certain circumstances that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of

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Anacor Pharmaceuticals, Inc.

Notes to Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)

contingent assets and liabilities. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. On an ongoing basis, the Company evaluates its estimates, including those related to revenue recognition, fair values of financial instruments in which it invests, income taxes, preclinical study and clinical trial accruals, accrued compensation and other contingencies. Management bases its estimates on historical experience or on various other assumptions that it believes to be reasonable under the circumstances. Actual results could differ from these estimates.

Cash, Cash Equivalents, Short-Term Investments, Long-Term Investments and Restricted Investments

        The Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash and cash equivalents. Unless restricted, investments with a maturity date of more than three months, but less than twelve months, from the date of purchase are considered short-term investments and are classified as current assets. Long-term investments have contractual maturities at the date of purchase of one to two years and are classified as noncurrent assets. The Company's investments in marketable securities are classified as available for sale (see Note 3). Securities available for sale are carried at estimated fair value, with unrealized gains and losses reported as part of accumulated other comprehensive income or loss, a separate component of stockholders' equity. The Company has estimated the fair value amounts by using available market information. The cost of available for sale securities sold is based on the specific-identification method. Restricted investments are classified as a current or noncurrent asset based upon the terms of the relevant contract and, in some cases, management's estimate of when the restrictions will be eliminated.

        Under its facility lease agreements, the Company is required to secure letters of credit. As of both December 31, 2013 and 2012, the Company had approximately $0.2 million of long-term restricted investments to secure these letters of credit.

Fair Value of Financial Instruments

        The carrying amounts of certain of the Company's financial instruments, including cash and cash equivalents, short-term investments, short-term restricted investments, contract receivables and accounts payable, approximate their fair value due to their short maturities. Based on the borrowing rates available to the entities with a similar financial standing to the Company for loans with similar terms and average maturities, the carrying value of the Company's long-term notes payable approximate their fair values as of December 31, 2013 and 2012.

        Short-term investments, long-term investments and restricted investments are carried at fair value. Fair value is considered to be the price at which an asset could be exchanged or a liability transferred (an exit price) in an orderly transaction between knowledgeable, willing parties in the principal or most advantageous market for the asset or liability. Where available, fair value is based on or derived from observable market prices or other observable inputs. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments' complexity.

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Anacor Pharmaceuticals, Inc.

Notes to Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)

Concentration of Credit Risk

        Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, short-term investments, long-term investments and restricted investments. Substantially all the Company's cash, cash equivalents, short-term investments, long-term investments and restricted investments are held by two financial institutions that management believes are of high credit quality. Such deposits may, at times, exceed federally insured limits. As of December 31, 2013 and 2012, approximately 93% and 85%, respectively, of the cash and cash equivalents were held in a money market fund invested in U.S. Treasuries, securities guaranteed as to principal and interest by the U.S. government and repurchase agreements in respect of such securities. The Company's short-term investments, long-term investments and restricted investments as of December 31, 2013 and 2012 are held in securities guaranteed as to principal and interest by the U.S. government. During the three years ended December 31, 2013, the Company has not experienced any losses on its deposits of cash, cash equivalents, short-term investments, long-term investments and restricted investments and management believes that its guidelines for investment of its excess cash maintain safety and liquidity through diversification and investment maturity.

Customer Concentration

        The Company's revenues consist primarily of contract revenues from a collaboration agreement with Lilly and the research agreement with the Bill and Melinda Gates Foundation (Gates Foundation). Collaborators, including GSK, have accounted for significant revenues in the past and may not provide contract revenues in the future under existing agreements and/or new collaboration agreements, which may have a material effect on the Company's operating results. In addition, the Company and Medicis Pharmaceutical Corporation (Medicis) terminated the research and development agreement with Medics and, upon termination, the Company recognized deferred revenue remaining under the agreement (see Notes 7 and 8), which resulted in revenue from Medicis of more than 10% of revenue in the current year.

        Contract revenues from collaborators, research institutions and not-for-profit organizations that accounted for 10% or more of total revenues were as follows:

 
  Year Ended December 31  
 
  2013   2012   2011  

Gates Foundation

    26 %        

Lilly

    24 %   49 %   25 %

GSK

    *     13 %   53 %

Medicis

    28 %   11 %   *  

Medicines for Malaria Venture (MMV)

    *     *     11 %

Research Institution A

    *     14 %   *  

*
less than 10% of total revenue

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2. Summary of Significant Accounting Policies (Continued)

Contract Receivable

        At December 31, 2013 and 2012, the contract receivable consisted of research funding due from Lilly of $0 and $0.8 million, respectively (see Note 8), $0.7 million and $0.3 million, respectively, due from GSK (see Note 8), $0.5 million from the United States Department of Defense, Defense Threat Reduction Agency (DTRA) at December 31, 2013 (see Note 8) and $0.1 million as of both dates due from other contracts.

        The Company's contract receivable is primarily composed of amounts due under collaboration and research agreements and the Company believes that the credit risks associated with these collaborators are not significant. During the three years ended December 31, 2013, the Company has not written-off any contract receivable and, accordingly, does not have an allowance for doubtful accounts as of December 31, 2013 and 2012.

Property and Equipment

        Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the respective assets, generally three to five years. Leasehold improvements are amortized over the shorter of the remaining lease term or the estimated useful economic lives of the related assets.

Impairment of Long-Lived Assets

        Losses from impairment of long-lived assets used in operations are recorded when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts. The Company regularly evaluates its long-lived assets for indicators of possible impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset and its eventual disposition are less than its carrying amount. Impairment, if any, is assessed using discounted cash flows.

Revenue Recognition

        The Company's contract revenues are generated primarily through research and development collaboration agreements, which typically may include non-refundable, non-creditable upfront fees, funding for research and development efforts, payments for achievement of specified development, regulatory and sales goals and royalties on product sales of licensed products.

        The Company recognizes revenue when persuasive evidence of an arrangement exists; transfer of technology has been completed, services are performed or products have been delivered; the fee is fixed or determinable; and collection is reasonably assured.

        For arrangements with multiple deliverables, the Company evaluates each deliverable to determine whether it qualifies as a separate unit of accounting. This determination is generally based on whether the deliverable has stand-alone value to the customer. The selling price used for each unit of accounting will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available or estimated selling price if neither vendor-specific nor third-party evidence is available. Management may be required to exercise considerable judgment

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2. Summary of Significant Accounting Policies (Continued)

in determining whether a deliverable is a separate unit of accounting and in estimating the selling prices of identified units of accounting for new agreements. Where multiple deliverables are combined as a single unit of accounting, revenues are recognized based on the performance requirements of the related agreement.

        Upfront payments for licensing the Company's intellectual property are evaluated to determine if the licensee can obtain stand-alone value from the license separate from the value of the research and development services to be provided by the Company. Typically, the Company has determined that the licenses it has granted to collaborators do not have stand-alone value separate from the value of the research and development services provided. As such, upfront payments are recorded as deferred revenue in the balance sheet and are recognized as contract revenue ratably over the contractual or estimated performance period that is consistent with the term of the research and development obligations contained in the research and development collaboration agreement. When stand-alone value is identified, the related consideration is recorded as revenue in the period in which the license or other intellectual property rights are issued.

        Some arrangements involving the licensing of the Company's intellectual property, the provision of research and development services or both may also include exclusivity clauses whereby the Company agrees that, for a specified period of time, it will not conduct further research on licensed compounds or on compounds that would compete with licensed compounds or that it will do so only on a limited basis. Such provisions may also restrict the future development or commercialization of such compounds. The Company does not treat such exclusivity clauses as a separate element within an arrangement and any upfront payments received related to the exclusivity clause would be allocated to the identified elements in the arrangement and recognized as described in the preceding paragraph.

        Payments resulting from the Company's efforts under research and development agreements or government grants are recognized as the activities are performed and are presented on a gross basis. Revenue is recorded gross because the Company acts as a principal, with discretion to choose suppliers, bears credit risk and performs part of the services. The costs associated with these activities are reflected as a component of research and development expense in the statements of operations and the revenues recognized from such activities approximate these costs.

        For certain contingent payments under research or development arrangements, the Company recognizes revenue using the milestone method. Under the milestone method, a payment that is contingent upon the achievement of a substantive milestone is recognized in its entirety in the period in which the milestone is achieved. A milestone is an event (i) that can be achieved based in whole or in part on either the Company's performance or on the occurrence of a specific outcome resulting from the Company's performance, (ii) for which there is substantive uncertainty at the date the arrangement is entered into that the event will be achieved and (iii) that would result in additional payments being due to the Company. The determination that a milestone is substantive is judgmental and is made at the inception of the arrangement. Milestones are considered substantive when the consideration earned from the achievement of the milestone is (i) commensurate with either the Company's performance to achieve the milestone or the enhancement of value of the item delivered as a result of a specific outcome resulting from the Company's performance to achieve the milestone, (ii) relates solely to past performance and (iii) is reasonable relative to all deliverables and payment terms in the arrangement. In making the determination as to whether a milestone is substantive or not, management of the Company considers all facts and circumstances relevant to the arrangement, including factors such as

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Notes to Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)

the scientific, regulatory, commercial and other risks that must be overcome to achieve the respective milestone, the level of effort and investment required to achieve the respective milestone and whether any portion of the milestone consideration is related to future performance or deliverables.

        Other contingent payments received for which payment is either contingent solely upon the passage of time or the results of a collaborative partner's performance (bonus payments) are not accounted for using the milestone method. Such bonus payments will be recognized as revenue when earned and when collectibility is reasonably assured.

        Royalties based on reported sales of licensed products will be recognized based on contract terms when reported sales are reliably measurable and collectibility is reasonably assured. To date, none of the Company's products have been approved and therefore the Company has not earned any royalty revenue from product sales.

Research and Development Expenses

        All research and development expenses, including those funded by third parties, are expensed as incurred. Research and development expenses include, but are not limited to, salaries, benefits, stock-based compensation, lab supplies, allocated overhead, fees for professional service providers and costs associated with product development efforts, including preclinical studies and clinical trials.

Preclinical Study and Clinical Trial Accruals and Deferred Advance Payments

        The Company estimates preclinical study and clinical trial expenses based on the services performed pursuant to contracts with research institutions and clinical research organizations that conduct these activities on its behalf. In recording service fees, the Company estimates the time period over which the related services will be performed and compares the level of effort expended through the end of each period to the cumulative expenses recorded and payments made for such services and, as appropriate, accrues additional service fees or defers any non-refundable advance payments until the related services are performed. If the actual timing of the performance of services or the level of effort varies from the estimate, the Company will adjust its accrual or deferred advance payment accordingly. If the Company later determines that it no longer expects the services associated with a deferred non-refundable advance payment to be rendered, the deferred advance payment will be charged to expense in the period that such determination is made.

Fair Value of Common Stock Warrants

        The Company estimates the fair value of common stock warrants using the Black-Scholes option-pricing model, based on the inputs for the fair value of the underlying common stock at the valuation measurement date, the remaining contractual term of the warrant, risk-free interest rates, expected dividend rates and expected volatility of the price of the underlying common stock. These estimates are based on subjective assumptions.

Stock-Based Compensation

        Employee stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the employee's requisite service period (generally the vesting period). Stock option awards granted to the Company's nonemployee directors for their board-

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Notes to Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)

related services are included in employee stock-based compensation in accordance with current accounting standards. The Company uses the Black-Scholes option-pricing model to estimate the fair value of its stock-based awards and uses the straight-line (single-option) method for expense attribution. The Company estimates forfeitures and recognizes expense only for those shares expected to vest.

        The Company accounts for equity instruments issued to nonemployees based on their fair values on the measurement dates using the Black-Scholes option-pricing model. The fair values of the options granted to nonemployees are remeasured as they vest. As a result, the noncash charge to operations for nonemployee options that vest in any given reporting period is affected by changes in the fair value of the Company's common stock during that period.

Income Taxes

        The Company utilizes the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax reporting bases of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse.

        The Company periodically evaluates the prospects of it generating future taxable income based on its history of taxable income or losses and its projections for the foreseeable future. Based on such evaluations, the Company makes a determination as to whether it is more likely than not that it will be unable to utilize all of its deferred tax assets in the future and, if so, the Company records a valuation allowance to reduce deferred tax assets to the amounts expected to be realized. The Company will maintain full valuation allowances until there is sufficient evidence to support the reversal of all or a portion of the valuation allowances (see Note 12).

        The Company accounts for uncertain tax positions in the financial statements when it is more likely than not that the position will be sustained upon examination by the tax authorities. Such tax positions must initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts. The Company's policy is to recognize any interest and penalties related to income taxes in income tax expense.

Net Income (Loss) per Common Share

        Basic net income (loss) per common share is calculated by dividing the net income (loss) by the weighted-average number of common shares outstanding during the period, without consideration for common stock equivalents. Diluted net income (loss) per share includes the effect of all potential common stock equivalents outstanding for the period, determined using the treasury-stock method. For purposes of this calculation, potentially dilutive securities consisting of stock options and warrants are considered to be common stock equivalents. For each loss period presented in these financial statements, these dilutive securities are excluded in the calculation of diluted net income (loss) per share because their effect would be antidilutive. The following table presents the calculation of basic

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Notes to Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)

and diluted net income (loss) per share of common stock (in thousands, except share and per share data):

<
 
  Year Ended December 31  
 
  2013   2012   2011  

Net income (loss) per common share

                   

Numerator:

   
 
   
 
   
 
 

Net income (loss)

  $ 84,765   $ (56,087 ) $ (47,944 )
               
               

Denominator:

                   

Weighted-average number of common shares used in calculating net income (loss) per common share—basic

    39,178,289     31,901,966     28,109,302  

Dilutive effect of common stock options and employee stock purchase rights

    956,397          

Dilutive effect of warrants to purchase common stock

    185,501          
               

Weighted-average number of common shares used in calculating net income (loss) per common share—diluted

    40,320,187     31,901,966     28,109,302  
               
               

Net income (loss) per common share

                   

Basic

  $ 2.16   $ (1.76 ) $ (1.71 )

Diluted

  $ 2.10   $ (1.76 ) $ (1.71 )

Outstanding securities at period end not included in the computation of diluted net income (loss) per share as they had an anti-dilutive effect:

   
 
   
 
   
 
 

Common stock options

    1,853,547     3,912,182     2,991,674  

Warrants to purchase common stock

    40,623     451,597     367,371