The following discussion of our financial condition and the results of operations should be read in conjunction with the condensed consolidated financial statements and notes to condensed consolidated financial statements included elsewhere in this quarterly report on Form 10-Q. This discussion contains forward looking statements that involve risks and uncertainties. When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that characterize our business. In particular, we encourage you to review the risks and uncertainties described in Part II - Item 1A. "RISK FACTORS" elsewhere in this report. These risks and uncertainties could cause actual results to differ materially from those projected in forward-looking statements contained in this report or implied by past results and trends. Forward-looking statements are statements that attempt to forecast or anticipate future developments in our business; we encourage you to review the examples of our forward-looking statements under the heading "Cautionary Note Regarding Forward-Looking Statements" that appears at the end of this discussion. These statements, like all statements in this report, speak only as of their date (unless another date is indicated), and we undertake no obligation to update or revise these statements in light of future developments.

Overview

ARYx Therapeutics, Inc., or ARYx, is a biopharmaceutical company focused on developing a portfolio of internally discovered product candidates designed to eliminate known safety issues associated with well-established, commercially successful drugs. We use our RetroMetabolic Drug Design technology to design structurally unique molecules that retain the efficacy of these original drugs but are metabolized through a potentially safer pathway to avoid specific adverse side effects associated with these compounds. Our product candidate portfolio includes: an oral antiarrhythmic agent, budiodarone (ATI-2042), designed to have the efficacy of amiodarone, in Phase 2b clinical development for the treatment of atrial fibrillation, a form of irregular heartbeat; an oral anticoagulant, tecarfarin (ATI-5923), designed to have the same therapeutic benefits as warfarin, in Phase 2/3 clinical development for the treatment of patients who are at risk for the formation of dangerous blood clots; an oral prokinetic agent, ATI-7505, designed to have the same therapeutic benefits as cisapride, in Phase 2b clinical development for the treatment of chronic constipation, gastroparesis, functional dyspepsia, irritable bowel syndrome with constipation, and gastroesophageal reflux disease; and, a novel, next-generation atypical antipsychotic agent, ATI-9242, currently in Phase 1 clinical testing for the treatment of schizophrenia and other psychiatric disorders. Additionally, we have several product candidates in preclinical development. Each of our product candidates is an orally available, patentable new chemical entity designed to address similar indications as those of the original drug upon which each is based. Our product candidates target what we believe to be multi-billion dollar market opportunities.

We were incorporated in the State of California on February 28, 1997 and reincorporated in the State of Delaware on August 29, 2007. We maintain a wholly-owned subsidiary, ARYx Therapeutics Limited, with registered offices in the United Kingdom, which has had no operations since its inception in September 2004 and was established to serve as a legal entity in support of our clinical trial activities conducted in Europe. We operate in a single business segment with regard to the development of human pharmaceutical products.

Since our inception, we have incurred significant net losses, and we expect to continue to incur net losses for the next several years as we develop our own product candidates, potentially acquire or in-license additional products or product candidates, conduct clinical trials, manufacture materials for use in non-clinical studies and clinical trials, expand our research and development activities, seek regulatory approvals and engage in commercialization preparation activities. It is very expensive to gain approval of and launch a pharmaceutical product. Many expenses are incurred before revenue is received. We are unable to predict the extent of any future losses or when we will become profitable, if at all.

We are engineering potentially safer oral product candidates that retain the efficacy of commercially successful drugs for well-established chronic markets. We have established proof of concept with our three leading product candidates, budiodarone, tecarfarin, and ATI-7505. The following is a summary of our product candidates that are currently in clinical development:

Budiodarone

Budiodarone is an oral antiarrhythmic agent in Phase 2 clinical development for the treatment of patients with atrial fibrillation. Budiodarone was designed to have the efficacy of amiodarone, a drug that has been used for many years, despite its adverse side effects, because physicians consider it to be the most effective drug for treating patients with atrial fibrillation. Amiodarone accumulates in many different organs and can only be metabolized by CYP450, potentially leading to serious side effects that are not immediately reversible upon withdrawal of the drug. Since budiodarone is predominantly metabolized through the esterase pathway, it should avoid accumulation in organs and have fewer drug-drug interactions. We

have completed a Phase 2 pilot study (CLN-208) with budiodarone involving six atrial fibrillation patients with implanted recordable pacemakers who did not respond to previous drug therapy. This pilot study suggested that the effect of budiodarone improved as the dose increased. Based upon the results of this pilot study, we conducted an additional Phase 2b clinical trial to further demonstrate the efficacy of budiodarone in patients with atrial fibrillation. The clinical trial, which enrolled 72 patients, was a multi-centered, randomized, double blind, placebo-controlled study of the efficacy and safety of budiodarone in patients with paroxysmal atrial fibrillation, or PAF. All patients entering this study had previously implanted permanent pacemakers with appropriate diagnostic and recording capabilities. In December 2008, we announced successful top-line efficacy results from this Phase 2b clinical trial. By achieving statistical significance at the two highest doses of the three tested, the results essentially mirrored the findings of the earlier Phase 2 pilot study also conducted in paroxysmal atrial fibrillation patients. The Phase 2b study also demonstrated that patients in the study quickly returned to their pre-treatment level of atrial fibrillation once the treatment ended. We have also announced the complete safety results from this Phase 2b clinical trial which indicate that budiodarone is generally safe and well-tolerated, and appears to avoid the tissue accumulation evident with amiodarone. We are actively seeking a large pharmaceutical company partner for the full development and eventual commercialization of budiodarone, in the event we obtain requisite regulatory approval.

Tecarfarin

Tecarfarin is an oral anticoagulant agent in Phase 2/3 clinical development for the treatment of patients who are at risk for the formation of dangerous blood clots, such as those with atrial fibrillation or those at risk of venous thromboembolism. Tecarfarin was designed to have the same therapeutic benefits as the drug warfarin which for over 50 years has been the oral anticoagulant of choice. Despite its widespread use, warfarin has several significant limitations. It is metabolized by CYP450 and has many drug-drug interactions that often lead to serious side effects. We designed tecarfarin to be metabolized through the esterase pathway, eliminating metabolism through CYP450 and avoiding drug-drug interactions. Warfarin also has a very steep dose response curve which means that a small change in dose may lead to a substantial change in the anticoagulation status of the patient. These two factors can create significant challenges in maintaining therapeutic levels of warfarin and this can put patients at risk for either life-threatening clotting or bleeding, especially in patients with compromised CYP clearance. In preclinical testing and in clinical testing to date, it appears that tecarfarin may be inherently more stable than warfarin due to its predictable metabolism through the esterase pathway that has a much larger capacity than CYP450. The rate of anticoagulation for both warfarin and tecarfarin is measured by the standard assay known as International Normalized Ratio, or INR.

We have treated over 400 patients with tecarfarin measuring the drug's ability to maintain those patients within the target therapeutic range of INR of 2 to 3 (2.5 to 3.5 for heart valve patients). Two of the clinical trials performed were Phase 2 studies (CLN-504 and CLN-509) and the third was the recently completed Phase 2/3 trial, EmbraceAC (CLN-505). The tecarfarin efficacy results in each were nearly identical, appearing to demonstrate tecarfarin's ability to maintain patients' INR within the target therapeutic range during a consistent percentage of the time treated: 71.5% (CLN-504); 73.9% (CLN-509); and 74% (EmbraceAC). Statistical significance was achieved in CLN-504 when comparing the tecarfarin response to the same patients' historical experience with warfarin: 71.5% time within therapeutic range versus 59.3% time within therapeutic range, respectively (p= 0.0009). However, statistical significance was not achieved at the primary endpoint in the 607-patient EmbraceAC clinical trial, directly measuring the ability of tecarfarin to maintain patients within the target therapeutic range of INR as compared to warfarin patients. The endpoint was missed due to the virtually unprecedented time within therapeutic range in the warfarin-treated patients of 73.2% (p=0.506). We believe the warfarin outcome resulted from the intense monitoring and dose control provided by the study's central dosing methodology, executed in accord with our agreement on the study design with the U.S. Food and Drug Administration, or FDA. We believe a second Phase 3 study must be conducted to seek regulatory approval, again directly comparing tecarfarin to warfarin but in a "real-world" setting in which all monitoring and dosing decisions will be made at the study sites. This will be similar to how tecarfarin was dosed in CLN-504 and how warfarin is typically dosed and titrated in clinical practice. Similar studies conducted in the past with warfarin have typically shown a time in therapeutic range of 56% to 66%, considerably less than was seen in the EmbraceAC study which was highly controlled. Subsequent additional analyses of the data generated in the EmbraceAC trial, looking at specific subpopulations in the study, support our belief that a real-world study would demonstrate the importance of warfarin's dependence on CYP450 metabolism versus tecarfarin's avoidance of that metabolic pathway in maintaining patients within the target therapeutic range of INR. Our belief that tecarfarin would continue to maintain patients' INR within the previously demonstrated target therapeutic range when tested in a real-world study is further supported by the results to date of the safety extension phase of EmbraceAC. In this phase, 95 patients treated with tecarfarin remained on the drug for an additional period of up to one year of total treatment. To date, these tecarfarin treated patients are in therapeutic INR range 79% of the time treated. During this safety extension phase, monitoring and dose adjustments have occurred on an average of every three weeks, similar to monitoring in a real-world study. In previous discussions, the FDA indicated that the ability to maintain patients within the targeted INR will likely be an acceptable surrogate and primary endpoint for tecarfarin's clinical development. Using INR maintenance as a surrogate and primary endpoint should reduce both the size of and time to

complete our planned clinical trials for tecarfarin compared to clinical trials measuring survival rates or other outcomes. Based upon our earlier discussions with the FDA, we believe the completed EmbraceAC clinical trial may qualify as a registration study. We are seeking FDA guidance on the continued development of tecarfarin and we expect to receive FDA feedback within the fourth quarter of 2009. We are also continuing to actively seek a pharmaceutical company partner for the full development and eventual commercialization of tecarfarin, in the event we obtain requisite regulatory approval. This potential partner will be responsible for conducting the required second Phase 3 study.

ATI-7505

ATI-7505 is an oral prokinetic drug that speeds up the motion of contents through the gut, which has successfully completed a series of Phase 2 clinical trials for the treatment of multiple gastrointestinal disorders including gastroesophageal reflux disease, or GERD, functional dyspepsia and chronic idiopathic constipation. ATI-7505 was designed to have the same therapeutic benefits as cisapride, a drug marketed by Johnson & Johnson as Propulsid in the United States. Launched in 1993, cisapride was withdrawn from the market in 2000 due to serious cardiovascular side effects. These side effects occurred as blood levels of the drug rose significantly when CYP450 clearance was inhibited because of the presence of other drugs cleared by the same metabolic pathway. We designed ATI-7505 to be metabolized through the esterase pathway, eliminating metabolism through CYP450 as well as the off-target cardiovascular effects. More than 900 subjects have been treated with ATI-7505 as part of our clinical trial program, which includes four Phase 2 trials to date. In June 2006, we entered into a collaboration agreement with Procter & Gamble Pharmaceuticals, Inc., or P&G, to develop and commercialize ATI-7505. On July 2, 2008, we received notice from P&G that it elected to exercise its option to terminate the collaboration agreement effective July 2, 2008. P&G subsequently announced that it is exiting pharmaceutical drug development. Upon termination of the collaboration agreement by P&G, all rights to ATI-7505 reverted to ARYx. Also on July 2, 2008, we announced the overall successful results of a Thorough QT study, or TQT study, on ATI-7505, which we believe supports the agent's favorable cardiac safety profile. In March 2009, we received written confirmation from the FDA that based on the FDA's review of results from our TQT study of ATI-7505, the FDA concurs with our interpretation of the results that the findings were negative, meaning ATI-7505 does not significantly increase the QT interval at the proposed therapeutic or supratherapeutic doses. Since the QT interval is an important measure of cardiac safety, this result supports our belief that ATI-7505 does not lead to cardiac liabilities. On August 22, 2008, we announced the results of a Phase 2b clinical trial testing the safety and efficacy of ATI-7505 in patients with chronic idiopathic constipation. The clinical trial, conducted by P&G, was designed to enroll 400 patients evaluating four doses of the agent compared to placebo. As a result of the termination of the collaboration between ARYx and P&G, the study was terminated early after only 214 patients had been enrolled. In spite of the early termination of the study, ATI-7505 achieved statistical significance at the study's primary endpoint in the 80 milligram twice daily dose. In addition, all doses tested demonstrated a clinically meaningful and desired increase in spontaneous bowel movements over baseline compared to placebo after one week of treatment. We are now actively seeking a new pharmaceutical company partner to complete the development and eventually commercialize ATI-7505, in the event we obtain requisite regulatory approval.

ATI-9242

ATI-9242 is a novel antipsychotic agent in Phase 1 clinical development for the treatment of schizophrenia and other psychiatric disorders. ATI-9242's receptor profile is targeted at the treatment of both the positive and the negative symptoms of schizophrenia as well as the improvement of cognitive function. To date, preclinical work has supported this profile. ATI-9242 is designed to avoid certain drug-drug interactions by avoiding CYP450 enzymes for metabolism and reduce certain metabolic problems associated with this class of therapy, including weight gain and type 2 diabetes. The Phase 1 single-dose clinical trial, testing the safety and tolerability of ATI-9242, is underway and is expected to be completed as financial resources allow.

Research and Development Expense

Our research and development, or R&D, expense consists of expenses incurred in identifying, testing and developing our product candidates. These expenses consist primarily of fees paid to contract research organizations and other third parties to assist us in managing, monitoring and analyzing our clinical trials, clinical trial costs paid to sites and investigators' fees, costs of non-clinical studies including toxicity studies in animals, costs of contract manufacturing services, costs of materials used in clinical trials and non-clinical studies, laboratory related expenses, R&D support costs including certain regulatory, quality assurance, project management and administration, allocated expenses such as facilities and information technology that are used to support our research and development activities and related personnel expenses, including stock-based compensation. R&D costs are expensed as incurred.

Clinical trial costs are a significant component of our R&D expense. Currently, we conduct our clinical trials primarily through coordination with contract research organizations and other third-party service providers. We recognize research and development expense for these activities based upon a variety of factors, including actual and estimated patient enrollment, clinical site initiation activities, direct pass-through costs and other activity-based factors.

The following table summarizes our R&D expense for the three and nine months ended September 30, 2009 and 2008:

                                             Three Months Ended       Nine Months Ended
                                               September 30,            September 30,
                                              2009         2008        2009        2008
                                                           (in thousands)
Direct R&D expense by product candidate:
Budiodarone                                $      141    $  1,592   $      847   $  4,930
Tecarfarin                                      1,607       6,573        7,098     12,654
ATI-7505                                           19          93          135        226
ATI-9242                                           82          80           26      1,172
Other research programs                            78         148          178        796
Total direct R&D expense                        1,927       8,486        8,284     19,778
R&D personnel, administrative and other
expense                                         3,067       3,230        9,770      9,468
Less: R&D portion of the cost of
collaboration service revenue                       -           -            -        (39 )
Total R&D expense                          $    4,994    $ 11,716   $   18,054   $ 29,207

From our inception through September 30, 2009, we estimate that approximately $25.1 million was incurred for our budiodarone product candidate, approximately $39.9 million of expense was incurred for our tecarfarin product candidate, approximately $22.6 million was incurred for our ATI-7505 product candidate, approximately $5.1 million was incurred for our ATI-9242 product candidate, and approximately $67.9 million was incurred for costs related to our R&D personnel, administrative and other research programs.

The expenditures summarized in the above table reflect costs directly attributable to each product candidate and to our other research programs. We do not allocate salaries, employee benefits, or other indirect costs to our product candidates or other research programs and have included those expenses in "R&D personnel, administrative and other expense" in the above table. The portion of our R&D expense that is identified as cost of collaboration service revenue is included within a separate category of expense in our condensed consolidated financial statements and is subtracted from total expenses in the above table to derive total research and development expense as reported in our condensed consolidated financial statements.

At this time, due to the risks inherent in the clinical trial process and given the various stages of development of our product candidates, we are unable to estimate with any certainty the costs we will incur in the continued development of our product candidates. Clinical development timelines, the probability of success and development costs can differ materially from expectations. While we are currently focused on advancing each of our product candidates, our future research and development expense will depend on the clinical success of each product candidate, as well as ongoing assessments as to each product candidate's commercial potential. In addition, we cannot forecast with any degree of certainty which product candidates will be subject to future collaborations, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements.

The process of developing and obtaining FDA approval of products is costly and time consuming. Development activities and clinical trials can take years to complete, and failure can occur at any time during the development and clinical trial process. In addition, the results from early clinical trials may not be predictive of results obtained in subsequent and larger clinical trials, and product candidates in later stages of clinical trials may fail to show the desired safety and efficacy despite having progressed successfully through initial clinical testing. Although our approach to identifying and developing new product candidates is designed to mitigate risk, the successful development of our product candidates is highly uncertain. Further, even if our product candidates are approved for sale, they may not be successfully commercialized and therefore the future revenue we anticipate may not materialize.

If we fail to complete the development of any of our product candidates in a timely manner, it could have a material effect on our operations, financial position and liquidity. In addition, any failure by us or our partners to obtain, or any delay in obtaining, regulatory approvals for our product candidates could have a material adverse effect on our results of operations. A further discussion of the risks and uncertainties associated with completing our programs on schedule, or at all, and certain consequences of failing to do so are discussed in Part II-Item 1A. "Risk Factors" section of this report.

Critical Accounting Policies and Significant Estimates

We have prepared our consolidated financial statements in accordance with U.S. generally accepted accounting principles. Accordingly, we have had to make estimates, assumptions and judgments that affect the amounts reported in our consolidated financial statements. These estimates, assumptions and judgments about future events and their effects on our results cannot be determined with certainty, and are made based upon our historical experience and on other assumptions that are believed to be reasonable under the circumstances. These estimates may change as new events occur or additional information is obtained, and we may periodically be faced with uncertainties, the outcomes of which are not within our control and may not be known for a prolonged period of time.

Our critical accounting policies are more fully described in Note 1 of the audited consolidated financial statements for the year ended December 31, 2008, which are included in our annual report on Form 10-K filed with the Securities and Exchange Commission. There have been no material changes in our critical accounting policies and significant estimates during the three and nine months ended September 30, 2009.

Results of Operations



Comparison of Three and Nine Months Ended September 30, 2009 and 2008



Revenue



                      Three Months Ended                                Nine Months Ended
                         September 30,              Change                September 30,               Change
                    2009           2008            $         %       2009           2008            $         %
                                                      (In thousands, except %)
Collaboration
service revenue    $     -    $            -   $       -       -     $    -    $          232   $    (232 )   (100 )%
Technology
license fees             -            17,544     (17,544 )  (100 )%       -            19,492     (19,492 )   (100 )%
Total revenue      $     -    $       17,544   $ (17,544 )  (100 )%  $    -    $       19,724   $ (19,724 )   (100 )%

We generated no revenue for the three and nine months ended September 30, 2009. Our only source of revenue in 2008 was in connection with our prior collaboration agreement with P&G for the licensing of our ATI-7505 product candidate and for providing pharmaceutical development and other services to P&G. The decreases in revenue for the three and nine months ended September 30, 2009, as compared to the same periods in 2008, were due to the termination of the collaboration agreement with P&G in July 2008.

Cost of Collaboration Service Revenue



                          Three Months Ended                                  Nine Months Ended
                             September 30,                Change                September 30,               Change
                         2009             2008         $          %         2009            2008          $         %
                                                           (In thousands, except %)
Cost of
collaboration

We incurred costs for certain services provided in connection with our prior collaboration agreement with P&G, including costs for pharmaceutical development, patent filing and maintenance and other activities related to the ATI-7505 product candidate. We did not generate any collaboration service revenue nor associated cost for the three and nine months ended September 30, 2009, nor for the three months ended September 30, 2008. The $232,000 decrease in cost of revenue for the nine months ended September 30, 2009, as compared to the same period in 2008, was the result of the termination of the collaboration agreement with P&G in July 2008.

Research and Development Expense



                        Three Months Ended                             Nine Months Ended
                          September 30,             Change               September 30,             Change
. . .