1. Nature of the Business

Achillion Pharmaceuticals, Inc. (the "Company") was incorporated on August 17, 1998 in Delaware. The Company is focused on discovering, developing and commercializing innovative anti-infective drug therapies. The Company is devoting substantially all of its efforts towards product research and development.

The Company incurred losses of $249,353 from inception through September 30, 2011 and had an accumulated deficit of $263,215 at September 30, 2011, which includes preferred stock dividends recognized until the Company's initial public offering in 2006. The Company has funded its operations primarily through the sale of equity securities, borrowings from debt facilities and the receipt of milestone and cost-sharing receipts from a collaboration partner, Gilead Sciences, Inc. ("Gilead").

The Company believes that its existing cash, cash equivalents and marketable securities will be sufficient to support its current operating plan through at least September 30, 2012. However, the Company's operating requirements may change as a result of many factors, including but not limited to:

2. Accounting Standards Updates

In October 2009, an update was made to the Accounting Standards Codification ("ASC") 605, Revenue Recognition, which provides accounting principles and application guidance on how revenue arrangements with multiple deliverables should be separated and the consideration allocated. Assuming other criteria are met, this guidance eliminates the requirement to establish the fair value of undelivered products and services and instead provides for separate revenue recognition. Allocation of consideration is now based on management's estimate of the selling price for an undelivered item where there is no other means to determine the fair value of that undelivered item. This update is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company adopted this guidance as of January 1, 2011. There was no impact to the Company's financial statements upon adoption of this standard as there were no new or materially modified agreements.

In May 2011, the Financial Accounting Standards Board ("FASB") issued an Accounting Standards Update ("ASU") No. 2011-04 "Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs". The amendments clarify the FASB's intent about the application of existing fair value measurement and disclosure requirements and in some instances change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. Notable changes under the amended guidance include: (i) application of the highest and best use and valuation premise concepts solely for non-financial assets and liabilities; (ii) measuring the fair value of an instrument classified in a reporting entity's shareholders' equity; and (iii) disclosing quantitative information about unobservable inputs used in the fair value measurement within Level 3 of the fair value hierarchy. For public entities, the amendment is effective for interim and annual periods beginning after December 15, 2011. Early application is not permitted. The Company does not expect adoption of this standard to have a material effect on its financial statements.

In June 2011, the FASB issued ASU No. 2011-05 "Comprehensive Income: Presentation of Comprehensive Income." Under the amendment, an entity will have the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This amendment, therefore, eliminates the currently available option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendment does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The Company will adopt this amended guidance for the fiscal year beginning January 1, 2012. As this guidance relates to presentation only, the adoption of this guidance will not have any other effect on the Company's financial statements.

3. Basis of Presentation

The accompanying unaudited financial statements of the Company should be read in conjunction with the audited financial statements and notes as of and for the year ended December 31, 2010 included in the Company's Annual Report on Form 10-K filed with the SEC on March 3, 2011. The accompanying financial statements have been prepared in accordance with generally accepted accounting principles in the United States ("U.S. GAAP") for interim financial information, in accordance with the instructions to Form 10-Q and the guidance in Article 10 of Regulation S-X. Accordingly, since they are interim financial statements, the accompanying financial statements do not include all of the information and disclosures required by U.S. GAAP for complete financial statements. The accompanying financial statements reflect all adjustments, consisting of normal recurring adjustments, that are, in the opinion of management, necessary for a fair statement of the results of operations for the interim periods presented. Interim results are not necessarily indicative of results for a full year.

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements and notes thereto. A discussion of the Company's critical accounting policies and management estimates is described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Part I, Item II of this quarterly report on Form 10-Q.

4. Financing Activities

Public Offering

In June 2011, the Company entered into an underwriting agreement (the "Underwriting Agreement") with Merrill Lynch, Pierce, Fenner & Smith Incorporated and Leerink Swann LLC, as underwriters (the "Underwriters"), related to a public offering of shares of the Company's common stock, par value $.001 per share, at a price of $5.90 per share less underwriting discounts and commissions (the "Offering"). The Company issued and sold an aggregate of 11,040 shares of common stock in connection with the Offering and the exercise of the over-allotment option that was granted to the underwriters in the Underwriting Agreement.

The Offering resulted in net proceeds to the Company of $60,947, after deducting offering related expenses and underwriting discounts. The Company intends to use the net proceeds to continue clinical testing of ACH-1625, ACH-2684, and ACH-2928, to continue IND-enabling preclinical studies of ACH-3102 and for general corporate expenses.

5. Earnings (Loss) Per Share ("EPS")

Basic EPS is calculated by dividing net income or loss attributable to common stockholders by the weighted average common stock outstanding. Diluted EPS is calculated by adjusting weighted average common shares outstanding for the dilutive effect of common stock options and warrants. In periods in which a net loss is recorded, no effect is given to potentially dilutive securities, since the effect would be antidilutive. Securities that could potentially dilute basic EPS in the future that were not included in the computation of diluted EPS because to do so would have been antidilutive were as follows for the three and nine months ended September 30, 2011 and 2010:

6. Collaboration Arrangements

Gilead Sciences, Inc.

In November 2004, the Company entered into a research collaboration and license agreement with Gilead Sciences, Inc. pursuant to which the Company agreed to collaborate exclusively with Gilead throughout the world to develop and commercialize compounds for the treatment of HCV which inhibit HCV replication through a novel mechanism of action targeting the HCV NS4A protein. In September 2009, the Company and Gilead amended the collaboration arrangement so that the Company may continue to develop ACH-1095 independently during an "Interim Period," while Gilead may rejoin in the development of ACH-1095 at clinical proof-of-concept, as defined in the agreement. At this time, however, the Company has elected not to devote significant resources to clinical development of ACH-1095.

The Company continues to be responsible for preclinical assessment of a limited number of other NS4A antagonists until such time as proof-of-concept is achieved. Gilead will otherwise be responsible for all manufacturing, formulation and commercialization activities associated with such compounds, if nominated, including all regulatory filings and clinical trials after proof-of-concept. The Company received $10,000 from Gilead upon the execution of the license agreement, of which $2,000 was allocated to the fair value of the preferred stock purchased concurrent with entering into the license agreement. The remaining $8,000 of the non-refundable up-front license fee, as well as a $2,000 milestone achieved during the period prior to achievement of proof-of-concept, are being accounted for under the proportionate performance model.

Gilead has the right to terminate the agreement without cause upon 30 days written notice to the Company. Upon termination of the Gilead arrangement for any reason, all cost share amounts due and payable through the date of termination shall be paid by the appropriate party and no previously paid amounts will be refundable. In addition to Gilead's rights to unilaterally terminate this agreement, each party has the right to terminate for material breach; however, the Company may terminate for Gilead's breach only on a market-by-market basis, and, if applicable, a product-by-product basis.

Revenue under the proportionate performance model is recognized as the Company's effort under the collaboration is incurred. The proportion of actual performance to total expected performance is applied to these payments in determining periodic revenue. Payments made by the Company to Gilead in connection with this collaboration are recognized as a reduction of revenue. When the Company's performance obligation is complete, the Company will recognize milestone payments, if any, when the corresponding milestone is achieved. The Company will recognize royalty payments, if any, upon product sales. Under the proportionate performance method, revenue recognized will be limited by the aggregate cash received or receivable to date by the Company.

At this time, the Company cannot accurately estimate its future obligations under the collaboration as it has not identified a new lead compound that will be developed jointly. Therefore, during the three and nine months ended September 30, 2011 and 2010, the Company did not recognize revenue from upfront, milestone and full-time equivalent, or "FTE," fees previously received under the collaboration. The Company will determine its remaining obligations if and when a new lead compound is identified.

During the three months ended September 30, 2011 and 2010, the Company recognized revenue of $64 and $45, respectively, under the arrangement, all of which related to external costs billed by the Company to Gilead. During the nine months ended September 30, 2011 and 2010, the Company recognized revenue of $185 and $162, respectively, under the arrangement, all of which related to external costs billed by the Company to Gilead.

Included in the accompanying balance sheets as of September 30, 2011 and December 31, 2010 are $64 and $18, respectively, of accounts receivable resulting from this collaboration agreement and $2,489 and $2,489, respectively, of deferred revenue resulting from the up-front fee, a milestone payment, and FTE costs.

GCA Therapeutics, Ltd.

In February 2010, the Company entered into a license agreement (the "Agreement") with GCA Therapeutics, Ltd. ("GCAT") for elvucitabine, the Company's nucleoside reverse transcriptase inhibitor for the treatment of both hepatitis B virus ("HBV") infection and human immunodeficiency virus ("HIV") infection. The Agreement was amended and restated in March 2010. The exclusive license grants GCAT the right, through a Chinese joint venture with Tianjing Institute of Pharmaceutical Research, to clinically develop and commercialize elvucitabine in mainland China, Hong Kong and Taiwan.

Under the terms of the Agreement, GCAT, through a sublicense agreement with a Chinese joint venture, T&T Pharma Co., Ltd., will assume all development and regulatory responsibility and associated costs for elvucitabine. The Company will be eligible to receive development milestones and royalties on net sales in the territories covered by the agreement.

The Agreement may be terminated by either party based upon material breaches by the other party, effective 90 days after providing written notice to the breaching party, if the breaching party fails to cure its material breach.

The Company may terminate the Agreement upon 30 days written notice in the event GCAT fails to meet any of the development or commercialization diligence milestones by the deadlines specified in the Agreement, or may terminate upon 90 days written notice in the event of a change of corporate control. In the event of a change of control, as defined, the Company shall pay GCAT termination fees, in an amount determined based upon specified progress milestones.

7. Marketable Securities

The Company applies the provisions of ASC 820, Fair Value Measurements and Disclosures, for financial assets and liabilities measured on a recurring basis which requires disclosure that establishes a framework for measuring fair value and expands disclosures in the financial statements. The guidance requires that fair value measurements be classified and disclosed in one of the three categories:

Level 1: Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date;

Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; or

Level 3: Unobservable inputs.

The fair value of the Company's marketable securities of $66,612 and $29,827 as of September 30, 2011 and December 31, 2010, respectively, is valued based on level 2 inputs. The Company's investments consist mainly of U.S government and agency securities, government sponsored bond obligations and certain other corporate debt securities. Fair value is determined based upon quoted market prices; however, due to lack of sufficiency of transactions and trading volume, the Company has assessed these as level 2 within the fair value hierarchy of ASC 820. The Company classifies its entire investment portfolio as available for sale as defined in ASC 320, Debt and Equity Securities. Securities are carried at fair value with the unrealized gains (losses) reported as a separate component of stockholders' equity within accumulated other comprehensive income.

The unrealized (loss) gain from marketable securities was $(43) and $2 at September 30, 2011 and December 31, 2010, respectively.

As of September 30, 2011 and December 31, 2010, none of the Company's investments were determined to be other than temporarily impaired.

8. Accrued Expenses

Accrued expenses consist of the following:

Accrued research and development expenses are comprised of amounts owed to third-party contract research organizations or "CROs", clinical investigators, laboratories and data managers for research and development work performed on behalf of the Company.

9. Debt

Debt consists of the following:

In March 2011, the Company entered into a Master Security Agreement for a $2,000 Capital Expenditure Line of Credit, ("the 2011 Credit Facility") with Webster Bank. Under the 2011 Credit Facility, the Company may draw down equipment loan advances for the purchase of new laboratory equipment through March 2012. Through September 30, 2011, the Company had drawn down $438 under the 2011 Credit Facility.

10. Stock Based Compensation

The Company's 2006 Stock Incentive Plan, or the 2006 Plan, is administered by the Company's Board of Directors and provides for the grant of incentive stock options, nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights and other stock based awards. The Company's officers, employees, consultants, advisors and directors are eligible to receive awards under the 2006 Plan; however, incentive stock options may only be granted to employees. Options granted are exercisable for a period determined by the Board of Directors, but in no event longer than ten years from the date of the grant. Options generally vest ratably over four years. There were 1,050 shares available to be granted under the 2006 Plan as of September 30, 2011.

A summary of the status of the Company's stock option activity for the nine months ended September 30, 2011 is presented in the table and narrative below:

The Company utilizes the Black-Scholes option pricing model for determining the estimated fair value for stock based awards. The Black-Scholes model requires the use of assumptions which determine the fair value of the stock based awards. The assumptions used to value options granted are as follows:

Total compensation expense recorded in the accompanying statements of operations associated with option grants made to employees was $615 and $513 for the three months ended September 30, 2011 and 2010, respectively. Total compensation expense recorded in the accompanying statements of operations associated with option grants made to employees was $1,828 and $1,426 for the nine months ended September 30, 2011 and 2010, respectively. The Company recorded no tax benefit related to these options since the Company currently maintains a full valuation allowance on its deferred tax assets.

As of September 30, 2011, the intrinsic value of the options outstanding was $9,078, of which $3,732 related to vested options and $5,346 related to unvested options. The intrinsic value of stock options is calculated based on the difference between the exercise prices of the underlying awards and the quoted stock price of the Company's common stock as of the reporting date.

As of September 30, 2011, the total compensation cost related to unvested options not yet recognized in the financial statements is approximately $5,475, net of estimated forfeitures, and the weighted average period over which this amount is expected to be recognized is 1.6 years.

11. Comprehensive Loss

The Company reports and presents comprehensive loss in accordance with ASC 220, Comprehensive Income, which establishes standards for reporting and display of comprehensive loss and its components in a full set of general purpose financial statements. The objective of the statement is to report a measure of all changes in equity of an enterprise that result from transactions and other economic events of the period other than transactions with owners (comprehensive loss). The Company's other comprehensive loss arises from net unrealized losses on marketable securities, and is immaterial for all periods presented.

12. Stockholders' Equity

Changes in stockholders' equity for the nine months ended September 30, 2011 and 2010 were as follows: