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: September 30, 2012

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: 001-32325

CALLISTO PHARMACEUTICALS, INC.

(Exact name of Registrant as specified in its charter)

Delaware		13-3894575
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

420 Lexington Avenue, Suite 1609, New York, New York 10170

(Address of principal executive offices) (Zip Code)

(212) 297-0010

(Registrant’s telephone number)

(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No o

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

Large accelerated filer o		Accelerated filer o

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

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

The number of the registrant’s shares of common stock outstanding was 158,965,565 as of November 19, 2012.

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CALLISTO PHARMACEUTICALS, INC.

FORM 10-Q

CONTENTS

		Page
PART I—FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of September 30, 2012 (unaudited) and December 31, 2011	4
	Condensed Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 2012 and 2012 (unaudited) and the period June 5, 1996 (Inception) to September 30, 2012 (unaudited)	5
	Condensed Consolidated Statements of Changes in Stockholders’ Equity (Deficit) for the period June 5, 1996 (Inception) to September 30, 2012 (period from January 1 to September 30, 2012 is unaudited)	6
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2012 and 2011 (unaudited) and for the period June 5, 1996 (Inception) to September 30, 2012 (unaudited)	15
	Notes to Condensed Consolidated Financial Statements (unaudited)	17
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30
PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 6.	Exhibits	47
Signatures		49

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INTRODUCTORY NOTE

This Report on Form 10-Q for Callisto Pharmaceuticals, Inc. (“Callisto” or the “Company”) may contain forward-looking statements. You can identify these statements by forward-looking words such as “plan,” “may,” “will,” “expect,” “intend,” “anticipate,” “believe,” “estimate” and “continue” or similar words. Forward-looking statements include information concerning possible or assumed future business success or financial results. You should read statements that contain these words carefully because they discuss future expectations and plans, which contain projections of future results of operations or financial condition or state other forward-looking information. We believe that it is important to communicate future expectations to investors. However, there may be events in the future that we are not able to accurately predict or control. Accordingly, we do not undertake any obligation to update any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties set forth under “Risk Factors” in this report and in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities Exchange Commission on March 30, 2012. Accordingly, to the extent that this Report contains forward-looking statements regarding the financial condition, operating results, business prospects or any other aspect of the Company, please be advised that Callisto’s actual financial condition, operating results and business performance may differ materially from that projected or estimated by the Company in forward-looking statements.

On May 9, 2012, Callisto deconsolidated Synergy and derecognized the Synergy assets, liabilities, and non-controlling interest from its financial statements. All drug candidates to treat GI disorders and diseases, currently plecanatide and SP-333, are being developed exclusively by Synergy Pharmaceuticals, Inc., our former controlled subsidiary (“Synergy”). Use of the terms “we”, “our” or “us” in connection with GI drug candidates discussed herein refer to research and development activities and plans of Synergy.

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

CALLISTO PHARMACEUTICALS, INC.

(A Development Stage Company)

CONDENSED CONSOLIDATED BALANCE SHEETS

	September 30, 2012			December 31, 2011
	(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents	$	120		$	13,244,961
Prepaid expenses and other	—			796,028
Tax credits receivable	—			377,865

Total Current Assets	120			14,418,854
Equity investment in Synergy	114,453,453			—
Property and equipment, net	—			5,774
Security deposits	73,715			87,740

Total Assets	$	114,527,288		$	14,512,368

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable	$	1,625,092		$	3,206,827
Accrued expenses	114,343			1,457,427
Total Current Liabilities	1,739,435			4,664,254
Derivative financial instruments, at estimated fair value—warrants	—			3,325,114
Due to related party	2,655,594			—

Total Liabilities	4,395,029			7,989,368
Commitments and contingencies
Stockholders’ Deficit:
Series A convertible preferred stock, par value $0.0001, 700,000 shares authorized, none shares outstanding at September 30, 2012 and 8,000 shares outstanding at December 31, 2011	—			1
Common stock, par value of $.0001 per share: 225,000,000 shares authorized; 158,965,565 and 158,516,071 shares outstanding at September 30, 2012 and December 31, 2011 respectively	15,897			15,852
Additional paid-in capital	169,221,471			168,531,201
Deficit accumulated during development stage	(59,105,109		)	(142,366,313		)

Total Callisto Stockholders’ Equity	110,132,259			26,180,741
Non-controlling interest	—			(19,657,741		)

Total Stockholders’ Equity	110,132,259			6,523,000

	$	114,527,288		$	14,512,368

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CALLISTO PHARMACEUTICALS, INC.

(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,						June 5, 1996 (Inception) to
	2012			2011			2012			2011			September 30, 2012
Revenues	$	—		$	—		$	—		$	—		$	—
Costs and expenses:
Research and development	—			3,882,802			7,880,230			7,610,829			66,974,747
Government grants	—			—			3,508			—			(1,131,810		)
Purchased in process research and development	—			—			—			—			6,944,553
General and administrative	418,001			1,288,945			3,176,502			5,124,477			63,549,160

Loss from operations	(418,001		)	(5,171,747		)	(11,060,240		)	(12,735,306		)	(136,336,650		)
Gain on deconsolidation of Synergy	—			—			120,393,000			—			120,393,000
Loss related to equity method investment	(3,360,997		)	—			(5,750,997		)	—			(5,750,997		)
Interest and investment income	—			3			20,942			57			937,519
Tax credit (expense)	(72,807		)	—			(297,770		)	—			1,067,008
Other income or expense	(40,000		)	(4,425		)	45,180			(10,631		)	(869,503		)
Loss on debt extinguishment	—			—			—			—			(2,099,892		)
Change in fair value of derivative instruments	—			4,382,796			(431,170		)	3,346,421			(17,341,455		)

Net income/(loss)	(3,891,805		)	(793,373		)	102,918,945			(9,399,459		)	(40,000,970		)
Add: Net loss of subsidiary attributable to non-controlling interest	—			280,055			6,957,805			4,624,178			26,615,546

Net income/(loss) attributable to Callisto	(3,891,805		)	(513,318		)	109,876,750			(4,775,281		)	(13,385,424		)
Series A Preferred stock conversion rate change and beneficial conversion feature accreted as a dividend	—			—			—			—			(5,025,849		)
Series B Preferred stock conversion rate change and beneficial conversion feature accreted as a dividend	—			—			—			—			(12,174,391		)
Cumulative effect of adopting ASC Topic 815 January 1, 2009	—			—			—			—			(1,903,900		)

Net income/(loss) available to Callisto common stockholders	$	(3,891,805	)	$	(513,318	)	$	109,876,750		$	(4,775,281	)	$	(32,489,564	)

Weighted average common shares outstanding
basic	158,866,092			158,516,071			158,633,596			158,225,741
diluted	158,866,092			158,516,071			159,201,398			158,225,741

Net income/(loss) per common share
Basic	$	(0.02	)	$	(0.00	)	$	0.69		$	(0.03	)
Diluted	$	(0.02	)	$	(0.00	)	$	0.69		$	(0.03	)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

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CALLISTO PHARMACEUTICALS, INC.

(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN

STOCKHOLDERS’ EQUITY (DEFICIT)

(Unaudited)

	Preferred Shares	Preferred Stock, Par Value		Common Shares		Common Stock, Par Value			Additional Paid in Capital
Balance at inception, June 5, 1996	—	$	—	—		$	—		$	—
Net loss for the year
Issuance of founder shares	—	—		2,642,500		264			528
Common stock issued	—	—		1,356,194		136			272
Common stock issued via private placement	—	—		1,366,667		137			1,024,863

Balance, December 31, 1996	—	—		5,365,361		537			1,025,663
Net loss for the year	—	—		—		—			—
Common stock issued via private placement	—	—		1,442,666		144			1,081,855

Balance, December 31, 1997	—	—		6,808,027		681			2,107,518
Net loss for the year	—	—		—		—			—
Amortization of Stock based Compensation	—	—		—		—			52,778
Common stock issued via private placement	—	—		1,416,667		142			1,062,358
Common stock issued for services	—	—		788,889		79			591,588
Common stock repurchased and cancelled	—	—		(836,792	)	(84		)	(96,916		)

Balance, December 31, 1998	—	—		8,176,791		818			3,717,326
Net loss for the year	—	—		—		—			—
Deferred Compensation—stock options	—	—		—		—			9,946
Amortization of Stock based Compensation	—	—		—		—			—
Common stock issued for services	—	—		—		—			3,168,832
Common stock issued via private placement	—	—		346,667		34			259,966

Balance, December 31, 1999	—	—		8,523,458		852			7,156,070
Net loss for the year	—	—		—		—			—
Amortization of Stock based Compensation	—	—		—		—			—
Common stock issued	—	—		4,560,237		455			250,889
Other	—	—		—		—			432
Preferred shares issued	3,485,299	348		—		—			5,986,302
Preferred stock issued for services	750,000	75		—		—			1,124,925

Balance, December 31, 2000	4,235,299	423		13,083,695		1,307			14,518,618
Net loss for the year	—	—		—		—			—
Deferred Compensation—stock Options	—	—		—		—			20,000
Amortization of Stock based Compensation	—	—		—		—			—

Balance, December 31, 2001	4,235,299	423		13,083,695		1,307			14,538,618
Net loss for the year	—	—		—		—			—
Amortization of Stock based Compensation	—	—		—		—			—

Balance, December 31, 2002	4,235,299	$	423	13,083,695		$	1,307		$	14,538,618

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CALLISTO PHARMACEUTICALS, INC.
(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)

	Unamortized Deferred Stock Based Compensation			Deficit Accumulated during the Development Stage			Total Stockholders’ Equity
Balance at inception, June 5, 1996	$	—		$	—		$	—
Net loss for the year				(404,005		)	(404,005		)
Issuance of founder shares	—			—			792
Common stock issued	—			—			408
Common stock issued via private placement	—			—			1,025,000

Balance, December 31, 1996	—			(404,005		)	622,195
Net loss for the year	—			(894,505		)	(894,505		)
Common stock issued via private placement	—			—			1,081,999

Balance, December 31, 1997	—			(1,298,510		)	809,689
Net loss for the year	—			(1,484,438		)	(1,484,438		)
Amortization of Stock based Compensation	—			—			52,778
Common stock issued							1,062,500
Common stock issued for services	—			—			591,667
Common Stock repurchased and cancelled	—			—			(97,000		)

Balance, December 31, 1998	—			(2,782,948		)	935,196
Net loss for the year	—			(4,195,263		)	(4,195,263		)
Deferred Compensation—stock options	(9,946		)	—			—
Amortization of Stock based Compensation	3,262			—			3,262
Common stock issued for services	—			—			3,168,832
Common stock issued via private placement	—			—			260,000

Balance, December 31, 1999	(6,684		)	(6,978,211		)	172,027
Net loss for the year				(2,616,261		)	(2,616,261		)
Amortization of Stock based Compensation	4,197						4,197
Common stock issue	—			—			251,344
Other	—			—			432
Preferred shares issued	—			—			5,986,650
Preferred stock issued for services	—			—			1,125,000

Balance, December 31, 2000	(2,487		)	(9,594,472		)	4,923,389
Net loss for the year	—			(1,432,046		)	(1,432,046		)
Deferred Compensation—stock options	(20,000		)	—			—
Amortization of Stock based Compensation	22,155			—			22,155

Balance, December 31, 2001	(332		)	(11,026,518		)	3,513,498
Net loss for the year	—			(1,684,965		)	(1,684,965		)
Amortization of Stock based Compensation	332			—			332

Balance, December 31, 2002	$	—		$	(12,711,483	)	$	1,828,865

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CALLISTO PHARMACEUTICALS, INC.
(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)

	Preferred Stock		Preferred Stock Par Value			Common Stock	Common Stock Par Value		Additional Paid in Capital			Unamortized Deferred Stock Based Compensation			Deficit Accumulated during the Development Stage			Total Stockholders’ Equity
Balance December 31, 2002	4,235,299		$	423		13,083,695	$	1,307	$	14,538,618		$	—		$	(12,711,483	)	$	1,828,865
Net loss for the year	—		—			—	—		—			—			(13,106,247		)	(13,106,247		)
Conversion of preferred stock in connection with the Merger	(4,235,299	)	(423		)	4,235,299	423		—			—			—			—
Common stock issued to former Synergy stockholders	—					4,329,927	432		6,494,458			—			—			6,494,890
Common stock issued in exchange for Webtronics common stock	—					1,503,173	150		(150		)	—			—			—
Deferred Compensation—stock options	—					—	—		9,313,953			(9,313,953		)	—			—
Amortization of deferred Stock based Compensation	—					—	—		—			3,833,946			—			3,833,946
Private placement of common stock, net	—		—			2,776,666	278		3,803,096			—			—			3,803,374

Balance, December 31, 2003	—		$	—		25,928,760	$	2,590	$	34,149,975		$	(5,480,007	)	$	(25,817,730	)	$	2,854,828

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CALLISTO PHARMACEUTICALS, INC.
(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)

	Common Stock		Common Stock Par Value			Additional Paid in Capital			Unamortized Deferred Stock Based Compensation			Deficit Accumulated during the Development Stage			Total Stockholders’ Equity
Balance, December 31, 2003	25,928,760		$	2,590		$	34,149,975		$	(5,480,007	)	$	(25,817,730	)	$	2,854,828
Net loss for the year	—		—			—			—			(7,543,467		)	(7,543,467		)
Amortization of deferred Stock-based compensation expense	—		—			—			3,084,473			—			3,084,473
Variable accounting for stock options	—		—			(816,865		)	—			—			(816,865		)
Stock-based compensation net of forfeitures	—		—			240,572			93,000			—			333,572
Common stock issued via private placements, net	3,311,342		331			6,098,681			—			—			6,099,012
Warrant and stock-based compensation for services in connection with the Merger	—		—			269,826			—			—			269,826
Common stock returned from former Synergy stockholders	(90,000	)	(9		)	(159,083		)	—			—			(159,092		)
Stock issued for patent rights	25,000		3			56,247			—			—			56,250
Common stock issued for services	44,000		7			70,833			—			—			70,840

Balance, December 31, 2004	29,219,102		$	2,922		$	39,910,186		$	(2,302,534	)	$	(33,361,197	)	$	4,249,377

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CALLISTO PHARMACEUTICALS, INC.

(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)

	Common Stock	Common Stock Par Value		Additional Paid in Capital			Unamortized Deferred Stock Based Compensation			Deficit Accumulated during the Development Stage			Total Stockholders’ Equity (Deficit)
Balance, December 31, 2004	29,219,102	$	2,922	$	39,910,186		$	(2,302,534	)	$	(33,361,197	)	$	4,249,377
Net loss for the year	—	—		—			—			(11,779,457		)	(11,779,457		)
Deferred stock-based compensation—new grants	—	—		1,571,772			(1,571,772		)	—			—
Amortization of deferred stock-based compensation	—	—		—			2,290,843			—			2,290,843
Variable accounting for stock options	—	—		75,109			—			—			75,109
Common stock issued via private placement:
March 2005	1,985,791	198		3,018,203			—			—			3,018,401
August 2005	1,869,203	187		1,812,940			—			—			1,813,127
Finders fees and expenses	—	—		(176,249		)	—			—			(176,249		)
Exercise of common stock warrant	125,000	13		128,737			—			—			128,750
Common stock issued for services	34,000	3		47,177			—			—			47,180

Balance, December 31, 2005	33,233,096	$	3,323	$	46,387,875		$	(1,583,463	)	$	(45,140,654	)	$	(332,919	)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CALLISTO PHARMACEUTICALS, INC.

(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN

STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)

	Series A Convertible Preferred Shares	Series A Convertible Preferred Stock		Common Stock	Common Stock Par Value		Additional Paid in Capital			Unamortized Deferred Stock Based Compensation			Deficit Accumulated during the Development Stage			Total Stockholders’ Equity (Deficit)
Balance, December 31, 2005	—	$	—	33,233,096	$	3,323	$	46,387,875		$	(1,583,463	)	$	(45,140,654	)	$	(332,919	)
Net loss for the year	—	—		—	—		—			—			(12,919,229		)	(12,919,229		)
Reclassification of deferred unamortized stock-based compensation upon adoption of FAS 123R	—	—		—	—		(1,583,463		)	1,583,463			—			—
Stock based compensation expense	—	—		—	—		2,579,431			—			—			2,579,431
Common stock issued via private placement:										—			—
February 2006	—			4,283,668	428		5,139,782									5,140,210
Finders fees and expenses	—	—		—			(561,808		)	—			—			(561,808		)
April 2006	—	—		666,667	67		799,933									800,000
Finders fees and expenses	—	—		—	—		(41,000		)	—			—			(41,000		)
Waiver and Lock-up Agreement	—	—		740,065	74		579,622			—			—			579,696
Common stock issued for services	—	—		87,000	9		121,101			—			—			121,110
Exercise of common stock warrants	—	—		184,500	18		190,017			—			—			190,035
Series A convertible preferred stock issued via private placement:	574,350	57		—	—		5,743,443			—			—			5,743,500
Finders fees and expenses	11,775	1		—	—		(448,909		)	—			—			(448,908		)
Detachable warrants	—	—		—	—		2,384,485			—			—			2,384,485
Beneficial conversion feature accreted as a dividend	—	—		—	—		—			—			(2,384,485		)	(2,384,485		)

Balance, December 31, 2006	586,125	$	58	39,194,996	$	3,919	$	61,290,509		$	—		$	(60,444,368	)	$	850,118

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CALLISTO PHARMACEUTICALS, INC.

(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN

STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)

	Series A Convertible Preferred Shares		Series A Convertible Preferred Stock, Par Value			Series B Convertible Preferred Shares		Series B Convertible Preferred Stock, Par Value			Common Shares	Common Stock, Par Value		Additional Paid in Capital			Deficit Accumulated during the Development Stage			Total Stockholders’ Equity
Balance, December 31, 2006	586,125		$	58		—		$	—		39,194,996	$	3,919	$	61,290,509		$	(60,444,368	)	$	850,118
Net loss for the year	—		—			—		—			—	—		—			(7,887,265		)	(7,887,265		)
Stock-based compensation expense	—		—			—		—			—	—		591,561			—			591,561
Common stock issued for services	—		—			—		—			80,000	8		36,792			—			36,800
Series A convertible preferred stock, issued via private placement	28,000		4			—		—			—	—		279,997			—			280,001
Finders fees and expenses, Series A private placement	—		—			—		—			—	—		(36,400		)	—			(36,400		)
Conversion of Series A preferred stock to common stock	(395,450	)	(40		)	—		—			7,668,165	767		(727		)	—			—
Beneficial conversion feature accreted as a dividend to Series A preferred stock	—		—			—		—			—	—		2,504,475			(2,504,475		)	—
Series B convertible preferred stock, issued via private placement	—		—			1,147,050		115			—	—		11,470,385			—			11,470,500
Finders fees and expenses, Series B private placement	—		—			—		—			—	—		(920,960		)	—			(920,960		)
Beneficial conversion feature accreted as a dividend to Series B preferred stock	—		—			—		—			—	—		10,495,688			(10,495,688		)	—
Change in fair value of Series B warrants from date of issuance to expiration of put option	—		—			—		—			—	—		(2,591,005		)	—			(2,591,005		)

Balance, December 31, 2007	218,675		22			1,147,050		115			46,943,161	4,694		83,120,315			(81,331,796		)	1,793,350
Net loss for the year	—		—			—		—			—	—		—			(9,655,471		)	(9,655,471		)
Recapitalization of majority owned subsidiary via private placements of common stock	—		—			—		—			—	—		2,951,913			—			2,951,913
Minority interest in equity of subsidiary acquired	—		—			—		—			—	—		(42,824		)	—			(42,824		)
Stock-based compensation expense	—		—			—		—			—	—		589,063			—			589,063
Proceeds from issuance of 11% Notes attributable to detachable warrants	—		—			—		—			—	—		181,732			—			181,732
Conversion of Series A preferred stock to common stock	(120,675	)	(12		)	—		—			2,413,500	241		(229		)	—			—
Conversion of Series B preferred stock to common stock	—		—			(10,000	)	(1		)	200,000	20		(19		)	—			—

Balance, December 31, 2008	98,000		$	10		1,137,050		$	114		49,556,661	$	4,955	$	86,799,951		$	(90,987,267	)	$	(4,182,237	)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CALLISTO PHARMACEUTICALS, INC.
(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)

(Unaudited)

	Series A Convertible Preferred Shares		Series A Convertible Preferred Stock			Series B Convertible Preferred Shares		Series B Convertible Preferred Stock			Common Shares	Common Stock Par Value		Additional Paid in Capital			Deficit Accumulated during the Development Stage			Non- Controlling Interest			Total Stockholders’ Equity (Deficit)
Balance, December 31, 2008	98,000		$	10		1,137,050		$	114		49,556,661	4,955		$	86,799,951		$	(90,987,267	)	$	—		$	(4,182,237	)
Cumulative effect of adoption of ASC Topic 815	—		—			—		—			—	—		(181,732		)	(1,903,900		)	—			(2,085,632		)
Net Loss	—		—			—		—			—	—		—			(15,073,021		)	(3,282,393		)	(18,355,414		)
Stock based compensation expense	—		—			—		—			—	—		1,119,856			—			—			1,119,856
Conversion of Series A preferred stock to common stock	(35,000	)	(4		)	—		—			894,445	89		(85		)	—			—			—
Conversion of Series B preferred stock to common stock	—		—			(122,884	)	(12		)	2,963,236	296		(284		)	—			—			—
Private placements of common stock of majority owned subsidiary	—		—			—		—			—	—		15,970,100			—			—			15,970,100
Fees and expenses associated with private placements of majority owned subsidiary	—		—			—		—			—	—		(260,002		)	—			—			(260,002		)
Preferred Stock dividend attributable to reset of conversion price in conjunction with waiver of liquidation preference	—		—			—		—			—	—		1,815,592			(1,815,592		)	—			—
Cashless Conversion of Warrants to Common Stock	—		—			—		—			193,769	19		(19		)	—			—			—
Balance December 31, 2009	63,000		$	6		1,014,166		$	102		53,608,111	$	5,359	$	105,263,377		$	(109,779,780	)	$	(3,282,393	)	$	(7,793,329	)
Net Loss	—		—			—		—			—	—		—			(25,793,488		)	(7,854,264		)	(33,647,752		)
Stock based compensation expense	—		—			—		—			—	—		854,651			—			—			854,651
Conversion of Series A preferred stock to common stock	(55,000	)	(5		)	—		—			1,527,777	153		(148		)	—			—			—
Conversion of Series B preferred stock to common stock	—		—			(1,014,166	)	(102		)	28,171,278	2,817		(2,715		)	—			—			—
Common shares in exchange for modification of convertible notes	—		—			—		—			265,770	27		100,169			—			—			100,196
Extinguishment on debt	—		—			—		—			—	—		2,809,531			—			—			2,809,531
Cashless conversion of Warrants to common stock upon extinguishment of convertible notes	—		—			—		—			72,355,769	7,236		(7,236		)	—			—			—
Warrants exchanged	—		—			—		—			1,505,699	151		(151		)	—			—			—
Direct offering of common stock of controlled subsidiary	—		—			—		—			—	—		7,179,000			—			—			7,179,000
Fair value of warrants issued in connection with controlled subsidiary registered direct offerings reclassified to derivative liability	—		—			—		—			—	—		(3,784,743		)	—			—			(3,784,743		)
Fees and expenses associated with direct offering of controlled subsidiary	—		—			—		—			—	—		(468,130		)	—			—			(468,130		)
Reclassification of derivative liability to equity upon termination of price protection	—		—			—		—			—	—		27,511,730			—			—			27,511,730
Common stock issued as settlement for director’s fees	—		—			—		—			75,000	8		41,117			—			—			41,125
Balance December 31, 2010	8,000		$	1		—		$	—		157,509,404	$	15,751	$	139,496,452		$	(135,573,268	)	$	(11,136,657	)	$	(7,197,721	)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CALLISTO PHARMACEUTICALS, INC.
(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)

(Unaudited)

	Series A Convertible Preferred Shares		Series A Convertible Preferred Stock			Series B Convertible Preferred Shares	Series B Convertible Preferred Stock		Common Shares	Common Stock Par Value		Additional Paid in Capital			Deficit Accumulated during the Development Stage			Non- Controlling Interest			Total Stockholders’ Equity (Deficit)
Balance December 31, 2010	8,000		$	1		—	—		157,509,404	$	15,751	$	139,496,452		$	(135,573,268	)	$	(11,136,657	)	(7,197,721		)
Net Loss	—		—			—	—		—	—		—			(6,793,045		)	(8,521,084		)	(15,314,129		)
Stock based compensation expense	—		—			—	—		—	—		424,168			—			—			424,168
Common stock issued for services	—		—			—	—		850,000	85		532,915			—			—			533,000
Value of common stock issued by controlled subsidiary for consulting services provided	—		—			—	—		—	—		341,295			—			—			341,295
Placement of common stock of controlled subsidiary	—		—			—	—		—	—		34,369,064			—			—			34,369,064
Fees and expenses associated with direct offering of controlled subsidiary	—		—			—	—		—	—		(2,148,384		)	—			—			(2,148,384		)
Warrant exercise									106,667	11		53,323									53,334
Warrants issued in connection with controlled subsidiary registered direct offering reclassified to derivative liability-net	—		—			—	—		—	—		(5,094,186		)	—			—			(5,094,186		)
Exercise of warrants-controlled subsidiary	—		—			—	—		—	—		415,309			—			—			415,309
Common stocks issued for settlement of directors’ fee	—		—			—	—		50,000	5		41,245			—			—			41,250
Sale of option to purchase shares of controlled subsidiary	—		—			—	—		—	—		100,000			—			—			100,000

Balance December 31, 2011	8,000		1			—	—		158,516,071	15,852		168,531,201			(142,366,313		)	(19,657,741		)	6,523,000
Net income/(loss) for the period	—		—			—	—		—	—		—			109,876,750			(6,957,805		)	102,918,945
Stock based compensation expense	—		—			—	—		—	—		497,651			—			—			497,651
Value of common stock issued by controlled subsidiary for services rendered												92,663									92,663
Common stock issued in settlement of directors fees	—		—			—	—		227,272	23		99,977			—			—			100,000
Reclassification of non-controlling interest upon deconsolidation May 9, 2012	—		—			—	—		—	—		—			(26,615,546		)	26,615,546			—
Conversion of Series A preferred stock to common stock	(8,000	)	(1		)	—	—		222,222	22		(21		)	—			—			—

Balance September 30, 2012	—		$	—		—	$	—	158,965,565	$	15,897	$	169,221,471		$	(59,105,109	)	$	—		$	110,132,259

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CALLISTO PHARMACEUTICALS, INC.

(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine months ended September 30, 2012			Nine months ended September 30, 2011			Period from June 5, 1996 (inception) to September 30, 2012
Cash flows from operating activities:
Net income/(loss)	$	102,918,945		$	(9,399,459	)	$	(40,000,970	)

Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation	—			3,128			111,458
Purchase discount accreted as interest income on U.S.Treasury bills	—			—			(26,950		)
Stock-based compensation expense	665,315			574,545			21,598,154
Purchased in-process research and development	—			—			6,841,053
Interest expense on notes	—			—			759,400
Loss on disposal of property and equipment	5,774			—			5,774
Stock-based liquidated damages	—			—			579,696
Change in fair value of derivative instruments—warrants	431,170			(3,346,421		)	17,341,455
Loss on debt extinguishment							2,099,892
Net liabilities assumed in excess of assets acquired in merger	—			—			(282,752		)
Gain on deconsolidation of Synergy	(120,393,000		)	—			(120,393,000		)
Loss related to equity method investment	5,750,997			—			5,750,997
Changes in operating assets and liabilities:
Prepaid expenses	721,028			149,314			—
Tax credit receivable	377,865			781,127			—
Security deposit	14,025			—			(73,715		)
Accounts payable and accrued expenses	(6,392,554		)	1,648,202			(1,698,426		)
Due to related party	2,655,594			—			2,655,594
Total Adjustments	(116,163,786		)	(190,105		)	(64,731,370		)
Net cash used in operating activities	(13,244,841		)	(9,589,564		)	(104,732,340		)
Cash flows from investing activities:
Short term investments—purchased	—			—			(5,921,825		)
Short term investments—liquidated	—			—			5,948,775
Acquisition of equipment	—			—			(117,233		)
Net cash used in investing activities	—			—			(90,283		)
Cash flows from financing activities:
Issuance of common and preferred stock	—			—			48,719,673
Issuance of common stock of controlled subsidiary	—			8,040,463			60,543,163
Proceeds from exercise of warrants of controlled subsidiary	—			415,309			415,309
Selling Agent fees and expenses-combined	—			(661,051		)	(5,930,684		)
Proceeds from sale of 11% Notes	—			—			603,163
Exercise of common stock warrants	—			53,334			372,119
Proceeds from sale of option	—			100,000			100,000
Net cash provided by financing activities	—			7,948,055			104,822,743
Net (decrease) increase in cash and cash equivalents	(13,244,841		)	(1,641,509		)	120
Cash and cash equivalents at beginning of period	13,244,961			1,708,982			—

Cash and cash equivalents at end of period	$	120		$	67,473		$	120

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

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CALLISTO PHARMACEUTICALS, INC.
(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Unaudited)

	Nine months ended September 30, 2012		Nine months ended September 30, 2011		Period from June 5, 1996 (inception) to September 30, 2012
Supplementary disclosure of cash flow information:
Cash paid for taxes	$	304,251	$	6,481	$	629,135
Supplementary disclosure of non-cash investing and financing activities:
Series A Preferred stock beneficial conversion feature accreted as a dividend	—		—		(4,888,960		)
Series B Preferred stock beneficial conversion feature accreted as a dividend	—		—		(10,495,688		)
Series A Preferred stock conversion rate change accreted as a dividend	—		—		(136,889		)
Series B Preferred stock conversion rate change accreted as a dividend	—		—		(1,678,703		)
Director’s fees settled for shares of common stock	100,000		41,250		182,375
Cash received in escrow for June 30, 2010 direct registered offering	—		—		—
Accrued finders’ fees related to direct registered offering	—		—		—
Common stock issued to extend notes payable	—		—		100,196
Value of warrants classified as derivative liability – net	$	—	$	3,719,300	$	20,331,912
Value of shares issued for services	$	—	$	533,000	$	625,663

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CALLISTO PHARMACEUTICALS, INC.

(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Business overview:

Callisto Pharmaceuticals, Inc. (which may be referred to as “Callisto”, “the Company”) is a development stage biopharmaceutical company incorporated under the laws of the State of Delaware on June 5, 1996 (inception). Since inception, Callisto’s efforts have been principally devoted to research and development, securing and protecting patents and raising capital.

From inception through September 30, 2012, Callisto has sustained cumulative net losses attributable to common stockholders of $32,489,564. Callisto’s losses have resulted primarily from expenditures incurred in connection with research and development activities, application and filing for regulatory approval of proposed products, stock-based compensation expense, patent filing and maintenance expenses, purchase of in-process research and development, outside accounting and legal services and regulatory, scientific and financial consulting fees, as well as deemed dividends attributable to the beneficial conversion rights of convertible preferred stock at issuance. From inception through September 30, 2012, Callisto has not generated any revenue from operations.

Callisto - Synergy Merger

On July 20, 2012, Callisto entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Synergy Pharmaceuticals, Inc., a Delaware corporation (“Synergy”). Pursuant to the Merger Agreement, following the satisfaction or waiver of each of the applicable conditions set forth in the Merger Agreement, Callisto and Synergy will merge (the “Merger”), whereupon Callisto’s separate corporate existence will cease and Synergy will continue as the surviving corporation of the Merger. Callisto is Synergy’s largest shareholder.

On October 15, 2012, Callisto entered into Amendment No. 1 to the above Agreement and Plan of Merger, dated July 20, 2012 with Synergy Pharmaceuticals, Inc., a Delaware corporation. Pursuant to the Amendment, the parties have agreed to, among other things, increase the exchange ratio from .17 to .1799 and change the lock-up provision such that each share of Synergy common stock received in connection with the merger shall be subject to a lock-up beginning on the effective date of the merger and ending on the earlier of (i) twenty-four (24) months after such date, (ii) a Change in Control (as defined in the Merger Agreement), or (iii) written consent of Synergy, at Synergy’s sole discretion, provided Synergy’s consent shall apply to all shares of Synergy’s common stock issued pursuant to the merger.

The consummation of the Merger is subject to various customary closing conditions, including but not limited to, (i) approval by Callisto’s and Synergy’s stockholders, (ii) the Registration Statement on Form S-4 shall have been declared effective by the SEC and (iii) the shares of Synergy’s common stock to be issued in the Merger shall have been approved for listing on The NASDAQ Capital Market. Upon consummation of the Merger the related party balances due to Synergy, $2,655,594 as of September 30, 2012, will be eliminated.

Completion of the merger is anticipated to occur during the first quarter of 2013, although there can be no assurance the merger will occur within the expected timeframe or at all.

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2. Basis of presentation and going concern:

These condensed consolidated financial statements include Callisto and one subsidiary Callisto Research Labs, LLC (including its wholly-owned subsidiary, Callisto Pharma, GmbH (Germany—inactive). All intercompany balances and transactions have been eliminated. These condensed consolidated financial statements do not include all of the information and footnote disclosures required by GAAP for complete financial statements. These statements should be read in conjunction with Callisto’s audited financial statements and notes thereto for the year ended December 31, 2011, included in Form 10-K filed with the SEC on March 30, 2012. Certain items in the prior year’s financial statements have been reclassified to conform to the current year’s presentation.

Deconsolidation

On May 9, 2012, Callisto’s controlled subsidiary, Synergy, closed an underwritten public offering of 10 million shares of common stock at an offering price of $4.50 per share, resulting in gross proceeds of $45 million before deducting underwriting discounts, commissions and other estimated offering expenses of approximately $3 million. As a result Callisto’s equity ownership decreased to approximately 34% of Synergy and Callisto determined that it no longer had control over the operations and decision making of Synergy. Therefore, Callisto deconsolidated Synergy and derecognized the Synergy assets, liabilities, and non-controlling interest from its financial statements.

As of the date of deconsolidation, May 9, 2012, Callisto began accounting for its investment in Synergy under the equity method and accordingly recognized its share of Synergy losses in the amount of $3,360,997 and $5,750,997 for the quarter and nine months ended September 30, 2012. No dividends have been received from Synergy since inception. As of September 30, 2012, Callisto’s investment in Synergy was $114,453,453.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, primarily consisting of normal adjustments, necessary for the fair presentation of the balance sheet and results of operations for the interim periods. The results of operations for the three and nine months ended September 30, 2012 are not necessarily indicative of the results of operations to be expected for the full year ending December 31, 2012. The condensed consolidated balance sheet as of December 31, 2011 presented above was derived from the audited consolidated financial statements as of that date.

The condensed consolidated financial statements as of September 30, 2012 and December 31, 2011 have been prepared under the assumption that Callisto will continue as a going concern for the twelve months ending December 31, 2012. Callisto’s ability to continue as a going concern is dependent upon its ability to obtain additional equity or debt financing, attain further operating efficiencies and, ultimately, to generate revenue. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Net cash used in operating activities was $13,244,841 during the nine months ended September 30, 2012 as compared to $9,589,564 for the nine months ended September 30, 2011 and $104,732,340 during the period from June 5, 1996 (inception) to September 30, 2012. During the three months and nine months ended September 30, 2012 Callisto reported a net loss attributable to common stockholders of $3,891,805 and net income of $109,876,750, respectively. The net loss of attributable to common stockholders recorded during the period from June 5, 1996 (inception) to September 30, 2012 was $32,489,564. The gain recognized upon deconsolidation of $120,393,000 is reflected in net losses for the nine month ended and the period from inception to September 30, 2012. To date, Callisto’s sources of cash have been primarily limited to the sale of equity securities and issuance of debt instruments. No cash was provided by financing activities for the nine months ended September 30, 2012; and for the period from June 5, 1996 (inception) to September 30, 2012, financing activities provided $104,822,743

3. Recent Accounting Pronouncements

In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”) which is intended to facilitate the convergence of U.S. GAAP and International Financial Reporting Standards (“IFRS”) as well as to increase the transparency of items reported in other comprehensive income. As a result of ASU 2011-05, all non-owner changes in stockholders’ equity are required to be presented in a single continuous statement of comprehensive income or in two separate but consecutive statements. The option to present other comprehensive income in the statement of changes in equity has been eliminated. ASU 2011-05 is effective for fiscal years beginning after December 15, 2011 and should be applied retrospectively. The Company adopted this standard on January 1, 2012 and the adoption did not have a material impact on the Company’s consolidated financial statements.

In May 2011, FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 amends Topic 820 to provide common fair value measurement and disclosure requirements in U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) and International Financial Reporting Standards. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements, as well as providing guidance on how fair value should be applied where its use is already required or permitted by other standards within U.S. GAAP. ASU No. 2011-04 is to be applied prospectively, and early adoption is not permitted. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The adoption of ASU No. 2011-04 on January 1, 2012 did not have a material impact on the Company’s consolidated financial statements.

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In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.” ASU 2011-11 provides for additional disclosures of both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The amendments in this Update are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods, and disclosures required by these amendments should be provided retrospectively for all comparative periods presented. The adoption of ASU No. 2011-11 is not expected to have a material impact on the Company’s consolidated financial statements.

4. Accounting for share-based payments

ASC Topic 718 did not change the way Callisto accounts for non-employee stock-based compensation. Callisto continues to account for shares of common stock, stock options and warrants issued to non-employees based on the fair value of the stock, stock option or warrant, if that value is more reliably measurable than the fair value of the consideration or services received. The Company accounts for stock options issued and vesting to non-employees in accordance with ASC Topic 505-50 “ Equity-Based Payment to Non-Employees” whereas the value of the stock compensation is based upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instruments is complete. Accordingly the fair value of these options is being “marked to market” quarterly until the measurement date is determined.

Callisto accounts for common stock, stock options, and warrants granted to employees and non-employees based on the fair market value of the instrument, using the Black-Scholes option pricing model based on assumptions for expected stock price volatility, term of the option, risk-free interest rate and expected dividend yield, at the grant date.

Callisto options

Stock based compensation expense, related to Callisto employee and non-employee share based payments, has been recognized in operating results as follow:

	Three Months Ended September 30,				Nine Months Ended September 30,				June 5, 1996 (Inception) to September 30,
	2012		2011		2012		2011		2012
Employees—included in research and development	$	—	$	—	$	—	$	—	$	2,692,157
Employees—included in general and administrative	5,900		2,426		17,572		23,202		4,875,833
Subtotal employee stock option grants	5,900		2,426		17,572		23,202		7,567,990
Non-employee—research and development	—		—		—		—		102,750
Non-employee—general and administrative	9,213		109,412		91,596		244,509		10,402,618
Subtotal non-employee stock option grants	9,213		109,412		91,596		244,509		10,505,368
Total stock based compensation expense	$	15,113	$	111,838	$	109,168	$	267,261	$	18,073,358

The unrecognized compensation cost related to employee non-vested Callisto stock options outstanding at September 30, 2012, net of expected forfeitures, was $9,824 to be recognized over a weighted average vesting period of approximately 4 months. No options were granted during the quarter ended September 30, 2012.

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The estimated fair value of each Callisto stock option award was determined on the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions during the six months ended September 30, 2011.

	Nine months ended September 30,
	2012		2011
Risk free interest rate	(*	)%	1.85	%
Dividend yield	(*	)	n/a
Expected volatility	(*	)%	90	%
Expected term	(*	)	5 years

(*) No options were granted during nine months ended September 30, 2012.

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A summary of stock option activity and of changes in Callisto stock options outstanding under Callisto’s plans is presented below:

	Number of options	Exercise Price Per Share		Weighted Average Exercise Price Per Share		Aggregate Intrinsic Value		Weighted Average Remaining Contractual Term
Balance outstanding, December 31, 2011	7,435,372	$	0.08 - 3.60	$	1.49	$	7,200	3.39
Granted	—	$	—	$	—	—
Forfeitures	—	$	—	$	—	—

Balance outstanding, September 30, 2012	7,435,372	$	0.08 - 3.60	$	1.49	$	360,215	2.64

Exercisable as of September 30, 2012	5,907,372	$	0.08 - 3.60	$	1.37	$	250,155	2.42

Synergy Options

ASC Topic 718 “Compensation—Stock Compensation” requires companies to measure the cost of employee services received in exchange for the award of equity instruments based on the estimated fair value of the award at the date of grant. The expense is to be recognized over the period during which an employee is required to provide services in exchange for the award. ASC Topic 718 did not change the way Synergy accounts for non-employee stock-based compensation. Synergy continues to account for shares of common stock, stock options and warrants issued to non-employees based on the fair value of the stock, stock option or warrant, if that value is more reliably measurable than the fair value of the consideration or services received. The Company accounts for stock options issued and vesting to non-employees in accordance with ASC Topic 505-50 “ Equity -Based Payment to Non-Employees” and accordingly the value of the stock compensation to non-employees is based upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instruments is complete. Accordingly the fair value of these options is being “marked to market” quarterly until the measurement date is determined.

ASC Topic 718 requires that cash flows resulting from tax deductions in excess of the cumulative compensation cost recognized for options exercised (excess tax benefits) be classified as cash inflows from financing activities and cash outflows from operating activities. Due to Synergy’s accumulated deficit position, no excess tax benefits have been recognized. Synergy accounts for common stock, stock options, and warrants granted to employees and non-employees based on the fair market value of the instrument, using the Black-Scholes option pricing model based on assumptions for expected stock price volatility, term of the option, risk-free interest rate and expected dividend yield, at the grant date.

Synergy adopted the 2008 Equity Compensation Incentive Plan (the “Plan”) during the quarter ended September 30, 2008. Stock options granted under the Plan typically vest after three years of continuous service from the grant date and have a contractual term of ten years.

	Three Months Ended September 30,				Nine Months Ended September 30				November 15, 2005 (inception) to September 30,
	2012 (1)		2011		2012 (1)		2011		2012 (1)
Employees—included in research and development	$	—	$	—	$	164,460	$	—	$	791,242
Employees—included in general and administrative	—		2,426		127,013		23,202		901,424
Non-employees—included in research and development	—		—		—		—		168,096
Non-employees—included in general and administrative	—		109,412		264,674		244,059		1,664,034

Total stock-based compensation expense	$	—	$	111,838	$	556,147	$	267,261	$	3,524,796

(1) On May 9, 2012, Callisto deconsolidated Synergy and derecognized the Synergy assets, liabilities, and non-controlling interest from its financial statements. Accordingly stock based compensation expense for Synergy is not included subsequent to that date.

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5. Investment in Synergy

On May 9, 2012, Callisto’s controlled subsidiary, Synergy, closed an underwritten public offering of 10 million shares of common stock at an offering price of $4.50 per share, resulting in gross proceeds of $45 million before deducting underwriting discounts, commissions and other estimated offering expenses of approximately $3 million. As a result, Callisto’s equity ownership decreased to approximately 34% of Synergy and Callisto determined that it no longer had control over the operations and decision making of Synergy. Therefore, Callisto deconsolidated Synergy and derecognized the Synergy assets, liabilities, and non-controlling interest from its financial statements.

As of the date of deconsolidation, May 9, 2012, Callisto began accounting for its investment in Synergy under the equity method and accordingly recognized its share of Synergy losses in the amount of $3,360,997 and $5,750,997 for the three months and nine months ended September 30, 2012, respectively. No dividends have been paid by Synergy from inception to September 30, 2012. The balance of the investment in Synergy carried on Callisto’s balance sheet, using the equity method of accounting as of September 30, 2012, was $114,453,453.

The following table summarizes financial information of Synergy at September 30, 2012.

Income Statement data:

	Three Months Ended September 30, 2012			Nine Months Ended September 30, 2012			November 15, 2005 (inception) to September 30, 2012
Loss from Operations	$	(10,088,770	)	$	(26,702,794	)	$	(102,917,092	)
Total Other Income/(Expense)	203,483			(763,585		)	5,913,516
Net Loss	(9,885,287		)	(27,466,379		)	(97,075,397		)

Balance Sheet data:

	September 30, 2012
	(unaudited)
Cash and cash equivalents	$	17,244,049
Available-for-sales securities short term	20,123,315
Due from related party (“Callisto Pharmaceuticals”)	2,655,594
Total Assets	41,329,685
Total Current Liabilities	4,975,195
Derivative financial instruments, at estimated fair value-warrants	4,663,395
Total Liabilities	9,638,590
Total Stockholders’ Equity	31,691,095

6. Research and Development Expense

Research and development costs include expenditures in connection with an in-house research and development laboratory, salaries and staff costs, application and filing for regulatory approval of proposed products, purchased in-process research and development, regulatory and scientific consulting fees, as well as contract research, patient costs, drug formulation and tableting, data collection, monitoring, insurance and FDA consultants.

In accordance with FASB ASC Topic 730-10-55, Research and Development, Synergy recorded prepaid research and development costs of $577,745 as of December 31, 2011, for nonrefundable pre-payments for production of drug substance and analytical testing services for its drug candidates. In accordance with this guidance, Synergy expenses deferred research and development costs when drug compound is delivered and services are performed. As of September 30, 2012 Synergy’s assets and liabilities have been deconsolidated and as a result there are no prepaid research and development costs on the balance sheet. See Note 5 above.

7. Income Taxes

For the nine months ended September 30, 2012 Callisto recorded $225,000 of New York State investment tax expense related to the tax years 2009 to 2011.

8. Net Loss per Share

Basic and diluted net loss per share is presented in conformity with ASC Topic 260, “Earnings per Share,” for all periods presented. In accordance with ASC Topic 260, basic and diluted net loss per common share was determined by dividing net loss attributable to common stockholders by the weighted-average common shares outstanding during the period. For the three months ended September 30, 2012 and 2011 and for the nine months ended September 30, 2011, diluted weighted-average shares are the same as basic weighted-average shares since the inclusion of issuable shares pursuant to the exercise of stock options and warrants, and the conversion of preferred stock would have been

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antidilutive. For the nine months ended September 30 diluted weighted-average shares were computed using the Treasury Stock Method, since the inclusion of issuable shares pursuant to the exercise of stock options and warrants, and the conversion of preferred stock was dilutive.

The following table sets forth the potentially dilutive effect of all outstanding equity instruments:

	September 30, 2012	September 30, 2011

Common Shares outstanding	158,965,565	158,516,071
Potentially dilutive common shares issuable upon:
Exercise of warrants	988,741	7,203,260
Exercise of Callisto stock options	7,435,372	7,435,372
Conversion of Series A Convertible Preferred Stock	—	222,222

Total fully diluted pro-forma	167,389,678	173,376,925

9. Derivative Financial Instruments

Effective January 1, 2009, the Company adopted provisions of ASC Topic 815-40, “Derivatives and Hedging: Contracts in Entity’s Own Equity” (“ASC Topic 815-40”). ASC Topic 815-40 clarifies the determination of whether an instrument issued by an entity (or an embedded feature in the instrument) is indexed to an entity’s own stock, which would qualify as a scope exception under ASC Topic 815-10.

Synergy Derivative Financial Instruments

Based upon the Company’s analysis of the criteria contained in ASC Topic 815-40, Synergy has determined that certain warrants issued in connection with sale of its common stock must be classified as derivative instruments. In accordance with ASC Topic 815-40, these warrants are also being re-measured at each balance sheet date based on estimated fair value, and any resultant changes in fair value is being recorded in the Company’s statement of operations. The Company estimates the fair value of certain warrants using the Black-Scholes option pricing model in order to determine the associated derivative instrument liability and change in fair value described above. The range of assumptions used to determine the fair value of the warrants at each period end during the periods indicated below were:

	January 1, 2012 to May 9, 2012 (1)		Nine Months Ended September 30, 2011
Estimated fair value of Synergy common stock	$4.05-$4.75		$2.56-$3.30
Expected warrant term	2.4 - 5.7 years		5 - 7 years
Risk-free interest rate	0.32%-1.33	%	1.18%-2.5	%
Expected volatility	60	%	90	%
Dividend yield	—		—

(1) Synergy’s assets and liabilities have been deconsolidated as of May 9, 2012 and as a result there was no derivative instrument liability on the balance sheet as of September 30 2012. Changes in fair values of Synergy derivative instruments have been recorded through May 9, 2012.

Estimated fair value of stock is the closing market price of the Company’s common stock on the date of warrant issuance and at the end of each reporting period when the derivative instruments are marked to market. Expected volatility is based on historical volatility of Synergy’s common stock. The warrants have a transferability provision and based on guidance provided in SAB 107 for instruments issued with such a provision, Synergy used the full contractual term as the expected term of the warrants. The risk free rate is based on the U.S. Treasury security rates for maturities consistent with the expected remaining term of the warrants and the date of grant or quarterly revaluation.

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Certain of Synergy’s warrants issued during the nine months ended September 30, 2011 contained a price protection clause which variable term required the Company to use a binomial model to determine fair value. There were no such price protected warrants issued during the nine months ended September 30, 2012. The range of assumptions used to determine the fair value of the warrants was as follows:

	Jan 1 to May 9, 2012	Nine months ended, September 30, 2011
Estimated fair value of stock	$3.28 - $4.50	$2.72 - $3.78
Expected warrant term	4.4 — 4.6 years	6.59 - 7 years
Risk-free interest rate	0.72% - 1.03%	1.18% - 2.50%
Expected volatility	60%	90%
Dividend yield	—	—

In the Binomial model, the assumption for estimated fair value of the stock is based on a Black-Scholes based apportionment of the unit price paid for the shares and warrants issued in Synergy’s most recent registered direct offerings, which resulting stock prices were deemed to be arms-length negotiated prices. Expected volatility is based on historical volatility of Synergy’s common stock. The warrants have a transferability provision and based on guidance provided in SAB 107 for instruments issued with such a provision, Synergy used the full contractual term as the expected term of the warrants. The risk free rate is based on the U.S. Treasury security rates for maturities consistent with the expected remaining term of the warrants.

The following table sets forth the components of changes in the Synergy’s derivative financial instruments liability balance for the periods indicated:

Date	Description	Warrants		Derivative Instrument Liability
12/31/2010	Balance of derivative financial instruments liability	728,469		$	3,487,959
3/31/2011	Fair value of new warrants issued during the quarter	210,000		$	1,312,673
3/31/2011	Change in fair value of warrants during the quarter recognized as other expense in the statement of operations	—		$	338,715
3/31/2011	Balance of derivative financial instruments liability	938,469		$	5,139,347
6/30/2011	Fair value of new warrants issued during the quarter	611,207		$	2,607,827
6/30/2011	Exercise of warrants during the quarter	(80,000	)	$	(486,328	)
6/30/2011	Change in fair value of warrants during the quarter recognized as other expense in the statement of operations	—		$	697,660
6/30/2011	Balance of derivative financial instruments liability	1,469,676		$	7,958,506
9/30/2011	Fair value of new warrants issued during the quarter	40,458		$	285,128
9/30/2011	Change in fair value of warrants during the quarter recognized as other income in the statement of operations	—		$	(4,382,796	)
9/30/2011	Balance of derivative financial instruments liability	1,510,134		$	3,860,838
12/31/2011	Fair value of new warrants issued during the quarter	1,810,294		$	3,082,203
12/31/2011	Reclass of derivative liability to equity during the quarter	(1,055,268	)	$	(1,707,317	)
12/31/2011	Change in fair value of warrants during the quarter recognized as other income in the statement of operations	—		$	(1,910,610	)
12/31/2011	Balance of derivative financial instruments liability	2,265,160		$	3,325,114
3/31/2012	Change in fair value of warrants during the quarter recognized as other income in the statement of operations	—		(7,946		)
3/31/2012	Balance of derivative financial instruments liability	2,265,160		3,317,168

5/9/12	Change in fair value of warrants during the quarter recognized as other income in the statement of operations	—		439,116
5/9/12	Reclassification due to deconsolidation	(2,265,160	)	(3,756,284		)

9/30/2012	Balance of derivative financial instruments liability	—		—

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Synergy Fair Value Measurements

The following table presents the Company’s liabilities that are measured and recognized at fair value on a recurring basis classified under the appropriate level of the fair value hierarchy as of December 31, 2011 and September 30, 2012:

Description		Quoted Prices in Active Markets for Identical Assets and Liabilities (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Balance as of December 31, 2011			Quoted Prices in Active Markets for Identical Assets and Liabilities (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Balance as of September 30, 2012
Derivative liabilities related to Warrants		$	—		$	—		$	3,325,114		$	3,325,114

CALLISTO PHARMACEUTICALS INC 10-Q