UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2006

OR

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

For the transition period from to

Commission File Number 000-51134

Favrille, Inc.

(Exact name of registrant as specified in its charter)

Delaware		33-0892797
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

10421 Pacific Center Court, San Diego, CA		92121
(Address of principal executive offices)		(Zip Code)

(858) 526-8000

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year if changed since last report)

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 x NO o

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

Large Accelerated Filer o

Accelerated Filer o

Non-Accelerated Filer x

Indicate by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO x

The number of shares of the Registrant’s common stock outstanding as of August 8, 2006 was 28,967,245.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

FAVRILLE, INC.

(a development stage company)

BALANCE SHEETS

(in thousands, except share and per share data)

	June 30, 2006			December 31, 2005
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	28,817		$	12,065
Short-term investments	32,835			22,427
Receivables	351			372
Prepaid expenses and other current assets	737			563
Total current assets	62,740			35,427
Property and equipment, net	10,987			9,430
Restricted cash	3,451			1,550
Other assets	640			600
Total assets	$	77,818		$	47,007
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable and accrued liabilities	$	5,439		$	3,888
Current portion of debt	3,676			2,553
Total current liabilities	9,115			6,441
Debt, less current portion	4,575			3,532
Deferred rent	2,013			1,320
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.001 par value 5,000,000 shares authorized at June 30, 2006 and December 31, 2005; no shares issued and outstanding at June 30, 2006 and December 31, 2005	—			—
Common stock, $0.001 par value:
Authorized shares, 75,000,000 at June 30, 2006 and December 31, 2005;
Issued and outstanding shares— 28,916,355 and 20,329,046 at June 30, 2006 and December 31, 2005, respectively	29			20
Additional paid-in capital	198,164			156,882
Deferred stock-based compensation	—			(5,655		)
Note receivable from stockholder	—			(96		)
Accumulated other comprehensive loss	(15		)	(54		)
Deficit accumulated during the development stage	(136,063		)	(115,383		)
Total stockholders’ equity	62,115			35,714
Total liabilities and stockholders’ equity	$	77,818		$	47,007

See accompanying notes.

FAVRILLE, INC.
(a development stage company)

STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)

Unaudited

	Three Months ended June 30,						Six Months ended June 30,						Period from January 21, 2000 (inception) to June 30,
	2006			2005			2006			2005			2006
Operating expenses:
Research and development	$	7,462		$	7,909		$	15,883		$	14,737		$	84,739
General and administrative	2,919			1,681			5,620			3,345			24,113
Total operating expenses	10,381			9,590			21,503			18,082			108,852
Interest income	798			409			1,231			705			3,640
Interest expense	(213		)	(181		)	(379		)	(389		)	(2,386		)
Other expense	(29		)	(11		)	(29		)	(12		)	(15		)
Loss on extinguishment of debt	—			—			—			—			(290		)
Total other income, net	556			217			823			304			949
Net loss	(9,825		)	(9,373		)	(20,680		)	(17,778		)	(107,903		)
Deemed dividend-beneficial conversion feature for Series C redeemable convertible preferred stock	—			—			—			—			(28,103		)
Accretion of Series C redeemable convertible preferred stock issuance costs	—			—			—			(6		)	(57		)
Net loss applicable to common stockholders	$	(9,825	)	$	(9,373	)	$	(20,680	)	$	(17,784	)	$	(136,063	)
Historical net loss per share:
Basic and diluted	$	(0.34	)	$	(0.47	)	$	(0.81	)	$	(1.10	)
Weighted-average shares-basic and diluted	28,708,766			19,810,409			25,597,762			16,118,557

See accompanying notes.

FAVRILLE, INC.
(a development stage company)

STATEMENTS OF CASH FLOWS
(in thousands)

Unaudited

							Period from
							January 21,
							2000
	Six Months ended						(inception) to
	June 30,						June 30,
	2006			2005			2006
Operating activities
Net loss	$	(20,680	)	$	(17,778	)	$	(107,903	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	1,010			884			5,368
Loss on disposal of fixed assets	29			—			29
Issuance of options and warrant related to consulting agreements	—			—			186
Stock-based compensation	1,864			1,454			7,314
Non-cash interest expense	100			22			272
Loss on extinguishment of debt	—			—			(290		)
Issuance of restricted common stock for license	—			—			24
Deferred rent	693			272			2,013
Amortization of premium/discount on short-term investments	(162		)	(3		)	(157		)
Accrued interest on short-term investments	140			(21		)	(174		)
Unrealized loss on cash and cash equivalents	—			1			(1		)
Changes in operating assets and liabilities:
Receivables	(119		)	(7		)	(177		)
Prepaid expenses and other assets	(214		)	41			(1,079		)
Accounts payable and accrued liabilities	1,551			344			5,439
Net cash used in operating activities	(15,788		)	(14,791		)	(89,136		)
Investing activities
Purchases of property and equipment	(2,595		)	(371		)	(16,353		)
Purchases of short-term investments	(32,055		)	(4,267		)	(66,543		)
Maturities of short-term investments	21,848			—			33,851
Other assets	—			—			(70		)
Restricted cash	(1,901		)	—			(3,611		)
Sale of restricted cash	—			—			160
Net cash used in investing activities	(14,703		)	(4,638		)	(52,566		)
Financing activities
Proceeds from debt	3,315			1,427			18,722
Payments on debt	(1,249		)	(1,237		)	(10,332		)
Issuance of preferred stock, net	—			—			76,144
Proceeds from issuance of convertible promissory note	—			—			650
Issuance of common stock and warrants	45,183			39,456			85,378
Repurchase of restricted common stock	(6		)	(7		)	(43		)
Net cash provided by financing activities	47,243			39,639			170,519
Net decrease increase in cash and cash equivalents	16,752			20,210			28,817
Cash and cash equivalents at beginning of period	12,065			25,065			—
Cash and cash equivalents at end of period	$	28,817		$	45,275		$	28,817

Supplemental schedule of non-cash investing and financing activities:
Conversion of convertible preferred stock to common stock upon initial public offering	$	—		$	43,678		$	43,678

See accompanying notes.

FAVRILLE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
JUNE 30, 2006
UNAUDITED

1. Basis of Presentation

The accompanying unaudited interim financial statements have been prepared in accordance with U.S. generally accepted accounting principles and with the rules and regulations of the Securities and Exchange Commission related to a quarterly report on Form 10-Q. Accordingly, they do not include all of the information and disclosures required by U.S. generally accepted accounting principles for complete financial statements. The balance sheet at December 31, 2005 has been derived from the audited financial statements at that date but does not include all information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. The interim financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial condition and results of operations for the periods presented. Except as otherwise disclosed, all such adjustments are of a normal recurring nature.

Operating results for the three and six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. These financial statements should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 and management’s discussion and analysis of financial condition and results of operations included elsewhere herein.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as expenses during the reporting period. Actual results could differ from those estimates. On an ongoing basis, we review our estimates based on information currently available, and changes in facts and circumstances may cause us to revise these estimates.

Certain reclassifications have been made to prior periods’ financial statements in order to conform to the current period’s presentation. The three and six months ended June 30, 2005 Statement of Operations includes stock-based compensation expense in the applicable research and development and marketing, general and administrative amounts in a manner consistent with the three and six months ended June 30, 2006 Statement of Operations presentation.

Stock-Based Compensation

Adoption of SFAS 123(R)

Favrille has its Amended and Restated 2001 Equity Incentive Plan (the Equity Incentive Plan), its 2005 Non-Employee Directors’ Stock Option Plan (the Directors’ Plan) and its 2005 Employee Stock Purchase Plan (the Stock Purchase Plan) that are described more fully in Note 5 to the Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (SFAS 123(R)). SFAS 123(R) requires the recognition of the fair value of stock-based compensation in net income. The Company recognizes the stock-based compensation expense over the requisite service period of the individual grantees on a straight-line basis over the vesting period, which is generally four years. Prior to January 1, 2006, the Company recorded compensation expense for stock options based upon their intrinsic value on the date of grant pursuant to Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). Prior to the Company’s initial public offering (IPO), the Company established the exercise price based on the fair value of the Company’s stock at the date of grant as determined by the Board of Directors (the Board). Therefore, the options had no intrinsic value upon grant and no expense was recorded upon issuance. With respect to certain options granted during 2005 and 2004, the Company had recorded deferred compensation of $350,000 and $9.4 million, respectively, for the incremental difference at the grant date between the fair value per share determined by the Board and the deemed fair value per share determined solely for financial reporting purposes.

The Company has elected the modified prospective transition method for adopting SFAS 123(R). Under this method, the provisions of SFAS 123(R) apply to all awards granted or modified after the date of adoption. The deferred stock-based compensation balance of $5.7 million as of December 31, 2005, which was accounted for under APB 25, was reclassified as a reduction of additional paid-in capital upon the adoption of SFAS 123(R). In addition, the unrecognized expense of awards not yet vested at the date of adoption will be recognized in net income or loss in the periods after the date of adoption using

the same Black-Scholes valuation method and assumptions determined under the original provisions of SFAS 123, “Accounting for Stock-Based Compensation,” as disclosed in our previous quarterly and annual reports. The cumulative effect of the change in accounting principle from APB 25 to SFAS 123(R) was not material, because the amortization of expense related to options granted prior to the adoption was based on the single-option approach.

Determining Fair Value

The Company estimates the fair value of each stock-based award on the grant date using the Black-Scholes valuation model. To facilitate the adoption of SFAS 123(R), the Company applied provisions of Staff Accounting Bulletin (SAB) 107 in developing our methodologies to estimate our Black-Scholes valuation model inputs. Option valuation models, including Black-Scholes, require the input of highly subjective assumptions, and changes in the assumptions used can materially affect the grant date fair value of an award. Below is a summary of the methodologies the Company utilized to estimate the assumptions:

Valuation and Amortization Method – The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing formula and a single-option award approach. This fair value is then amortized on a straight-line basis over the requisite service period, which is generally the vesting period.

Expected Term- The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding and is determined based on the SAB 107 simplified method, since the company does not have adequate history of exercises of its stock-based awards since its IPO in February 2005.

Expected Volatility- The Company estimates its volatility factor by using the historical average volatility, over a period equal to the expected term, of comparable companies since it does not have adequate stock price history of its own stock to determine volatility.

Expected Dividend - The Black-Scholes valuation model calls for a single expected dividend yield as an input. The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends in the future.

Risk-Free Interest Rate – The Company bases the risk-free interest rate used in the Black-Scholes valuation model on the implied yield currently available on the U.S. Treasury zero-coupon issues with an equivalent remaining term. Where the expected term of the Company’s stock-based awards does not correspond with the terms for which interest rates are quoted, the Company performs a straight-line interpolation to determine the rate from the available maturities.

Estimated Forfeitures – When estimating forfeitures, the Company considers voluntary termination behavior as well as an analysis of actual option forfeitures. As stock-based compensation expense recognized in the Statement of Operations for the three and six months ended June 30, 2006 is based on awards ultimately expected to vest, it should be reduced for estimated forfeitures.
SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated based on historical experience. In the Company’s pro forma information required under SFAS 123 for the periods prior to January 1, 2006, the Company accounted for forfeitures as they occurred.

Fair Value – The fair value of the Company’s stock options granted to employees and non-employee directors for the three and six months ended June 30, 2006 and 2005 and employee stock purchase plan offerings in the six months ended June 30, 2006 and 2005 was estimated using the following assumptions:

	Stock Option Plan
	Three Months ended June 30,
	2006			2005

Expected term (in years)	6.25			4.0
Volatility	61.8		%	70		%
Expected dividend	0			0
Weighted average risk-free interest rate	5.04		%	3.87		%
Estimated forfeitures	4.0		%	—
Weighted-average fair value	$	2.93		$	2.16

	Stock Option Plan						Employee Stock Purchase Plan
	Six Months ended June 30,						Six Months ended June 30,
	2006			2005			2006			2005

Expected term (in years)	6.25			4.0			1.25			1.25
Volatility	61.8		%	70		%	57.6		%	70		%
Expected dividend	0			0			0			0
Weighted average risk-free interest rate	4.76		%	4.26		%	4.71		%	3.02		%
Estimated forfeitures	4.0		%	—			4.0		%	—
Weighted-average fair value	$	4.14		$	3.23		$	3.01		$	3.18

Stock-Based Compensation Expense

Under provisions of SFAS 123(R), the Company recorded approximately $984,000 and $1.9 million of stock-based compensation expense in our Statement of Operations for the three and six months ended June 30, 2006, respectively. The Company utilized the Black-Scholes valuation model for estimating the fair value of the stock-based compensation granted both before and after the adoption of SFAS 123(R). Prior to the adoption of SFAS 123(R), the Company recorded approximately $700,000 and $1.5 million of stock-based compensation for certain options granted during 2004 and 2005 in our Statement of Operations for the three and six months ended June 30, 2005, respectively, under the provisions of APB 25 based upon their intrinsic value. Total stock-based compensation expense recognized for the three and six months ended June 30, 2006 and 2005 was as follows (in thousands, except per share data):

	Three Months ended June 30,		Three Months ended June 30,		Six Months ended June 30,		Six Months ended June 30,
	2006		2005		2006		2005
Research and development	$	485	$	349	$	918	$	716
General and administrative	499		358		946		738
Stock-based compensation expense	$	984	$	707	$	1,864	$	1,454

Net stock-based compensation expense, per common share

Basic and diluted	$	0.03	$	0.04	$	0.07	$	0.09

At June 30, 2006, the total compensation cost related to unvested stock-based awards granted to employees under the Company’s stock award plans but not yet recognized was approximately $8.1 million, net of estimated forfeitures of approximately $500,000. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 2.8 years and will be adjusted for subsequent changes in estimated forfeitures.

Pro-forma Disclosures

SFAS 123(R) requires the Company to present pro forma information for the comparative period prior to adoption as if it had accounted for all our stock options under the fair value method of the original SFAS 123. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation to the same period in the prior year:

	Three Months ended June 30,			Six Months ended June 30,
	2005			2005
Net loss applicable to common stockholders as reported	$	(9,373	)	$	(17,784	)
Add: Stock-based employee compensation expense included in net loss	707			1,454

Deduct: Stock-based employee compensation expense determined under fair value method for all awards	(814		)	(1,539		)

Pro forma net loss applicable to common stockholder	$	(9,480	)	$	(17,869	)
Net loss per share:
As reported—Basic and Diluted	$	(0.47	)	$	(1.10	)
Pro forma—Basic and Diluted	$	(0.48	)	$	(1.11	)

As a result of adopting SFAS 123(R), the Company’s net loss for the three and six months ended June 30, 2006 is approximately $300,000 and $500,000 larger, respectively, than if the Company had continued to account for stock-based compensation under APB 25. Basic and diluted net loss per share are $0.01 and $0.02 higher, respectively, than if the Company had continued to account for stock-based compensation under APB 25.

Stock Option Activity

The Company issues new shares of common stock upon exercise of stock options. The following is a summary of option activity for the Equity Incentive Plans:

	Shares		Approximate Weighted- average exercise price		Weighted- Average Remaining Contractual Term	Aggregate Intrinsic Value
	(in thousands)					(in thousands)
Outstanding at December 31, 2005	1,682		$	2.50
Granted	835		$	6.65
Exercised	(4	)	$	0.71
Forfeited	(125	)	$	4.42
Outstanding at June 30, 2006	2,388		$	3.86	8.75	$	3,846

Vested and expected to vest at June 30, 2006	2,299		$	3.81	8.73	$	3,777

Exercisable at June 30, 2006	1,090		$	1.53	7.89	$	3,584

Shares available for future stock option grants under the Equity Incentive Plan and the Directors’ Plan were 396,028 and 297,500, respectively, at June 30, 2006. Aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock for the 1.3 million options that were in-the-money as of June 30, 2006.

Stock Purchase Plan Information

During the three months ended June 30, 2006 no shares were issued. During the six months ended June 30, 2006, 36,070 shares were issued at a purchase price of $3.93. At June 30, 2006, approximately 160,000 shares were reserved for future issuance and the aggregate intrinsic value of these reserved shares outstanding under the Company’s Stock Purchase Plan was $100,000.

Net Loss per Common Share

Net loss per share is calculated in accordance with SFAS No. 128, Earnings Per Share, and SAB No. 98. Basic loss per share is calculated using the weighted average number of common shares outstanding during each period, without consideration for common stock equivalents. Diluted loss per share includes the dilutive effect of common equivalent shares outstanding for the period determined using the treasury-stock method. For purposes of this calculation, common stock subject to repurchase by the Company, preferred stock, options and warrants are considered to be common stock equivalents and are only included in the calculation of diluted earnings per share when their effect is dilutive.

The pro forma shares used to compute basic and diluted net loss per share below represent the weighted-average common shares outstanding, reduced by the weighted-average unvested common shares subject to repurchase, and include the assumed automatic conversion of all outstanding shares of preferred stock that automatically converted into shares of common stock upon the closing of our IPO, in February 2005, using the as-if converted method as of January 1, 2005 or the date of issuance, if later.

	Three Months ended						Six Months ended
	June 30,						June 30
	2006			2005			2006			2005
	(in thousands, except share and per share data)
Historical:
Numerator:
Net loss	$	(9,825	)	$	(9,373	)	$	(20,680	)	$	(17,778	)
Deemed dividend—beneficial conversion feature for Series C redeemable convertible preferred stock	—			—			—			—
Accretion of Series C redeemable convertible stock issuance costs	—			—			—			(6		)
Net loss applicable to common stockholders	$	(9,825	)	$	(9,373	)	$	(20,680	)	$	(17,784	)
Denominator:
Weighted-average common shares	28,918,782			20,299,889			25,832,433			16,648,144
Weighted-average unvested common shares subject to repurchase	(210,016		)	(489,480		)	(234,671		)	(529,587		)
Denominator for basic and diluted earnings per share	28,708,766			19,810,409			25,597,762			16,118,557

Basic and diluted net loss per share	$	(0.34	)	$	(0.47	)	$	(0.81	)	$	(1.10	)
Pro forma:
Net loss applicable to common stockholders	$	(9,825	)	$	(9,373	)	$	(20,680	)	$	(17,784	)

Pro forma basic and diluted net loss per share	$	(0.34	)	$	(0.47	)	$	(0.81	)	$	(0.96	)

Shares used above	28,708,766			19,810,409			25,597,762			16,118,557
Pro forma adjustments to reflect weighted-average affect of conversion of preferred stock	—			—			—			2,489,291
Pro forma shares used to compute basic and diluted net loss per share	28,708,766			19,810,409			25,597,762			18,607,848

	As of June 30,
	2006	2005
	(in thousands)
Historical outstanding antidilutive securities not included in diluted net loss per share calculation:
Common stock equivalents:
Redeemable convertible preferred stock	—	—
Convertible preferred stock	—	—
Stock warrants	3,122	30
Options to purchase common stock	2,388	1,464
Common stock subject to repurchase	185	444
	5,695	1,938

2. Comprehensive Loss

Components of comprehensive loss were as follows (in thousands):

	Three Months ended June 30,						Six Months ended June 30,
	2006			2005			2006			2005

Net loss	$	(9,825	)	$	(9,373	)	$	(20,680	)	$	(17,778	)
Change in unrealized gain/(loss) on short-term investments	(9		)	5			38			(12		)
Comprehensive loss	$	(9,834	)	$	(9,368	)	$	(20,642	)	$	(17,790	)

Accumulated other comprehensive loss totaled $15,000 and $54,000 at June 30, 2006 and December 31, 2005, respectively, and was attributed to unrealized losses on short-term investments.

3. Stockholders’ Equity

Registration Statement

On June 20, 2006, the Company filed a shelf registration statement with the Securities Exchange Commission on Form S-3. The shelf registration statement on Form S-3 permits the Company to sell, in one or more public offerings, shares of its common stock, debt securities or warrants, or any combination of such securities, for proceeds in an aggregate amount of up to $60 million. On July 11, 2006, the Securities Exchange Commission declared the Form S-3 effective. To date no securities have been issued pursuant to this registration statement.

Private Placement of Common Stock and Warrants

On March 6, 2006, the Company entered into a securities purchase agreement relating to a private placement in which the Company issued and sold to certain investors, for an aggregate purchase price of approximately $45.4 million, 8.6 million shares of its common stock and warrants to purchase up to 3 million shares of its common stock at an exercise price of $5.26 per share. At the closing, investors in the private placement paid $5.26 per share of common stock and an additional purchase price equal to $0.125 per warrant.

Certain of the Company’s existing stockholders, including two members of our board of directors, Ivor Royston, M.D. and Fred Middleton, and funds affiliated with Forward Ventures, Sanderling Ventures, Alloy Ventures and William Blair Capital Partners, invested in the private placement. Dr. Royston, Mr. Middleton, Doug Kelly, M.D. and Arda Minocherhomjee, Ph.D., members of our board of directors on March 6, 2006, are associated with Forward Ventures, Sanderling Ventures, Alloy Ventures and William Blair Capital Partners, respectively.

The Company filed a registration statement with the Securities and Exchange Commission on March 31, 2006 covering the resale of the shares of common stock issued in the private placement and the shares of common stock issuable upon exercise of the warrants issued in the private placement. On April 12, 2006, the Securities and Exchange Commission declared the registration statement effective.

Initial Public Offering

On February 7, 2005, the Company completed an initial closing of its IPO in which it sold 6 million shares of common stock for proceeds of $37.7 million, net of underwriting discounts and commissions and $1.4 million of offering expenses. In addition, on March 7, 2005, the Company completed an additional closing of its IPO in which it sold an additional 285,000 shares of common stock pursuant to the partial exercise by the underwriters of an over-allotment option which resulted in proceeds of $1.8 million, net of underwriting discounts and commissions.

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

Cautionary Note Regarding Forward-Looking Statements

This Form 10-Q contains certain forward-looking statements including expectations of market conditions, challenges and plans, within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and is subject to the Safe Harbor provisions created by that statute. The words “anticipate”, “expect”, “believe”, “plan”, “intend”, and similar expressions are intended to identify such statements. Although the forward-looking statements in this Form 10-Q reflect the good faith judgment of our management, such statements are subject to various risks and uncertainties, including but not limited to those discussed herein and, in particular, the risks described in Item 1A of Part II and throughout our Annual Report on Form 10-K for the year ended December 31, 2005. Actual results and the timing of selected events may differ materially from those anticipated in these forward-looking statements. Except as required by applicable law, we disclaim any duty to update any forward-looking statement to reflect events or circumstances that occur after the date on which such statement is made.

Overview

We are a biopharmaceutical company focused on the development and commercialization of targeted immunotherapies for the treatment of cancer and other diseases of the immune system. We have developed a proprietary technology that enables us to manufacture active immunotherapy products that are designed to stimulate a patient’s immune system to mount a specific and sustained response to disease. Our lead product candidate, FavId, is an active immunotherapy for the treatment of B-cell non-Hodgkin’s lymphoma, or NHL. FavId entered a pivotal Phase 3 clinical trial in follicular B-cell NHL in July 2004 and completed patient enrollment in January 2006 with 347 patients randomized into the trial. In addition, FavId has been evaluated in several multi-center, open-label Phase 2 clinical trials involving more than 130 patients.

We believe FavId may be effective in treating other types of B-cell NHL. Four additional Phase 2 clinical trials and one additional Phase 3 clinical trial of FavId are ongoing. One of these clinical trials is being conducted under a separate physician-sponsored Investigational New Drug, or IND, application in the United States. A second of these is being conducted as a physician-sponsored clinical trial in Switzerland. Moreover, we believe our active immunotherapy expertise and proprietary manufacturing technology may enable us to develop additional product candidates for other oncology indications, such as T-cell lymphoma, and for autoimmune diseases, with an initial focus on multiple sclerosis. In June 2006, we received an allowance from the FDA for an IND for our second product candidate, FAV-201, for the treatment of cutaneous T-cell lymphoma. We have retained exclusive worldwide commercialization rights to all of our product candidates.

We were incorporated in Delaware in January 2000. As of June 30, 2006, we had not generated any revenues, and we had financed our operations and internal growth through private placements of our common stock and warrants, equipment and leasehold debt financings and the sale of common stock in our initial public offering or IPO in February 2005. We are a development stage company and have incurred significant losses since our inception in 2000, as we have devoted substantially all of our efforts to research and development activities, including clinical trials. As of June 30, 2006, our deficit accumulated during the development stage was approximately $136.1 million. We expect to incur substantial and increasing losses for the next several years as we:

• continue to develop and prepare for the commercialization of our lead product candidate, FavId;

• expand our research and development programs;

• expand our current manufacturing capabilities to support commercial manufacturing of FavId; and

• acquire or in-license oncology products that are complementary to our own.

Financial Operations Overview

Research and Development Expense. Research and development expense consists primarily of costs associated with clinical trials of our product candidates, including the costs of manufacturing our product candidates, compensation and other expenses related to research and development personnel, facilities costs and depreciation. We charge all research and development expenses to operations as they are incurred. Our research and development activities are primarily focused on the development of FavId. We have completed enrollment in two Phase 2 clinical trials and continue to evaluate the results. We initiated our pivotal Phase 3 clinical trial of FavId following Rituxan in patients with follicular B-cell NHL in July 2004 and completed patient enrollment in the trial in January 2006. In addition, four additional Phase 2 clinical trials and one additional Phase 3 clinical trial of FavId are ongoing.

From inception through June 30, 2006, we incurred costs of approximately $84.7 million associated with the research and development of FavId, which represents substantially all of our research and development costs to date. We expect our research and development costs to increase as we advance FavId and new product candidates into later stages of clinical development. While difficult to predict, we estimate that research and development costs required to complete the development of and file a Biologics Licensing Application, or BLA, for FavId will be an additional $50 million. We are unable to estimate with any certainty the costs we will incur in the continued development of other product candidates for commercialization. On an ongoing basis, we expect to expand our research and development activities to include clinical development of FAV-201 and preclinical research of treatments for autoimmune diseases, primarily multiple sclerosis.

Clinical development timelines, likelihood of success and total costs vary widely. Although we are currently focused primarily on FavId, we anticipate that we will make determinations as to which research and development projects to pursue and how much funding to direct toward each project on an ongoing basis in response to the scientific and clinical success of each product candidate.

At this time, due to the risks inherent in the clinical trial process, clinical trial completion dates and costs vary significantly for each product candidate and are difficult to estimate. The lengthy process of seeking regulatory approvals and the subsequent compliance with applicable regulations require the expenditure of substantial resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals for our product candidates could cause our research and development expenditures to increase and, in turn, have a material adverse effect on our results of operations. We cannot be certain when any cash flows from our current product candidates will commence.

Marketing, General and Administrative Expense. Marketing, general and administrative expenses consist primarily of compensation and other expenses related to our marketing and corporate general and administrative employees, legal fees and other professional services expenses. We anticipate increases in marketing, general and administrative expenses as we add personnel and continue to develop and prepare for commercialization of our product candidates.

Interest Income Interest income primarily consists of interest earned on our cash reserves, cash invested in money market funds, government securities, corporate notes and bonds and certificates of deposit.

Interest Expense. Interest expense represents interest on our debt, including capital leases.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, expenses and related disclosures. Actual results could differ materially from those estimates. While our significant accounting policies are described in more detail in Note 1 of the Notes to Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements:

Deferred Tax Asset Valuation Allowance. Our estimate for the valuation allowance for deferred tax assets requires us to make significant estimates and judgments about our future operating results. Our ability to realize the deferred tax assets depends on our future taxable income as well as limitations on utilization. A deferred tax asset must be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized prior to its expiration. The projections of our operating results on which the establishment of a valuation allowance is based involve

significant estimates regarding future demand for our products, competitive conditions, product development efforts, approvals of regulatory agencies and product cost. We have recorded a full valuation allowance on our net deferred tax assets as of June 30, 2006 and December 31, 2005, due to uncertainties related to our ability to utilize our deferred tax assets in the foreseeable future. These deferred tax assets primarily consist of certain net operating loss carryforwards and research and development tax credits.

Stock-Based Compensation. We grant options to purchase our common stock to our employees and directors under our stock option plans. Eligible employees can also purchase shares of our common stock at 85% of the lower of the fair market value on the first day of an offering period or the last day of each six-month purchase period during a twenty-four month offering under our employee stock purchase plan. The benefits provided under these plans are stock-based payments subject to the provisions of SFAS 123(R). Effective January 1, 2006, we use the fair value method to apply the provisions of SFAS 123(R) with a modified prospective transition method, which provides for certain changes to the method for valuing stock-based compensation. The valuation provisions of SFAS 123(R) apply to new awards and to awards that are outstanding on the effective date and subsequently modified or cancelled. Under the modified prospective transition method, prior periods are not revised for comparative purposes. Prior to the adoption SFAS 123(R), we recorded compensation expense for these plans based upon their intrinsic value on the date of grant pursuant to Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). Prior to our IPO, we established the exercise price based on the fair value of the Company’s stock at the date of grant as determined by the Board of Directors (the Board). Therefore, the options had no intrinsic value upon grant and no expense was recorded upon issuance. With respect to certain options granted during 2005 and 2004, we had recorded deferred compensation of $350,000 and $9.4 million, respectively, for the incremental difference at the grant date between the fair value per share determined by the Board and the deemed fair value per share determined solely for financial reporting purposes. The deferred stock-based compensation balance of $5.7 million as of December 31, 2005, which was accounted for under APB 25, was reclassified as a reduction of additional paid-in capital upon the adoption of
SFAS 123(R) and the unrecognized expense of awards not yet vested at the date of adoption will be recognized in net income or loss in the periods after the date of adoption using the same Black-Scholes valuation model and assumptions determined under the original provisions of SFAS 123, “Accounting for Stock-Based Compensation,” as disclosed in our previous quarterly and annual reports. The cumulative effect of the change in accounting principle from APB 25 to SFAS 123(R) was not material, because the amortization of expense related to options granted prior to the adoption was based on the single-option approach. Stock-based compensation expense recognized under SFAS 123(R) for the three and six months ended June 30, 2006 was approximately $984,000 and $1.9 million, respectively. At June 30, 2006, total unrecognized estimated compensation expense related to unvested stock options granted prior to that date was $8.1 million, net of estimated forfeitures of $500,000, which is expected to be recognized over a weighted-average period of 2.8 years.

Upon adoption of SFAS 123(R), we estimated the value of stock-based awards on the date of grant using a Black-Scholes valuation model. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, risk-free interest rate and expected dividends.

If factors change and we employ different assumptions in the application of SFAS 123(R) in future periods, the compensation expense that we record under SFAS 123(R) may differ significantly from what we have recorded in the current period. Therefore, we believe it is important for investors to be aware of the high degree of subjectivity involved when using option pricing models to estimate stock-based compensation under SFAS 123(R). Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions, are fully transferable and do not cause dilution. Because our stock-based payments have characteristics significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect our estimates of fair values, in our opinion, existing valuation models, including the Black-Scholes and lattice binomial models, may not provide reliable measures of the fair values of our stock-based compensation. Consequently, there is a risk that our estimates of the fair values of our stock-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration, early termination or forfeiture of those stock-based payments in the future. Certain stock-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that is significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. There is currently no market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values. Although the fair value of stock-based awards is determined in accordance with SFAS 123(R) and the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107 (SAB 107) using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

Clinical Trial Accruals. In the normal course of business, we contract with numerous third-party clinical trial centers to perform various clinical trial activities in the on-going development of FavId. The financial terms of these agreements are subject to negotiation and variation from contract to contract may result in uneven payment flows. Payment under the contracts depends on factors such as the completion of individual patients’ treatments and the related required documentation. We record expenses for contracted clinical trial costs based upon patient enrollment and the dates that they receive treatment. These costs are a significant component of research and development expenses. The objective of our accrual policy is to match the recording of expenses in our financial statements to the actual services received and efforts expended. However, our estimates may not match the timing of actual services performed by the clinical trial centers, which may result in adjustments to our research and development expenses in future periods.

Short- Term Investments. We classify all of our short-term investments as available-for-sale. We carry these investments at fair value, based on quoted market prices, and unrealized gains and losses are included in accumulated other comprehensive income which is reflected as a separate component of stockholders’ equity. The amortized cost of securities in this category is adjusted for amortization of premiums and accretions of discounts to maturity. Such amortization is included in interest income. Realized gains and losses are recorded in our statement of operations. If we believe that an other-than-temporary decline exists, it is our policy to record a write-down to reduce the investments to fair value and record the related charge as a realized loss.

Management has discussed the development and selection of these critical accounting policies with the Audit Committee of our Board of Directors and the Audit Committee has reviewed the disclosures presented above relating to them.

Results of Operations

Comparison of the Three Months Ended June 30, 2006 and 2005

Research and Development. Research and development expense decreased from approximately $7.9 million for the three months ended June 30, 2005 to $7.5 million for the three months ended June 30, 2006. The decrease of approximately $400,000, or 5%, was due primarily to an increase of approximately $450,000 in compensation expenses related to additional personnel and the accrual of the 2006 merit bonus program; an increase of approximately $150,000 in operating expenses related to our manufacturing facility to support the production of FavId; an increase of approximately $150,000 in stock-based compensation costs due to the implementation of SFAS 123(R); an increase of approximately $100,000 in third-party consulting services to assist in developing the IT infrastructure to support the clinical development and marketing approval of FavId; offset by a decrease of approximately $700,000 in expenses for clinical trial site costs and other third-party vendors supporting the pivotal Phase 3 clinical trial and a decrease of approximately $600,000 of raw materials and supplies for the manufacture of FavId due to the completion of patient enrollment in the first quarter of 2006.

Marketing, General and Administrative . Marketing, general and administrative expense increased from approximately $1.7 million for the three months ended June 30, 2005 to $2.9 million for the three months ended June 30, 2006. The increase of $1.2 million, or 71%, primarily reflects an increase of approximately $500,000 in personnel and outside services related to strategic marketing programs; an increase of approximately $200,000 associated with an increase in general and administrative personnel from 15 employees to 23 employees and the accrual of the 2006 merit bonus program; an increase of approximately $200,000 for third-party services to assist in developing the IT infrastructure in preparation for the commercialization of FavId and an increase of approximately $150,000 in stock-based compensation costs due to implementation of SFAS 123(R).

Interest Income. Interest income increased from approximately $400,000 for the three months ended June 30, 2005 to approximately $800,000 for the three months ended June 30, 2006. The increase of $400,000, or 100%, was a result of rising interest rates during the past year and an average balance of approximately $64.0 million compared to approximately $53.0 million over the same period in 2005.

Comparison of the Six Months Ended June 30, 2006 and 2005

Research and Development. Research and development expense increased from approximately $14.7 million for the six months ended June 30, 2005 to $15.9 million for the six months ended June 30, 2006. The increase of $1.2 million, or 8%, was due primarily to an increase of approximately $1.5 million due to compensation costs of additional personnel and the accrual of the 2006 merit bonus program; an increase of approximately $650,000 of operating expenses related to our manufacturing facility to support the production of FavId; an increase of approximately $200,000 in stock-based compensation costs due to the implementation of SFAS 123(R); offset by a decrease of approximately $1.4 million of raw

materials and supplies for the manufacture of FavId due to the completion of patient enrollment in the first quarter of 2006.

Marketing, General and Administrative. Marketing, general and administrative expense increased from approximately $3.3 million for the six months ended June 30, 2005 to $5.6 million for the six months ended June 30, 2006. The increase of approximately $2.3 million, or 70%, primarily reflects an increase of approximately $700,000 in personnel and outside services related to strategic marketing programs; an increase of approximately $500,000 in compensation costs associated with an increase in administrative personnel from 15 employees to 23 employees and the accrual of the 2006 merit bonus program; an increase of approximately $500,000 in legal and audit fees and other public company expenses; an increase of approximately $200,000 in stock-based compensation due to the implementation of SFAS 123(R); and an increase of approximately $200,000 to assist in the building of the IT infrastructure for the commercialization of FavId.

Interest Income. Interest income increased from approximately $700,000 for the six months ended June 30, 2005 to approximately $1.2 million for the six months ended June 30, 2006. The increase of approximately $500,000, or 71%, was a result of rising interest rates during the past year.

Liquidity and Capital Resources

Sources of Liquidity

We have historically funded our operations primarily through the sale of our equity securities and equipment and leasehold debt financing. As of June 30, 2006, we had received proceeds of approximately $76.1 million, net of stock issuance costs of approximately $686,000, from the sale of preferred stock which was converted to common stock immediately preceding our IPO; proceeds from the sale of common stock in our IPO of approximately $39.5 million, net of underwriters’ discounts and commissions of approximately $3.1 million and offering expenses of approximately $1.4 million; and proceeds of approximately $45.0 million from the sale of common stock and warrants to purchase common stock to certain investors, in a private placement, net of offering expenses of approximately $400,000.

As of June 30, 2006 we had financed the purchase of equipment and leasehold improvements through debt totaling approximately $15.7 million. Total debt of $8.3 million was outstanding at that date. These obligations are secured by our existing and future assets excluding intellectual property and are due in monthly installments through January 2010. They bear interest at stated rates ranging from approximately 9.34% to 11.54%. The debt agreements subject us to certain financial and non-financial covenants. As of June 30, 2006, we were in compliance with the terms of the debt agreements.

Cash Flows

As of June 30, 2006, cash, cash equivalents and short-term investments were approximately $61.7 million as compared to $34.5 million at December 31, 2005, an increase of approximately $27.2 million. The increase primarily is due to the $45.4 million in gross proceeds received from our private placement during the first quarter of 2006, partially offset by net cash used to fund ongoing operations.

Net cash used in operating activities was approximately $15.8 million for the six months ended June 30, 2006 compared to $14.8 million for the same period in 2005. The increase of $1.0 million is primarily due to increased operating expenses related to additional personnel and other expenses related to the continuing clinical development and preparation for commercialization of FavId.

Net cash used in investing activities was approximately $14.7 million for the six months ended June 30, 2006 compared to net cash used in investing activities of $4.6 million for the same period in 2005. The increase of $10.1 million is due to $32.1 million in short-term investment purchases offset by increases of $21.8 million in short term investment maturities, $2.6 million in property and equipment purchases and the increase of $1.9 million in restricted cash to collateralize the letter of credit which has been increased to $3.5 million as required by our facility lease agreement.

Net cash provided by financing activities for the six months ended June 30, 2006 totaled $47.2 million, reflecting primarily the net proceeds from our private placement of common stock and warrants in March 2006 of approximately $45.0 million. Net cash provided by financing activities for the same period in 2005 totaled $39.6 million, reflecting primarily the net proceeds from our IPO of $39.5 million in February 2005.

Funding Requirements

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

• magnitude and cost of our product development efforts and other research and development activities;

• rate of progress toward obtaining regulatory approval for our product candidates;

• costs of filing, prosecuting, defending and enforcing our patent claims and other intellectual property rights;

• our ability to establish and maintain collaborative, licensing or other arrangements for the development, sale, marketing or distribution of our product candidates and the terms of those arrangements;

• effects of competing technological and market developments;

• the cost of expansion of our current facility for commercial production or the construction of a large separate commercial-scale production facility; and

• the success of the commercialization of FavId.

Until we can generate significant cash from our operations, we expect to continue to fund our operations with existing cash resources that were primarily generated from the proceeds of offerings of our equity securities and from equipment and leasehold improvement debt financing. In addition, we may finance future cash needs through the sale of other equity securities, strategic collaboration agreements and debt financing. However, we may not be successful in obtaining collaboration agreements, or in receiving milestone or royalty payments under those agreements. In addition, we cannot be sure that our existing cash, cash equivalents and short-term investments will be adequate or that additional financing will be available when needed or that, if available, financing will be obtained on terms favorable to us or our stockholders. Having insufficient funds may require us to delay, scale back or eliminate some or all of our research or development programs or to relinquish rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose. Failure to obtain adequate financing may also adversely affect our ability to operate as a going concern. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders would likely result. If we raise additional funds by incurring debt financing, the terms of the debt may involve significant cash payment obligations as well as covenants and specific financial ratios that may restrict our ability to operate our business.

Off-Balance Sheet Arrangements

As of June 30, 2006, we have not invested in any variable interest entities. We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. Some of the securities in which we invest may be subject to market risk. This means that a change in prevailing interest rates may cause the market value of the investment to fluctuate. To minimize this risk, we may maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds and direct or guaranteed obligations of the United States government. The risk associated with fluctuating interest rates is limited to our investment portfolio and we do not believe that a 1% change in interest rates would have a significant impact on our interest income. As of June 30, 2006, all of our short-term investments were government agency securities, corporate notes and bonds, and our cash equivalents were held in checking accounts and money market funds.

Item 4. Controls and Procedures.

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the

participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended, or Exchange Act. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to cause material information required to be disclosed by the Company in the reports that we file or submit under the Exchange Act to be recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. We believe that a control system, no matter how well designed and operated, is based in part upon certain assumptions about the likelihood of future events, and, therefore, can only provide reasonable, not absolute, assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company will be detected.

During the three months ended June 30, 2006, there were no changes in our internal control over financial reporting which materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION.

Item 1. Legal Proceedings.

We are currently not a party to any material legal proceeding. We may be subject to various claims and legal actions arising in the ordinary course of business from time to time.

Item 1A. Risk Factors

You should consider carefully the risk factors described below, together with the other information contained in this report. If any of the following risks actually occur, our business, financial condition, results of operations and future growth prospects would likely be materially and adversely affected. In these circumstances, the market price of our common stock could decline, and you may lose all or part of your investment in our common stock.

We have marked with an asterisk those risk factors that reflect substantive changes from the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2005.

Risks Related to the Development of Our Product Candidates

*We are dependent on the success of our lead product candidate, FavId, and we cannot be certain that it will be commercialized.

We have expended significant time, money and effort in the development of our lead product candidate, FavId, which is still in clinical development, has not yet received regulatory approval and may never be commercialized. In order to commercialize FavId, we will need to demonstrate to the FDA and other regulatory agencies that it satisfies rigorous standards of safety and effectiveness. We completed patient enrollment in a pivotal Phase 3 clinical trial of FavId following Rituxan for the treatment of follicular B-cell NHL in January 2006.

We are also evaluating FavId for use in other B-cell NHL indications. However, even if we were to receive regulatory approval of FavId for the treatment of follicular B-cell NHL or the other indications we are exploring, our ability to successfully commercialize FavId could be jeopardized by the emergence of a competitive product that exhibits greater efficacy, longer duration of response or other benefits. In addition, because our initial regulatory and marketing strategy contemplates the administration of FavId to patients following treatment with Rituxan, the commercial opportunity for FavId may be limited by the degree to which oncologists continue to use Rituxan to treat indolent B-cell NHL. Furthermore, to the extent FavId fails to gain market acceptance for its initial indication, it may be more difficult for us to generate sufficient credibility with physicians and patients to commercialize FavId for other indications.

Other than FavId, we have only two other product development programs, which are at significantly earlier stages of development. In June 2006, we received an allowance from the FDA for an IND for a product candidate, FAV-201, from one of these programs in patients with cutaneous T-cell lymphoma. We have ongoing preclinical studies to assess the applicability of our technology to autoimmune diseases, with an initial focus on multiple sclerosis. We cannot be certain that we will be able to successfully develop any product candidate from these development programs. We cannot be certain that the clinical development of FavId or any other product candidate in preclinical testing or clinical trials will be successful, that it will receive the regulatory approvals required to commercialize it, or that any of our other research programs will yield a product candidate suitable for entry into clinical trials. If we are unable to commercialize FavId or our other product

candidates, we may be unable to generate sufficient revenues to attain or maintain profitability, our ability to raise additional capital will be impaired and our stock price may be negatively affected.

Failure to obtain product approvals by the FDA could harm our business.

We are subject to rigorous and extensive regulation by the FDA. In the United States, our biologic product candidates, currently in the preclinical and clinical stages of development, cannot be marketed until they are approved by the FDA. Obtaining FDA approval involves the submission of the results of preclinical studies and clinical trials, among other information, of the product candidates. We may not be able to obtain FDA approval, and, even if we are able to do so, the approval process typically takes many years and requires the commitment of substantial effort and financial resources. The FDA can delay, limit or deny approval of a biologic product candidate for many reasons, including:

• the FDA may not find that the biologic product candidate is sufficiently safe or effective;

• FDA officials may interpret data from preclinical testing and clinical trials differently than we do; and

• the FDA may not find our manufacturing processes or facilities satisfactory.

In addition, the specific active immunotherapy technology on which FavId is based is a relatively new form of cancer therapy that presents novel issues for the FDA to consider, which may make the regulatory process especially difficult.

We cannot assure you that any of our product candidates in development will be approved in the United States in a timely fashion, or at all. Failure to obtain regulatory approval of our product candidates in a timely fashion would prevent or delay us from marketing or selling any products and, therefore, from generating revenues from their sale. If this occurs, we may be unable to generate sufficient revenues to attain or maintain profitability, our ability to raise additional capital will be impaired and our stock price may be negatively affected. In addition, both before and after approval, we are subject to numerous FDA requirements covering, among other things, testing, manufacturing, quality control, labeling, advertising, promotion and export of biologics. Failure to comply with the law, including statutes and regulations, administered by the FDA, could result in, among others, any of the following actions:

• warning letters;

• fines and other civil penalties;

• unanticipated expenditures;

• delays in approving or refusal to approve a product candidate;

• product recall or seizure;

• interruption of production;

• operating restrictions;

• injunctions; and

• criminal prosecution.

*Before we can seek regulatory approval of any of our product candidates, we must successfully complete clinical trials, which are uncertain.

Conducting clinical trials is a lengthy, time-consuming and expensive process, and the results of these trials are inherently uncertain. We have completed enrollment of patients in several Phase 2 clinical trials of FavId involving over 130 indolent B-cell NHL patients and are currently conducting follow-up evaluation of those patients. We completed enrollment of patients in a pivotal Phase 3 clinical trial of FavId for the treatment of follicular B-cell NHL in January 2006 and anticipate an analysis of the secondary endpoint, response improvement, during the fourth quarter of 2006 and a final analysis of the primary endpoint, TTP, during the second half of 2007. Four additional Phase 2 clinical trials and one additional Phase 3 clinical trial of FavId are ongoing. One of these clinical trials is being conducted under a separate physician-sponsored IND in the United States. A second of these is being conducted as a physician-sponsored clinical trial in Switzerland. In June

2006, we received an allowance from the FDA for an IND for our second product candidate, FAV-201, for the treatment of cutaneous T-cell lymphoma.

We have received a Special Protocol Assessment, or SPA, from the FDA for our pivotal Phase 3 clinical trial of FavId. In the SPA process, the FDA reviewed the design, size and planned analysis of our Phase 3 clinical trial and provided comments regarding the trial’s adequacy to form a basis with respect to effectiveness for approval of a Biologics Licensing Application, or BLA, if the trial meets its predetermined objectives. We cannot assure you that we will be able to file a BLA for FavId until after we receive an analysis of the primary endpoint, TTP, of our ongoing pivotal Phase 3 clinical trial (assuming the TTP data is positive), which analysis is anticipated in the second half of 2007, or at all. The FDA’s written agreement is binding, except in limited circumstances, such as when a substantial scientific issue essential to determining the safety or effectiveness of a product candidate is identified after the Phase 3 clinical trial is commenced. Despite having received an SPA, we may be required to conduct an additional Phase 3 clinical trial of FavId for the treatment of indolent B-cell NHL before we can apply for regulatory approval. Although the FDA typically requires successful results in two Phase 3 clinical trials to support marketing approval, the FDA has, on several occasions, approved products based on a single Phase 3 clinical trial that demonstrates a high level of statistical significance where there is an unmet need for a life-threatening condition. We currently plan to seek FDA approval of FavId based on our ongoing pivotal Phase 3 clinical trial alone. In the event that the FDA requires the results of a second Phase 3 clinical trial before accepting a BLA or before granting marketing approval of FavId, our launch of FavId would be delayed, possibly by several years, and we would incur significant costs in conducting the additional trial.

Completion of necessary clinical trials may take several years or more. Our commencement and rate of completion of clinical trials may be delayed by many factors, including:

• ineffectiveness of the product candidate, or perceptions by physicians that the product candidate is not safe or effective for a particular indication;

• inability to manufacture sufficient quantities of the product candidate for use in clinical trials;

• delay or failure in obtaining approval of our clinical trial protocols from the FDA;

• slower than expected rate of patient recruitment and enrollment;

• inability to adequately follow and monitor patients after treatment;

• difficulty in managing multiple clinical sites;

• unforeseen safety issues; and

• government or regulatory delays.

Even if we achieve positive interim results in clinical trials, these results do not necessarily predict final results, and positive results in early trials may not be indicative of success in later trials. A number of companies in the pharmaceutical industry have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. Negative or inconclusive results or adverse medical events during a clinical trial could cause us to repeat or terminate a clinical trial or require us to conduct additional trials. Our clinical trials may be suspended at any time for a variety of reasons, including if the FDA or we believe the patients participating in our trials are exposed to unacceptable health risks or if the FDA finds deficiencies in the conduct of these trials.

Failures or perceived failures in our clinical trials will directly delay our product development and regulatory approval process, damage our business prospects, make it difficult for us to establish collaboration and partnership relationships, and negatively affect our reputation and competitive position in the pharmaceutical community.

Failure to enroll patients in our clinical trials may cause delays in developing FavId or any other product candidate.

We may encounter delays in development and commercialization, or fail to obtain marketing approval, of FavId or any other product candidate that we may develop if we are unable to enroll enough patients to complete clinical trials. Our ability to enroll sufficient numbers of patients in our clinical trials depends on many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites, the eligibility criteria for the trial and competing clinical trials. Although we completed patient enrollment in our pivotal Phase 3 clinical trial of FavId in January 2006, we have from time to time experienced slower-than-expected patient enrollment in our clinical trials and may do so in

the future if additional clinical trials of FavId are required or if we clinically develop any of our other product candidates. Delays in planned patient enrollment may result in increased costs and harm our ability to complete our clinical trials and obtain regulatory approval.

The development of FavId requires the continued availability of two FDA-approved drugs: GM-CSF and Rituxan.

Administration of FavId requires an adjuvant, which is a substance that is used to enhance the immune response. We use a white blood cell growth factor known as GM-CSF, which is commercially available solely from Berlex Laboratories, Inc., as an adjuvant for FavId. We currently rely on purchase orders to purchase GM-CSF for use in our clinical trials and do not have a supply agreement with Berlex. GM-CSF is an FDA-approved and commercially available drug that may be purchased by physicians. Our current strategy for the initial commercialization of FavId involves the administration of FavId following treatment with Rituxan. Rituxan is a passive immunotherapy for patients with NHL, which is also FDA-approved and is commercially available solely from Genentech, Inc. and Biogen Idec Inc. We currently rely on physicians to order and administer Rituxan to patients prior to the administration of FavId in our registration trial. If GM-CSF or Rituxan were to become unavailable as a result of regulatory actions, supply constraints or other reasons, our ability to continue the clinical development of FavId would be jeopardized.

Risks Related to Our Financial Results and Need for Financing

*We have incurred significant operating losses since inception and anticipate that we will continue to incur substantial losses and negative cash flow from operations for the foreseeable future.

We are a development stage company with a limited operating history. We have financed our operations through private placements of stock and warrants, an initial public offering of our common stock and equipment and leasehold debt financing. We have incurred losses in each year since our inception in 2000. Net losses were $9.8 million and $20.7 million for the three and six months ended June 30, 2006, respectively, and $9.4 million and $17.8 million for the three and six months ended June 30 2005, respectively. As of June 30, 2006, we had an accumulated deficit of $136.1 million. These losses, among other things, have had and will continue to have an adverse effect on our stockholders’ equity and working capital. We expect to incur substantial operating losses for at least the next several years. This is due primarily to the expansion of our clinical trials and research and development programs, preparations to manufacture FavId on a commercial scale, and, to a lesser extent, general and administrative expenses. We also have substantial lease and debt obligations related to our new manufacturing and headquarters facilities impacting our operating expenses. We expect that our losses will fluctuate from quarter to quarter and that these fluctuations may be substantial. We cannot guarantee that we will successfully develop, manufacture, commercialize or market any products. As a result, we cannot guarantee that we will ever achieve or sustain product revenues or profitability.

We currently have no source of revenue and may never become profitable.

Our ability to become profitable will depend upon our ability to generate revenue. To date, FavId has not generated any revenue, and we do not know when or if FavId will generate revenue. Our ability to generate revenue depends on a number of factors, including our ability to:

• successfully complete clinical trials for FavId;

• obtain regulatory approval for FavId, including regulatory approval for our commercial scale manufacturing facility and process;

• manufacture commercial quantities of FavId at acceptable cost levels; and

• successfully market and sell FavId.

We do not anticipate that we will generate revenues until 2008, at the earliest. Further, we do not expect to achieve profitability for at least several years after generating material revenues. If we are unable to generate revenue, we will not become profitable, and we may be unable to continue our operations.

*We will need substantial additional funds to continue operations, which we may not be able to raise on favorable terms, or at all.

We will need substantial additional funds for existing and planned preclinical studies and clinical trials, to continue research and development activities, for lease and debt obligations related to our manufacturing and headquarter facilities, and to establish manufacturing and marketing capabilities for any products we may develop. In addition, because we do not expect

to generate revenues from the sale of our product candidates for several years, if at all, we will also need to raise additional capital to fund our operations.

We believe that our existing cash, cash equivalents and short-term investments, together with interest thereon, will be sufficient to meet our projected operating requirements through fiscal 2007. We will need to raise additional funds in order to commercialize FavId, including the completion of the expansion and qualification of our manufacturing facility for commercial-scale production. Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed elsewhere in this report. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect.

Our future capital requirements or the adequacy of our available funds will depend on many factors, including, but not limited to:

• magnitude and cost of our product development efforts and other research and development activities;

• rate of progress toward obtaining regulatory approval for our product candidates;

• costs of filing, prosecuting, defending and enforcing our patent claims and other intellectual property rights;

• effects of competing technological and market developments;

• the cost of expansion of our current facility for commercial production or the construction of a large separate commercial-scale production facility; and

• the success of the commercialization of FavId.

Future capital requirements will also depend on the extent to which we acquire or invest in businesses, products and technologies, but we currently have no commitments or agreements relating to any of these types of transactions.

To that end, on June 20, 2006, we filed a shelf registration statement with the SEC on Form S-3 pursuant to which we may periodically sell up to $60 million in debt securities, common stock or warrants to purchase debt securities or common stock. We may seek to access the public or private equity markets whenever conditions are favorable, even if we do not have an immediate need for additional capital at that time. Additional funding may not be available to us, and, if available, may not be on acceptable terms. If we raise additional funds by issuing equity securities, stockholders will incur immediate dilution. If adequate funds are not available to us, we may be required to delay, reduce the scope of, or eliminate one or more of our research, development and clinical activities. Alternatively, we may need to seek funds through arrangements with collaborative partners or others that require us to relinquish rights to technologies or product candidates that we would otherwise seek to develop or commercialize ourselves. Any of these events could have a material adverse effect on our business, results of operations, financial condition or cash flow.

*Future changes in financial accounting standards or practices or existing taxation rules or practices may cause adverse unexpected revenue or expense fluctuations and affect our reported results of operations.

A change in accounting standards or practices or a change in existing taxation rules or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and taxation rules and varying interpretations of accounting pronouncements and taxation practice have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, in December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” In April 2005, the SEC approved a vote that effectively required us to adopt this statement on January 1, 2006. This statement eliminates the ability to account for stock-based compensation using the intrinsic value method allowed under APB 25 and requires these transactions to be recognized as compensation expense in the statement of operations based on the fair values on the date of grant, with the compensation expense recognized over the period in which an employee or director is required to provide service in exchange for the stock award. This new requirement will result in an increase in our stock-based compensation expense, which may increase our net losses. For example, as a result of adopting

SFAS 123(R), the Company’s net loss for the three and six months ended June 30, 2006 is approximately $300,000 and $500,000 larger, respectively, than if the Company had continued to account for stock-based compensation under APB 25. Basic and diluted net loss per share for the three and six months ended June 30, 2006 are $0.01 and $0.02 higher, respectively, than if the Company had continued to account for stock-based compensation under APB 25.

Other Risks Related to Our Business and Industry

We currently depend on single source suppliers for critical raw materials for manufacturing. The loss of these suppliers could delay our clinical trials or prevent or delay commercialization of FavId.

We currently depend on single source suppliers for critical raw materials used in the manufacture of FavId. In particular, our manufacturing process for FavId requires a foreign protein derived from shellfish that is known as keyhole limpet hemocyanin, or KLH. We purchase KLH from biosyn Arzneimittel GmbH, or biosyn, which is currently the only supplier of KLH that has submitted the required filing, known as a drug master file, to the FDA. In November 2004, we entered into an eight-year supply and license agreement with biosyn under which biosyn has agreed to supply us with KLH and we have committed to annual KLH purchase requirements during the commercialization of FavId. An additional aggregate of up to $300,000 will be due upon the achievement of certain milestones, the timing of which is not known at this time. Either party may terminate the supply agreement upon a breach by the other party that is not cured within 60 days or other events relating to insolvency or bankruptcy. If we identify another supplier of KLH of suitable quality for our purposes, we will not be able to use the supplier as a second source of KLH for the commercial manufacture of FavId unless the KLH is tested to be comparable to the existing KLH.

In addition, we depend on a single source supplier for the cell growth media we use to produce FavId. We purchase this material from Expression Systems LLC, which in turn obtains several of the components used in the cell growth media from sole suppliers. We currently rely on purchase orders to obtain this material and do not have a supply agreement with Expression Systems. We intend to qualify a second source for the cell growth media or manufacture the cell growth media in house from commercially available raw materials but may not be able to do so.

Establishing additional or replacement suppliers for these materials may take a substantial amount of time. In addition, we may have difficulty obtaining similar materials from other suppliers that are acceptable to the FDA. If we have to switch to a replacement supplier, we may face additional regulatory delays and the manufacture and delivery of FavId, or any other product candidates that we may develop, could be interrupted for an extended period of time, which may delay completion of our clinical trials or commercialization. If we are unable to obtain adequate amounts of these materials, our clinical trials will be delayed. In addition, we will be required to obtain regulatory clearance from the FDA to use different materials that may not be as safe or as effective. As a result, regulatory approval of FavId, or any other product candidates that we may develop, may not be received at all.

*We rely on third parties to conduct our clinical trials. If these third parties do not successfully carry out their contractual duties or meet expected deadlines, we may be delayed or may not be able to obtain regulatory approval for or commercialize FavId or any other product candidates that we may develop.

Our pivotal Phase 3 clinical trial of FavId for the treatment of follicular B-cell NHL is being conducted at 67 centers in the United States and will require long-term follow up of the 347 patients randomized into the trial. Two clinical trials of FavId are being conducted under the direction of a physician sponsor, rather than under our supervision. We do not have the ability to independently conduct clinical trials for FavId, or any other product candidate that we may develop, and we must rely on third parties, such as medical institutions and clinical investigators, including physician sponsors, to conduct our clinical trials. In particular, we will rely on these parties to recruit and enroll patients in our clinical trials. We also rely on third-party couriers to transport patient tissue samples and FavId. If any of the third parties upon whom we rely to conduct our clinical trials or transport patient tissue samples and immunotherapies do not comply with applicable laws, successfully carry out their obligations or meet expected deadlines, and need to be replaced, our clinical trials may be extended, delayed or terminated.

If the quality or accuracy of the clinical data obtained by medical institutions and clinical investigators, including physician sponsors and other third-party vendors involved in data management, is compromised due to their failure to adhere to applicable laws or our clinical protocols or for other reasons, we may not be able to obtain regulatory approval for or successfully commercialize FavId, or any other product candidates that we may develop. If any of our relationships with any of these organizations or individuals terminates, we believe that we would be able to enter into arrangements with alternative third parties. However, replacing any of these third parties would delay our clinical trials and could jeopardize our ability to commercialize FavId and our other product candidates on a timely basis, or at all.

Even if we obtain regulatory approval, we will continue to be subject to extensive government regulation that may cause us to delay the introduction of our products or withdraw our products from the market.

Even if we obtain regulatory approval for FavId or our other product candidates, we will still be subject to extensive regulation. These regulations will impact many aspects of our operations, including production, record keeping, quality control, adverse event reporting, storage, labeling, advertising, promotion and personnel. In addition, the later discovery of previously unknown problems may result in restrictions of the product candidates, including their withdrawal from the market. Furthermore, regulatory approval may subject us to ongoing requirements for post-marketing studies. If we or any third party that we involve in our operations fail to comply with any continuing regulations, we may be subject to, among other things, product seizures, recalls, fines or other civil penalties, injunctions, suspensions or revocations of marketing licenses, operating restrictions and criminal prosecution.

*Before we can obtain marketing approval for or commercially distribute FavId, we must have a commercial-scale facility for the manufacture of FavId. In addition, the FDA and the California Department of Health Services must find our manufacturing facility and process satisfactory.

Our manufacturing methods, equipment and processes must comply with the FDA’s current Good Manufacturing Practices, or cGMP, requirements. We may also need to perform extensive audits of vendors, contract laboratories and suppliers. The cGMP requirements govern, among other things, record keeping, production processes and controls, personnel and quality control. We have only undertaken initial steps towards achieving compliance with these regulatory requirements. Additional steps will require expenditure of significant time, money and effort. We cannot predict the likelihood that the FDA will find our facility satisfactory, even if we believe that we have taken the necessary steps to achieve compliance. If we fail to comply with these requirements or fail to pass a pre-approval inspection of our manufacturing facility in connection with an application to obtain marketing approval for FavId or another product candidate, we would not receive regulatory approval, and we would be subject to possible regulatory action.

We manufacture FavId for our ongoing pivotal Phase 3 and for the planned and ongoing Phase 1/2/3 clinical trials at our facility in San Diego. We currently lease approximately 80,000 square feet of space in a facility in San Diego, California under a long-term lease agreement. This space is used for our corporate headquarters and manufacturing and laboratory facilities. Our manufacturing facility consists of approximately 26,000 square feet of space in the facility. Our manufacturing facility is subject to the licensing requirements of the California Department of Health Services. Our facility was inspected and licensed by the California Department of Health Services. Our facility is subject to re-inspection at any time. Failure to maintain a license from the California Department of Health Services or to meet the inspection criteria of the California Department of Health Services would disrupt our manufacturing processes and prevent us from supplying FavId to patients. If an inspection by the California Department of Health Services indicates that there are deficiencies in our manufacturing process, we could be required to take remedial actions at potentially significant expense, and our facility may be temporarily or permanently closed.

We will need to either expand and qualify our current facility or construct and qualify a commercial scale manufacturing facility in order to commercialize FavId or any other product candidates that we may develop. We believe our current facility could be used to manufacture FavId for initial commercial launch, and we began construction to expand this facility during the second quarter of 2006. We cannot assure you that we would be able to meet commercial demand for FavId in this facility. Additionally, we may require a larger production facility to meet the demand for FavId if it is approved. We would need to raise additional debt or equity capital to finance construction of the larger facility. Such financing may not be available or, if available, may not be obtained on terms favorable to us or our stockholders.

Preparing a facility for commercial manufacturing may involve unanticipated delays and the costs of complying with FDA regulations may be significant. In addition, any material changes we make to the manufacturing process after approval may require approval by the FDA and state regulatory authorities. Obtaining these approvals is a lengthy, involved process, and we may experience delays that could limit our ability to manufacture commercial quantities, increase our costs and adversely affect our business.

We may experience difficulties in manufacturing FavId or any other product candidates that we may develop, which could prevent us from completing our ongoing clinical trials and commercializing these product candidates.

Manufacturing FavId is a complex, multi-step process that requires us to expend significant time, money and effort in production, record keeping and quality systems to assure that FavId will meet product specifications and other regulatory requirements. To date, we have manufactured FavId only for use in Phase 2 and Phase 3 clinical trials and have no experience in manufacturing FavId for the commercial quantities that might be required if we receive regulatory approval. In particular, we cannot be sure that we will be able to manufacture FavId at a cost that would enable commercial use. We may experience

any of the following problems in our efforts to manufacture our product candidates for our expanding clinical trials or on a commercial scale:

• failure to obtain a sufficient supply of key raw materials;

• difficulties in completing the development and validation of the specialized assays required to ensure the consistency of our product candidates, including FavId;

• difficulties in obtaining adequate tumor samples from treating physicians and hospitals;

• difficulties in manufacturing FavId for multiple patients simultaneously;

• difficulties in the timely shipping of tumor samples to us or in the shipping of FavId to the treating physicians due to errors by third-party couriers, transportation restrictions or other reasons;

• failure to ensure adequate quality control and assurance in the manufacturing process as we increase the production quantities of FavId;

• difficulties in establishing and effectively managing a commercial-scale manufacturing facility;

• failure to comply with regulatory requirements, such as FDA regulations and environmental laws;

• significant changes in regulatory requirements;

• damage to or destruction of our manufacturing facility or equipment;

• difficulty in qualifying a second-source supplier for certain critical equipment; and

• shortages of qualified personnel.

In addition, because our manufacturing process only begins upon our receipt of a patient’s tumor biopsy, we cannot produce inventory reserves of our product candidate to be stored in anticipation of any of these potential manufacturing problems. The failure to produce an adequate supply of FavId could delay our clinical trials and, in turn, delay submission of a BLA for FavId and commercial launch. Similarly, any difficulties we experience in the manufacture and supply of other product candidates, such as FAV-201, would delay the clinical trials of those product candidates.

If our manufacturing facility is damaged or destroyed, our ability to manufacture products will be significantly affected, which could delay or prevent completion of our clinical trials and commercialization of FavId or any other product candidates that we may develop.

We currently rely on the availability and condition of our manufacturing facility in San Diego to manufacture FavId. We lease the property where this facility is located under a lease agreement that expires June 30, 2025, but may be extended at our option for two additional five-year periods. After that time, we may not be able to negotiate a new lease for our facility. If the facility or our equipment in the facility is damaged or destroyed, we will not be able to quickly or inexpensively replace our manufacturing capacity. This would significantly affect our ability to complete clinical trials of, and to manufacture and commercialize, FavId, or any other product candidates that we may develop.

In addition, our facilities have been subject to electrical blackouts as a result of a shortage of available electrical power. Although we have back-up emergency power generators to cover energy needs for key support systems, a lengthy outage could disrupt the operations of our facilities and clinical trials. While we carry business interruption insurance, this insurance may not be adequate. Any significant business interruption could cause delays in our product development and harm our business.

If we do not develop a sufficient sales and marketing force or enter into agreements with third parties to sell and market FavId, we may not be able to successfully commercialize our products, which would limit our ability to earn product revenues.

We plan to retain exclusive worldwide rights to FavId for oncology indications at least through the completion of our BLA filing with the FDA for approval to market FavId in the United States. If we are successful in obtaining BLA approval or foreign marketing approval for FavId, we will need to establish sales and marketing capabilities. In the United States, we plan

to do this either by establishing our own sales force or by entering into a co-promotion arrangement with a sales and distribution partner. Outside of the United States, we plan to establish strategic collaborations for the development and marketing of FavId.

We do not presently possess the resources or experience necessary to market FavId or our other product candidates ourselves, and we currently have no arrangements for the promotion or distribution of our product candidates. Our future commercial success will depend on our ability to establish our own sales and marketing infrastructure or to collaborate with third parties that have greater sales and marketing experience and resources. Developing effective internal sales and marketing capabilities, which would include the hiring of a sales force, would require a significant amount of our financial resources and time.

We may be unable to establish and manage an effective sales force in a timely or cost-effective manner, or at all, and any sales force we do establish may not be capable of generating demand for FavId or any other product candidate we may develop. In addition, if we cannot enter into co-promotion arrangements in the United States, or other strategic collaborations for the development and marketing of FavId in other countries, in a timely manner and on acceptable terms, we may not be able to successfully commercialize FavId or any other product candidate that we may develop.

To the extent that we enter into arrangements with third parties to perform sales, marketing and distribution services, our product revenues are likely to be lower than if we directly marketed and sold FavId, or any other product candidates that we may develop. If we are unable to establish adequate sales, marketing and distribution capabilities, independently or with others, we will not be able to generate product revenue and will not become profitable.

If physicians and patients do not use any of our products that may be approved, our ability to generate revenue in the future will be limited.

If approved, FavId and other product candidates that we may develop may not gain market acceptance among physicians, healthcare payors, patients and the medical community. Demand for any approved product that we may develop will depend on many factors, including:

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

• convenience and ease of administration;

• availability of alternative treatments;

• cost effectiveness;

• continuing widespread use of Rituxan to treat our initial target disease market;

• effectiveness of our regulatory and marketing strategies;

• prevalence and severity of adverse side effects;

• publicity concerning our products or competitive products; and

• our ability to obtain third-party coverage or reimbursement.

Furthermore, to the extent FavId fails to gain market acceptance for its initial indication, it may be more difficult for us to generate sufficient credibility with physicians and patients to commercialize FavId for other indications.

If we are unable to obtain acceptable prices or adequate coverage and reimbursement from third-party payors for FavId, or any other product candidates that we may develop, our revenues and prospects for profitability will suffer.

Our ability to commercialize FavId, or any other product candidates that we may develop, depends on the extent to which coverage and reimbursement for FavId, or any other product candidates that we may develop, will be available from:

• governmental payors, such as Medicare and Medicaid;

• private health insurers, including managed care organizations; and

• other third-party payors.

Many patients will not be capable of paying for FavId, or any other product candidates that we may develop, themselves and will rely on third-party payors to pay for their medical needs. The federal and state governments, insurance companies, managed care organizations and other third-party payors are actively seeking to contain or reduce costs of health care in the United States and exert increasing influence on decisions regarding the use of, and reimbursement levels for, particular treatments. Such third-party payors, including Medicare, are scrutinizing newly approved medical products and services and may not cover or may limit coverage and reimbursement for our product candidates. In particular, third-party payors may limit the indications for which they will reimburse patients who use FavId, or any other product candidates that we may develop. Cost-control initiatives could cause us to decrease the price we might establish for FavId, or any other product candidates that we may develop, which would result in lower product revenues. If the prices for FavId, or any other product candidates that we may develop, decrease or if governmental and other third-party payors do not provide adequate coverage and reimbursement levels for FavId, or any other product candidates that we may develop, our revenue and prospects for profitability will suffer.

If we are unable to establish or manage strategic collaborations in the future, our revenue and product development may be limited.

Our strategy may include reliance on strategic collaborations for co-promotion of FavId in the United States. In addition, we expect to rely on strategic collaborators for commercialization of FavId outside of the United States and, to an even greater extent, for worldwide development and commercialization of product candidates and programs for chronic autoimmune diseases, such as multiple sclerosis. To date, we have not entered into any agreements with third parties for any of these services and do not plan to establish a collaboration for FavId in the United States until at least completion of a BLA filing.

Establishing strategic collaborations is difficult and time-consuming. Our discussions with potential collaborators may not lead to the establishment of new collaborations on favorable terms, or at all. For example, potential partners may reject collaborations based upon their assessment of our financial, regulatory or intellectual property position. If we successfully establish new collaborations, these relationships may never result in the successful development or commercialization of our product candidates or the generation of sales revenue. To the extent that we enter into co-promotion or other collaborative arrangements, our product revenues are likely to be lower than if we directly marketed and sold any products that we may develop.

Management of any collaborative relationship we may establish in the future will require:

• significant time and effort from our management team;

• coordination of our research and development programs with the research and development priorities of our collaborators; and

• effective allocation of our resources to multiple projects.

If we enter into development or commercialization collaborations, our success will in part depend on the performance of our corporate collaborators. We will not directly control the amount or timing of resources devoted by our corporate collaborators to activities related to our product candidates. Our corporate collaborators may not commit sufficient resources to our research and development programs or the commercialization, marketing or distribution of our product candidates. If any corporate collaborator fails to commit sufficient resources, our preclinical or clinical development related to the collaboration could be delayed or terminated. Also, our collaborators may pursue development or commercialization of other products, product candidates or alternative technologies in preference to our product candidates. Finally, our collaborators may terminate our relationships, and we may be unable to establish additional corporate collaborations in the future on acceptable terms, or at all.

Our efforts to discover, develop and commercialize new product candidates beyond FavId are at an early stage and are subject to a high risk of failure.

Our strategy is focused on the research, development and commercialization of targeted immunotherapies for the treatment of cancer and other diseases of the immune system. The process of successfully developing product candidates is very time-consuming, expensive and unpredictable. We have only recently begun to direct significant effort toward the development of product candidates in addition to FavId, such as FAV-201 for T-cell lymphoma and a preclinical product candidate for the treatment of multiple sclerosis. We do not know whether our planned preclinical studies or clinical trials for these other product candidates will begin on time or be completed on schedule, or at all. In addition, we do not know whether these clinical trials will result in marketable products. Typically, there is a high rate of attrition for product candidates in preclinical and clinical trials. We do not anticipate that any of our product candidates will reach the market for at least several years.

We may not identify, develop or commercialize any additional new product candidates from our proprietary active immunotherapy technology. Our ability to develop successfully any of these product candidates depends on our ability to demonstrate safety and efficacy in humans through extensive preclinical testing and clinical trials and to obtain regulatory approval from the FDA and other regulatory authorities. Development of our product candidates will also depend substantially upon the availability of funding for our research and development programs.

If our competitors develop and market products that are more effective than our existing product candidates or others we may develop, or obtain marketing approval before we do, our commercial opportunity may be reduced or eliminated.

The development and commercialization of new pharmaceutical products for the treatment of cancer and autoimmune diseases is competitive, and we will face competition from numerous sources, including major pharmaceutical companies, specialty pharmaceutical companies and biotechnology companies worldwide. Many of our competitors have substantially greater financial and technical resources and development, production and marketing capabilities than we do. In addition, many of these companies have more experience than we do in preclinical testing, clinical trials and manufacturing of biologic therapeutics, as well as in obtaining FDA and foreign regulatory approvals. We will also compete with academic institutions, governmental agencies and private organizations that are conducting research in the fields of cancer and autoimmune disease. Competition among these entities to recruit and retain highly qualified scientific, technical and professional personnel and consultants is also intense.

We are aware of a number of companies that are developing active immunotherapies to treat B-cell NHL. Genitope Corporation is evaluating its idiotype immunotherapy product candidate in a Phase 3 clinical trial in patients with follicular B-cell NHL who are in remission following prior treatment with chemotherapy. Antigenics, Inc. completed a Phase 2 clinical trial evaluating its active immunotherapy candidate in indolent NHL patients. The NCI is also conducting a Phase 3 clinical trial of an active idiotype immunotherapy in collaboration with Accentia Biopharmaceuticals.

Several companies are engaged in the development and commercialization of passive immunotherapy products for the treatment of B-cell NHL that may compete with FavId. Genentech and Biogen Idec are co-marketing Rituxan for the treatment of relapsed or refractory, indolent B-cell NHL. Biogen Idec has also received FDA approval to market Zevalin, its passive radioimmunotherapy product. GlaxoSmithKline plc has received FDA approval to market Bexxar, a passive radioimmunotherapy product.

The most recent advances in the treatment of B-cell NHL have involved the combination of existing products and changes to approved schedules and doses, particularly for Rituxan. Numerous clinical trials reported in recent years have indicated that additional doses of Rituxan and maintenance dosing of Rituxan can improve TTP in patients who respond to therapy. Combination therapies involving chemotherapeutic or immunostimulatory drugs in combination with Rituxan at various doses and schedules may provide patients with an increase in TTP over that expected with Rituxan alone. Accordingly, we may face competition as a result of developments in this area.

We expect that our ability to compete effectively will depend upon our ability to:

• successfully and rapidly complete clinical trials and obtain all requisite regulatory approvals in a cost-effective manner;

• reliably and cost-effectively manufacture sufficient quantities of our products;

• maintain a proprietary position for our manufacturing process and other technology;

• price our products competitively;

• obtain appropriate reimbursement approvals for our products;

• establish an adequate sales and marketing force for our products; and

• attract and retain key personnel.

In addition, our ability to compete effectively will depend on the relative efficacy and safety of other active immunotherapy products approved for sale as compared to our own products.

We are subject to new legislation, regulatory proposals and managed care initiatives that may increase our costs of compliance and adversely affect our ability to market our products, obtain collaborators and raise capital.

There have been a number of legislative and regulatory proposals aimed at changing the healthcare system and pharmaceutical industry, including reductions in the cost of prescription products and changes in the levels at which consumers and healthcare providers are reimbursed for purchases of pharmaceutical products. For example, the Prescription Drug and Medicare Improvement Act of 2003 was recently enacted. This legislation provides a new Medicare prescription drug benefit beginning in 2006 and mandates other reforms. Although we cannot predict the full effects on our business of the implementation of this new legislation, it is possible that the new benefit, which will be managed by private health insurers, pharmacy benefit managers and other managed care organizations, will result in decreased reimbursement for prescription drugs, which may further exacerbate industry-wide pressure to reduce the prices charged for prescription drugs. This could harm our ability to market our products and generate revenues.

We depend on attracting and retaining key scientific and management personnel to advance our technology, and the loss of these personnel could impair the development of our products.

Our success depends on our continued ability to attract, retain and motivate highly qualified management, clinical and scientific personnel and on our ability to develop and maintain important relationships with leading academic institutions, clinicians and scientists. We are highly dependent upon our senior management and scientific staff, particularly John P. Longenecker, Ph.D., our President and Chief Executive Officer, and Daniel P. Gold, Ph.D., one of our co-founders and our Chief Scientific Officer. The loss of services of Dr. Longenecker or Dr. Gold, or one or more of our other members of senior management, could delay or prevent the successful completion of our pivotal Phase 3 clinical trial or the commercialization of FavId. Although we have employment agreements with each of our executives, their employment with us is “at will,” and each executive can terminate his or her agreement with us at any time. We do not carry “key person” insurance covering members of senior management, other than Drs. Longenecker and Gold. This insurance may not continue to be available on commercially reasonable terms and may prove inadequate to compensate us for the loss of their services.

The competition for qualified personnel in the biotechnology field is intense. In particular, our manufacturing process depends on our ability to attract and retain qualified manufacturing and quality control personnel. We will need to hire additional personnel as we continue to expand our manufacturing, research and development activities. We may not be able to attract and retain quality personnel on acceptable terms given the competition for such personnel among biotechnology, pharmaceutical and other companies. We are not aware of any key personnel planning to retire or terminate their employment in the near future.

*We will need to increase the size of our organization, and we may experience difficulties in managing growth.

As of June 30, 2006, we had 147 employees. Of these, 115 employees were in research and development comprised of 80 in manufacturing, quality control and quality assurance, 31 in research and process development, and four members of senior management. Of the remaining employees, three were members of senior management and 29 were in marketing, general and administration. We will need to expand our financial, managerial, operational and other resources in order to continue our clinical trials and commercialize FavId, FAV-201, or any other product candidates that we may develop. Future growth would impose significant added responsibilities on our management team, including the need to identify, recruit, maintain and integrate additional employees. Our ability to commercialize FavId, FAV-201, or any other product candidates that we may develop, and our future financial performance in general, will depend in part on our ability to manage any future growth effectively. In order to meet these challenges, we would need to:

• manage our clinical trials effectively;

• manage our research and development efforts effectively;

• develop our administrative, accounting and management information systems and controls; and

• hire, train and integrate additional management, administrative, manufacturing and sales and marketing personnel.

We may not be able to accomplish these tasks, and our failure to accomplish any of them could harm our business or future prospects.

If we use biological and hazardous materials in a manner that causes injury or violates laws, we may be liable for damages.

Our research and development and manufacturing activities involve the use of biological and hazardous materials that could be dangerous to human health, safety or the environment. Although we believe our safety procedures for handling and disposing of these materials comply with federal, state and local laws and regulations, we cannot entirely eliminate the risk of accidental injury or contamination from the use, storage, handling or disposal of these materials. In the event of contamination or injury, we could be held liable for any resulting damages, and any liability could exceed our resources. We currently maintain property and casualty insurance coverage which covers liability for hazardous and controlled materials. However, this insurance coverage may not be sufficient to cover our liability and we may not be able to obtain sufficient coverage in the future at a reasonable cost. In addition, we may incur significant costs complying with both existing and future environmental laws and regulations. In particular, we are subject to regulation by the Occupational Safety and Health Administration, or OSHA, and the Environmental Protection Agency, or EPA, and to regulation under the Toxic Substances Control Act and the Resource Conservation and Recovery Act. OSHA, the EPA or other agencies may adopt regulations that adversely affect our research and development programs.

We face a risk of product liability claims and may not be able to obtain adequate insurance.

Our business exposes us to potential liability risks that may arise from the clinical testing of our product candidates and the manufacture and sale of any approved products. These risks will exist even with respect to those product candidates that are approved for commercial sale by the FDA and manufactured in facilities regulated by the FDA. Any product liability claim or series of claims brought against us could significantly harm our business by, among other things, reducing demand for our products, injuring our reputation and creating significant adverse media attention and costly litigation. Plaintiffs have received substantial damage awards in some jurisdictions against pharmaceutical companies based upon claims for injuries allegedly caused by the use of their products. Any judgment against us that is in excess of our insurance policy limits would have to be paid from our cash reserves, which would reduce our capital resources. We currently maintain clinical trial insurance. Although we believe our current insurance coverage is adequate, we cannot be certain that it will be sufficient. Furthermore, we cannot be certain that our current insurance coverage will continue to be available, or that increased coverage, which will be necessary if we are able to commercialize our products, will be available in the future on reasonable terms, or at all. Further, we may not have sufficient capital resources to pay a judgment, in which case our creditors could levy claims against our assets, including our intellectual property.

We could be negatively impacted by future interpretation or implementation of federal and state fraud and abuse laws, including anti-kickback laws and other federal and state anti-referral laws.

If we are able to commercialize FavId or any other product candidates that we may develop, we will be subject to various federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback laws and physician self-referral laws. Violations of these laws are punishable by criminal and civil sanctions, including, in some instances, imprisonment and exclusion from participation in federal and state healthcare programs, including Medicare, Medicaid and Veterans Administration health programs. Because of the far-reaching nature of these laws, we may be required to alter one or more of our practices to be in compliance with these laws. Healthcare fraud and abuse regulations are complex, and even minor, inadvertent irregularities can potentially give rise to claims that a statute or prohibition has been violated. Any violations of these laws, or any action against us for violation of these laws, even if we successfully defend against it, could result in a material adverse effect on our business, financial condition and results of operations. If there is a change in law, regulation or administrative or judicial interpretations, we may have to change our business practices or our existing business practices could be challenged as unlawful, which could have a material adverse effect on our business, financial condition and results of operations. In addition, some allegations under these laws have been claimed to violate the False Claims Act, discussed in more detail below.

In addition, if we are able to commercialize FavId or any other product candidates that we may develop, we could become subject to false claims litigation under federal statutes, which can lead to civil money penalties, criminal fines and imprisonment, and exclusion from participation in Medicare, Medicaid and other federal and state healthcare programs. These false claims statutes include the False Claims Act, which allows any person to bring suit on behalf of the federal government alleging the submission of false or fraudulent claims, or causing to present such false or fraudulent claims, under federal programs or contracts claims or other violations of the statute and to share in any amounts paid by the entity to the government in fines or settlement. These suits against biotechnology companies have increased significantly in recent years and have increased the risk that a healthcare company will have to defend a false claim action, pay fines or be excluded from the Medicare, Medicaid or other federal and state healthcare programs as a result of an investigation arising out of such action. We cannot assure you that we will not become subject to such litigation or, if we are not successful in defending against such actions, that such actions will not have a material adverse effect on our business, financial condition and results

of operations. In addition, we cannot assure you that the costs of defending claims or allegations under the False Claims Act will not have a material adverse effect on our business, financial condition and results of operations.

Risks Related to Our Intellectual Property and Potential Litigation

*If we are unable to obtain and maintain protection for our intellectual property, the value of our technology and products may be adversely affected.

Our business and competitive positions are dependent upon our ability to protect our proprietary technology. Our success will depend in large part on our ability to obtain and maintain patent protection for our product and technologies, preserve trade secrets and operate without infringing the intellectual property right of others. Because of the substantial length of time and expense associated with development of new products, we, along with the rest of the biopharmaceutical industry, place considerable importance on obtaining and maintaining patent protection for new technologies, products and processes. The patent positions of pharmaceutical, biopharmaceutical and biotechnology companies, including us, are generally uncertain and involve complex legal and factual questions. Our patent applications may not protect our technologies and products because, among other things:

• there is no guarantee that any of our pending patent applications will result in issued patents;

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

• there is no guarantee that any patents issued to us, our collaborators or our licensors will provide a basis for a commercially viable product;

• there is no guarantee that any patents issued to us or our collaborators or our licensors will provide us with any competitive advantage;

• there is no guarantee that any patents issued to us or our collaborators or our licensors will not be challenged, circumvented or invalidated by third parties; and

• there is no guarantee that any patents previously issued to others or issued in the future will not have an adverse effect on our ability to do business.

We attempt to protect our intellectual property position by filing United States patent applications related to our proprietary technology, inventions and improvements that are important to the development of our business. Currently we own U.S. Patent No. 6,911,204 concerning the treatment of NHL with our technology together with four pending United States patent applications covering methods of treating immune system diseases, including B-cell and T-cell lymphomas, using our proprietary immunotherapy production methods, as well as methods for combining the idiotype immunotherapies with other therapies that are used to treat diseases of the immune system.

We also have four issued patents, two applications for which we have received notices indicating that patents will issue, and twenty-four patent applications pending outside of the United States. Limitations on patent protection in some countries outside the United States, and the differences in what constitutes patentable subject matter in these countries, may limit the protection we have under patents issued to us outside of the United States. In addition, laws of foreign countries may not protect our intellectual property to the same extent as would laws of the United States. In determining whether or not to seek a patent or to license any patent in a particular foreign country, we weigh the relevant costs and benefits, and consider, among other things, the market potential of our product candidates in the jurisdiction, and the scope and enforceability of patent protection afforded by the law of the jurisdiction. Failure to obtain adequate patent protection for our proprietary product candidates and technology would impair our ability to be commercially competitive in these markets.

Although we believe our issued patents, as well as our patent applications if they issue as patents, will provide a competitive advantage, we may not be able to develop additional patentable products or processes. Further, we may not be able to obtain patents from any of the pending applications. Even if patent claims are allowed, the claims may not issue, or in the event of issuance, may not be sufficient to protect our technology. In addition, any patents or patent rights we obtain may be circumvented, challenged or invalidated by our competitors.

We are not able to prevent others, including potential competitors, from using certain types of patient-specific idiotype protein-KLH conjugates, like those we use in our lead product candidate, FavId, for the treatment of indolent B-cell NHL.

Certain types of patient-specific idiotype-KLH conjugates, comprising single idiotype proteins, and their use for the treatment of indolent B-cell NHL are in the public domain and therefore cannot be patented. Consequently, we may only be able to seek patent protection for methods of treating immune system diseases, including B-cell and T-cell lymphomas, using our proprietary immunotherapy production methods for making idiotype protein conjugates and compositions comprising such conjugates, as well as methods for combining the idiotype or T-cell receptor-based immunotherapies with other therapies that are used to treat diseases of the immune system. As a result, we may not be able to prevent other companies using different manufacturing processes from developing active immunotherapies that directly compete with FavId.

We may have to engage in costly litigation to enforce our proprietary rights or to defend challenges to our intellectual property by our competitors, which may harm our business, results of operations, financial condition and cash flow.

The pharmaceutical field is characterized by a large number of patent filings involving complex legal and factual questions, and, therefore, we cannot predict with certainty whether our patents will be enforceable. Competitors may have filed applications for or have been issued patents and may obtain additional patents and proprietary rights related to products or processes that compete with or are similar to ours. We may not be aware of all of the patents potentially adverse to our interests that may have been issued to others. Litigation may be necessary to protect our patent position, and we cannot be certain that we will have the required resources to pursue litigation or otherwise to protect our patent rights. In addition, our efforts to protect our patents may not be successful.

Our ability to market our products may be impaired by the intellectual property rights of third parties.

Our commercial success will depend in part on not infringing the patents or proprietary rights of third parties. We are aware of competing intellectual property relating to active idiotype immunotherapies for cancer. Competitors or third parties may be issued, or may currently hold, patents that may cover subject matter that we use in developing the technology required to bring our product candidates to market, that we use in producing our product candidates, or that we use in treating patients with our product candidates. In addition, from time to time we receive correspondence inviting us to license patents from third parties. While we currently believe we have freedom to operate in our area, others may challenge our position in the future. There has been, and we believe that there will continue to be, significant litigation in the pharmaceutical industry regarding patent and other intellectual property rights.

While we believe that our pre-commercialization activities fall within the scope of an available exemption against patent infringement provided by 35 U.S.C. §271(e), and that our subsequent manufacture of our commercial products will also not require the license of any patents, claims may be brought against us in the future based on these or other patents held by others. As our product candidates progress toward commercialization, competitors or other parties may assert that we infringe on their patents or proprietary rights.

In particular, we are aware of the following third party patents:

• Genentech and City of Hope National Medical Center hold patent rights related to the expression of recombinant antibodies;

• Genitope holds patent rights relating to immunotherapy using idiotype proteins produced using T-lymphoid cells for the treatment of B-Cell lymphoma; and

• Schering Corp. holds patent rights relating to the use of GM-CSF as a vaccine adjuvant for use against infectious diseases.

The first patent listed above was issued to Genentech in 2001. We do not believe that this patent covers our technology, and we note that in May 2005, a third party filed a request for reexamination of this patent with the U.S. Patent and Trademark Office, requesting that the claims of this patent be reexamined as to their patentability. If this patent reissues and we decide to attempt to obtain a license for this patent, we cannot guarantee that we would be able to obtain such a license on commercially reasonable terms, or at all.

Additionally, because patent prosecution can proceed in secret prior to issuance of a patent, third parties may obtain other patents with claims of unknown scope relating to our product candidates, which they could attempt to assert against us. Further, as we develop our products, we may infringe the current patents of third parties or patents that may issue in the future. Third parties could bring legal actions against us claiming damages and seeking to enjoin clinical testing,

manufacturing and marketing of the affected product or products. If we become involved in any litigation, it could consume a substantial portion of our resources, regardless of the outcome of the litigation. If any of these actions are successful, in addition to any potential liability for damages, we could be required to obtain a license to continue to manufacture or market the affected product, in which case we may be required to pay substantial royalties or grant cross-licenses to our patents. However, there can be no assurance that any such license will be available on acceptable terms or at all. To enforce patents issued to us or to determine the scope and validity of other parties’ proprietary rights, we may also become involved in litigation or in interference proceedings declared by the United States Patent and Trademark Office, which could result in substantial costs to us, regardless of the outcome of the litigation, or an adverse decision as to the priority of our inventions. Ultimately, as a result of patent infringement claims, our business could be harmed and we could be prevented from commercializing a product, or forced to cease some aspect of our business operations.

If we are not able to protect and control unpatented trade secrets, know-how and other technological innovation, we may suffer competitive harm.

We also rely on trade secrets to protect our technology, particularly when we do not believe that patent protection is appropriate or available. However, trade secrets are difficult to protect. We attempt to protect our trade secrets by requiring each of our employees, consultants and advisors to execute a non-disclosure and assignment of invention agreement before beginning his or her employment, consulting or advisory relationship with us. We cannot guarantee that these agreements will provide meaningful protection, that these agreements will not be breached, that we will have an adequate remedy for any such breach, or that our trade secrets will not otherwise become known or independently developed by a third party. Our trade secrets, or those of our future collaborators, may become known or may be independently discovered by others, which could adversely affect the competitive position of our product candidates.

Risks Related to the Securities Markets and Ownership of Our Common Stock

*Until our initial public offering in February 2005, there was no public market for our common stock, and the price of our common stock may be volatile and could decline significantly.

Until our initial public offering, or IPO, in February 2005, there was no public market for our common stock, and despite our IPO, an active public market for these shares may not develop or be sustained. Our stock price has traded in the range of $7.77 - $3.20 from the commencement of our IPO on February 2, 2005 to August 8, 2006.

The stock market in general has been experiencing dramatic fluctuations that have often been unrelated to the operating performance of companies. The market prices for securities of biotechnology companies in general have been highly volatile and may continue to be highly volatile in the future. If market-based or industry-based volatility continues, the trading price of our common stock could decline significantly, independent of our actual operating performance, and you could lose all or part of your investment. The market price of our common stock could fluctuate significantly as a result of several factors, including:

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

• announcement of FDA approval or non-approval of FavId or any other product candidates that we may develop, or delays in the FDA review process;

• actions taken by regulatory agencies with respect to FavId and FAV-201, or any other product candidates that we may develop, or our clinical trials, manufacturing process or sales and marketing activities;

• regulatory developments in the United States and foreign countries;

• success of our research efforts and clinical trials;

• any intellectual property infringement lawsuit in which we may become involved;

• announcements concerning our competitors, or the biotechnology or biopharmaceutical industries in general;

• actual or anticipated fluctuations in our operating results;

• changes in financial estimates or recommendations by securities analysts;

• sales of large blocks of our common stock;

• sales of our common stock by our executive officers, directors and significant stockholders;

• changes in accounting principles; and

• loss of any of our key scientific or management personnel.

Specifically, you may not be able to resell your shares at or above the price you paid for such shares. In addition, class action litigation has often been instituted against companies whose securities have experienced periods of volatility in market price. Any such litigation brought against us could result in substantial costs and a diversion of management’s attention and resources, which could hurt our business, operating results and financial condition.

*Concentration of ownership among our existing officers, directors and principal stockholders may prevent other stockholders from influencing significant corporate decisions and depress our stock price.

As of June 30, 2006, our officers and directors, stockholders affiliated with our directors and those stockholders owning at least ten percent of our outstanding capital stock together beneficially held approximately 60.7% of our outstanding common stock on an as-converted basis. If some or all of these officers, directors and principal stockholders act together, they will be able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors, the merger, consolidation or sale of all or substantially all of our assets, and any other significant corporate transaction. The interests of this concentration of ownership may not always coincide with our interests or the interests of our other stockholders. For instance, officers, directors and principal stockholders, acting together, could cause us to enter into transactions or agreements that we would not otherwise consider. Similarly, this concentration of ownership may have the effect of delaying or preventing a change in control of us otherwise favored by our other stockholders. This concentration of ownership also could depress our stock price.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws and applicable Delaware law may prevent or discourage third parties or our stockholders from attempting to replace our management or influencing significant decisions.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws may have the effect of delaying or preventing a change in control of us or our management, even if doing so would be beneficial to our stockholders. These provisions include:

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

• authorizing our board of directors to issue preferred stock without stockholder approval;

• prohibiting cumulative voting in the election of directors;

• prohibiting stockholder actions by written consent;

• limiting the persons who may call special meetings of stockholders;

• prohibiting our stockholders from making certain changes to our certificate of incorporation or bylaws except with 66.7% stockholder approval; and

• requiring advance notice for raising business matters or nominating directors at stockholders’ meetings.

We are also subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for five years unless the holder’s acquisition of our stock was approved in advance by our board of directors. Together, these charter and statutory provisions could make the removal of management more difficult and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.

Because we do not intend to pay any cash dividends on our shares of common stock, our stockholders will not be able to receive a return on their shares unless they sell them.

We have never paid or declared any cash dividends on our capital stock and intend to retain any future earnings to finance the development and expansion of our business. The payment of dividends by us on our common stock is limited by our debt

agreements. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. Unless we pay dividends, our stockholders will not be able to receive a return on their shares unless they sell them.

We may incur increased costs as a result of recently enacted and proposed changes in laws and regulations.

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules related to corporate governance and other matters subsequently adopted by the SEC and the Nasdaq Stock Market, could result in increased costs to us. The new rules and any related regulations that may be proposed in the future could make it more difficult or more costly for us to obtain certain types of insurance, including directors’ and officers’ liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We are presently evaluating and monitoring developments with respect to new and proposed rules and cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs.

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

Our initial public offering of our common stock, par value $0.001, was effected through a Registration Statement on Form S-1 (File No. 333-114299) that was declared effective by the Securities and Exchange Commission on February 2, 2005. Our initial public offering commenced on February 2, 2005. On February 7, 2005, 6 million shares of our common stock were sold for an aggregate offering price of $42.0 million. On March 7, 2005, 285,000 shares of our common stock were sold for an aggregate offering price of $2.0 million upon the partial exercise of the underwriters’ over-allotment option. Our initial public offering resulted in aggregate proceeds to us of approximately $39.5 million, net of underwriting discounts and commissions of approximately $3.1 million and offering expenses of approximately $1.4 million, through a syndicate of underwriters managed by Bear, Stearns & Co. Inc., CIBC World Markets Corp., Needham & Company, Inc. and A.G. Edwards & Sons, Inc.

No offering expenses were paid directly or indirectly to any of our directors or officers (or their associates) or person owning ten percent or more of any class of our equity securities or to any other affiliates. All offering expenses were paid directly to others.

We had invested $40.9 million in proceeds from the offering, net of underwriting discounts and commissions but before expenses, in government agency securities, corporate bonds and notes and money market funds. Through June 30, 2006, we used approximately $31.2 million of the proceeds from our initial public offering to develop and prepare for filing a biologic license application, or BLA, for regulatory approval of FavId, for development of our other product candidates, for marketing, general and administrative expenses, and for working capital, including debt repayments.

The foregoing payments were direct payments made to third parties who were not our directors or officers (or their associates), persons owning ten percent or more of any class of our equity securities or any other affiliate, except that the proceeds used for salaries expense included regular compensation for our officers and directors. The use of proceeds does not represent a material change from the use of proceeds described in the prospectus we filed pursuant to Rule 424(b)(4) of the Securities Act of 1933, as amended, with the Securities and Exchange Commission on February 3, 2005.

Item 4. Submission of Matters to a Vote of Security Holders.

At our 2006 annual meeting of stockholders held on June 14, 2006, the stockholders were asked to vote on three items as follows:

1. The election of two Class I directors to hold office for a three-year term, through the 2009 annual meeting of stockholders. The nominees for election were Arda Minocherhomjee, Ph.D. and Ivor Royston, M.D. No other nominations were received in accordance with the Company’s Bylaws.

2. The amendment of the Company’s 2005 Non-Employee Directors’ Stock Option Plan to increase the automatic annual grant to each non-employee director of options to purchase common stock from 8,000 shares to 12,500 shares, and to provide for the additional automatic annual grant of options for the Chair of the Board and the Chairs of Board Committees.

3. The ratification of the selection of Ernst & Young LLP to serve as the independent registered public accounting firm of the Company for the fiscal year ending December 31, 2006.

The results of the matters presented at the annual meeting, based on the presence in person or by proxy of holders of 18,659,827 shares of the 28,920,426 shares of our common stock of record entitled to vote, were as follows:

1. The election of Arda Minocherhomjee, Ph.D. and Ivor Royston, M.D. as directors of the Company until the 2009 annual meeting of stockholders and until their successors are elected was approved as follows:

	For	Withheld
Arda Minocherhomjee, Ph.D.	18,603,670	56,157

Ivor Royston, M.D.	18,019,405	640,422

The following individuals are continuing directors with terms expiring upon the 2007 annual meeting of stockholders: Michael L. Eagle, Cam L. Garner and Peter Barton Hutt. The following individuals are continuing directors with terms expiring upon the 2008 annual meeting of stockholders: Antonio J. Grillo-Lopez, M.D., John P. Longenecker, Ph.D., Fred Middleton and Wayne I. Roe.

For		Against		Abstain
15,444,229		647,962		170,624

3. The ratification of Ernst & Young LLP as the independent registered public accounting firm of the Company for its fiscal year ending December 31, 2006 was approved as follows:

For		Against		Abstain
18,621,157		16,518		22,152

Item 6. Exhibits.

The exhibits listed on the accompanying index to exhibits are filed or incorporated by reference (as stated therein) as part of this Quarterly Report on Form 10-Q.

Exhibit Number		Description of Document

3.1		Registrant’s Amended and Restated Certificate of Incorporation.(1)

3.2		Registrant’s Amended and Restated Bylaws.(1)

4.1		Form of Common Stock Certificate of Registrant.(1)

4.2		Amended and Restated Investor Rights Agreement dated March 26, 2004 between the Registrant and certain of its stockholders.(1)

4.3		Amendment No. 1 to Amended and Restated Investor Rights Agreement dated April 6, 2004 between the Registrant and certain of its stockholders.(1)

4.4		Securities Purchase Agreement dated March 6, 2006, by and among Favrille and the individuals and entities identified on Exhibit A thereto (the “Securities Purchase Agreement”). (2)

4.5		Form of Warrant issued pursuant to the Securities Purchase Agreement. (2)

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Previously filed as an Exhibit to Favrille, Inc.’s Registration Statement on Form S-1 (File No. 333-114299), as amended, and incorporated by reference herein.

(2) Previously filed as an exhibit to Favrille’s Current Report on Form 8-K dated March 6, 2006 and incorporated herein by reference.

Dated: August 14, 2006

	Favrille, Inc.


	/s/ Tamara A. Seymour

	Tamara A. Seymour

	Chief Financial Officer

	(On behalf of the registrant and as the registrant’s Principal Financial and Accounting Officer)

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Balance Sheets as of June 30, 2006 (Unaudited) and December 31, 2005
	Statements of Operations (Unaudited) for the three and six months ended June 30, 2006 and 2005 and the period from January 21, 2000 (inception) to June 30, 2006 (Unaudited)
	Statements of Cash Flows (Unaudited) for the six months ended June 30, 2006 and 2005 and the period from January 21, 2000 (inception) to June 30, 2006 Unaudited)
	Notes to Condensed Financial Statements (Unaudited)
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures

PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 1A.	Risk Factors
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 4.	Submission of Matters to a Vote of Security Holders
Item 6.	Exhibits

SIGNATURES