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  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**** ****FORM 10-Q**   þ **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934****For the quarterly period ended March 31, 2006****or**   o **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934****For the transition period from                      to                     ****Commission file number: 000-50642****MemoryPharmaceuticals Corp.**(Exact Name of Registrant as Specified in Its Charter)   Delaware 04-3363475   (State or Other Jurisdiction of Incorporation or (I.R.S. Employer Identification No.)Organization)     100 Philips Parkway, Montvale, New Jersey 07645   (Address of Principal Executive Offices) (Zip Code)(201) 802-7100 (Registrant’s Telephone Number, Including Area Code)None. (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 filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.þ Yes                      o NoIndicateby check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):Large Accelerated Filer o            Accelerated Filer o            Non-Accelerated Filer þIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).o Yes                      þ NoAs of May 8, 2006 the registrant had 37,770,019 shares of common stock, $0.001 par value per share,outstanding.  
 

 
**MEMORY PHARMACEUTICALS CORP.****Table of Contents**     Part I. Financial Information  3      Item 1. Financial Statements (unaudited)  3      BALANCE SHEETS  3      STATEMENTS OF OPERATIONS  4      STATEMENTS OF CASH FLOWS  5      NOTES TO FINANCIAL STATEMENTS  6      Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations  14      Item 3. Quantitative and Qualitative Disclosures About Market Risk  20      Item 4. Controls and Procedures  20      Part II. Other Information  21      Item 1A. Risk Factors  21      Item 6. Exhibits  21      SIGNATURES  22  EX-10.1: AMENDED AND RESTATED STRATEGIC ALLIANCE AGREEMENT EX-31.1: CERTIFICATION EX-31.2: CERTIFICATION EX-32.1: CERTIFICATION
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**PART I. FINANCIAL INFORMATION****Item 1. Financial Statements****MEMORY PHARMACEUTICALS CORP.****BALANCE SHEETS****(unaudited)****(in thousands, except for share and per share amounts)**           **March 31,**  **December 31,**   **2006**  **2005** **ASSETS**        **Current assets:**        Cash and cash equivalents $34,024  $39,533 Marketable securities  2,484   4,546 Receivables  825   1,562 Prepaid and other current assets  1,036   1,000        Total current assets  38,369   46,641 Property and equipment, net  8,772   9,167 Restricted cash  505   505        Total assets $47,646  $56,313        **LIABILITIES AND STOCKHOLDERS’ EQUITY**        **Current liabilities:**        Accounts payable $601  $759 Accrued expenses  2,766   3,839 Current portion of equipment notes payable  1,172   1,303 Deferred revenue — current  4,320   8,797        Total current liabilities  8,859   14,698 Warrant liability  10,738   8,477 Equipment notes payable, less current portion  854   1,089 Deferred revenue — long-term  13,620   11,098        Total liabilities  34,071   35,362                 **Stockholders’ equity:**        Common stock, $0.001 par value per share;100,000,000 shares authorized and 37,763,338and 37,714,703 issued and outstanding atMarch 31, 2006, and December 31, 2005respectively;  38   38 Additional paid-in capital  173,852   173,195 Accumulated deficit  (160,301)  (152,120)Accumulated other comprehensive loss  (14)  (23)Deferred compensation  —   (139)       Total stockholders’ equity  13,575   20,951        Total liabilities and stockholders’ equity $47,646  $56,313        See accompanying notes to financial statements.
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**MEMORY PHARMACEUTICALS CORP.****STATEMENTS OF OPERATIONS****(unaudited)****(in thousands, except for share and per share amounts)**           **Three Months Ended**   **March 31,**   **2006**  **2005** Revenue $2,780  $2,430 Operating expenses:        Research and development  6,843   8,926 General and administrative  2,238   2,086        Total operating expenses  9,081   11,012        Loss from operations  (6,301)  (8,582)       Change in fair value of warrants  (2,260)  — Interest:        Income  441   208 Expense  (59)  (73)       Interest income (expense), net  382   135        Net loss before income taxes  (8,179)  (8,447)Income taxes  2   2        Net loss attributable to common stockholders $(8,181) $(8,449)                Basic and diluted net loss per share of common stock $(0.22) $(0.41)       Basic and diluted weighted average number of sharesof common stock outstanding  37,745,394   20,689,320        See accompanying notes to financial statements.
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**MEMORY PHARMACEUTICALS CORP.****STATEMENTS OF CASH FLOWS****(unaudited)****(in thousands)**           **Three Months Ended**   **March 31,**   **2006**  **2005** Cash flows used in operating activities:        Net loss $(8,181) $(8,449)Adjustments to reconcile net loss to net cash used in operating activities:        Depreciation and amortization  516   534 Non-cash stock based compensation  716   36 Change in fair value of warrants  2,260   — Changes in operating accounts:        Receivables  737   (46)Prepaid and other current assets  (36)  (521)Other assets  —   7 Accounts payable  (158)  (135)Accrued expenses  (1,073)  (550)Deferred revenue  (1,955)  (805)       Net cash used in operating activities  (7,174)  (9,929)       Cash flows from investing activities:        Sales of marketable securities  2,072   2,385 Additions to property and equipment  (121)  (391)       Net cash provided by investing activities  1,951   1,994        Cash flows provided by financing activities:        Proceeds from issuance of common stock and warrants  80   272 Proceeds from equipment notes payable  —   495 Principal repayment equipment notes payable  (366)  (545)       Net cash (used in) / provided by financing activities  (286)  222        Net decrease in cash and cash equivalents  (5,509)  (7,713)Cash and cash equivalents, beginning of period  39,533   31,220        Cash and cash equivalents, end of period $34,024  $23,507        Supplemental cash flow information:        Cash paid for interest $59  $73 Cash paid for taxes  2   2 See accompanying notes to financial statements.
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**MEMORY PHARMACEUTICALS CORP.****NOTES TO FINANCIAL STATEMENTS****(unaudited)**(**in thousands**)**(1)** **Basis of Presentation**   As used herein, “we,” “us,” “the Company” and similar terms refer to Memory PharmaceuticalsCorp. We are a biopharmaceutical company focused on the development of innovative drugcandidates for the treatment of a broad range of central nervous system, or CNS, conditions thatexhibit significant impairment of memory and other cognitive functions. These conditionsinclude neurological diseases associated with aging, such as Alzheimer’s disease, and also include certainpsychiatric disorders such as schizophrenia, bipolar discorder and depression.   The financial statements included herein have been prepared from our books and records pursuantto the rules and regulations of the Securities and Exchange Commission (SEC) for reporting onForm 10-Q. The information and note disclosures normally included in complete financialstatements prepared in accordance with generally accepted accounting principles in the UnitedStates of America (U.S. GAAP) have been condensed or omitted pursuant to these rules andregulations. The interim financial statements should be read in conjunction with the auditedfinancial statements and notes thereto included in our Annual Report on Form 10-K for the yearended December 31, 2005.   We are responsible for the financial statements included in this document. Our interimfinancial statements are unaudited. Interim results may not be indicative of the results andtrends that may be expected for the year. However, we believe all adjustments considerednecessary for a fair presentation of these interim statements have been included and are of anormal and recurring nature. **(2)** **New Accounting Pronouncement**   Effective January 1, 2006, we began recording compensation expense associated with stock optionsand other forms of equity compensation in accordance with Statement of Financial AccountingStandards No. 123 (revised 2004), Share-Based Payment and related Financial Accounting StandardsBoard’s Staff Positions (SFAS 123R), as interpreted by SEC Staff Accounting Bulletin No. 107(SAB 107). Prior to January 1, 2006, we accounted for stock options according to the provisions ofAccounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*(APB 25),and related interpretations, and therefore no related compensation expense was recorded foremployee awards granted with no intrinsic value. We have adopted the modified prospectivetransition method provided for under SFAS 123R and, consequently, have not retroactivelyadjusted results from prior periods. Under this transition method, compensation cost associatedwith stock options recognized in the first quarter of fiscal 2006 includes: 1) quarterlyamortization related to the remaining unvested portion of all stock option awards granted priorto January 1, 2006, based on the grant-date fair value estimated in accordance with the originalprovisions of the Statement of Financial Accounting Standards No. 123, *Accounting forStock-Based Compensation*(SFAS 123); and 2) quarterly amortization related to all stock optionawards granted on or subsequent to January 1, 2006, based on the grant-date fair value estimatedin accordance with the provisions of SFAS 123R.   As a result of the adoption of SFAS 123R, the compensationexpense recognized in the statements of operations during the quarter ended March 31, 2006 for stock options was $716,000.   Prior to the adoption of SFAS 123R, we presented all tax benefits resulting from the exercise ofstock options as operating cash flows in the statements of cash flows. SFAS 123R requires thatcash flows resulting from tax deductions in excess of the cumulative compensation costrecognized for options exercised (excess tax benefits) be classified as financing cash flows. Wehave sufficient net operating loss carryforwards to generally eliminate cash payments for incometaxes. Therefore, no cash has been retained as a result of excess tax benefits relating to sharebased payments made to directors and employees.   For stock options granted prior to the adoption of SFAS 123R, if compensation expense for ourvarious stock option plans had been determined based upon estimated fair values at the grantdates in accordance with SFAS 123, our pro forma net loss and basic and diluted loss per commonshare would have been as follows:
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       **March 31, 2005**   **(in thousands**   **except per share**   **amounts)** Net loss attributable to common stockholders, as reported $(8,449)Add: Stock-based director compensation expense included in reported net loss  36 Deduct: Employee stock-based compensation expense under fair-value based method  (469)         Pro forma net loss attributable to common stockholders $(8,882)         Pro forma basic and diluted net loss per share of common stock $(0.43)         Net loss attributable to common stockholders, as reported $(8,449)         Basic and diluted net loss per share of common stock, as reported $(0.41)    The fair values of stockoptions granted during the three-month period ended March 31, 2005 were calculated using the following assumptions:        **Three Months**  **Ended**  **March 31, 2005**Expected stock price volatility  70%Expected term until exercise 5 yearsRisk-free interest rate  4.0%Expected dividend yield  0% **(3)** **Stock-Based Compensation**   As of March 31, 2006, we had two types of stock-based compensation plans, which are describedbelow. The compensation expense recognized in the statements of operations in the firstquarter of 2006 for stock-based compensation plans was $716,000. Of the $716,000 ofstock-based compensation expense recognized in the first quarter of 2006, $399,000 was acomponent of general and administrative expenses and $317,000 was a component of research anddevelopment expenses. Cash received from stock options exercised and common stock purchased under the 2004 Employee Stock Purchase Plan (the “2004 ESPP”) for the quarter ended March 31, 2006, was $80,000.   **Stock Options**   Our 2004 Stock Incentive Plan (the “2004 Plan”) was adopted in April 2004. The 2004 Planpermits the granting of both incentive stock options and non-qualified stock options. Stockoptions are exercisable over a period determined by our Board of Directors, but such periodcannot be longer than ten years after the grant date. The exercise price is the closingmarket price of our stock at the date of grant. Stock options issued generally vest over fouryears on a quarterly basis (graded vesting).   Our 1998 Employee, Director and Consultant Stock Option Plan (the “1998 Equity Plan”), wasadopted in March 1998. Both incentive stock options and non-qualified stock options weregranted under the 1998 Equity Plan. Options granted under the 1998 Equity Plan areexercisable over a period of ten years after the grant date. Our Board of Directorsdetermined the exercise price at the time of grant of such options. Options issued generallyvest over four years on a quarterly basis (graded vesting). The 1998 Equity Plan wassuperseded by the 2004 Plan in April 2004.   The weighted-average fair value of stock option awards granted after the adoption of SFAS 123Rwas $1.87 per share and was estimated on the date of grant using the Black-Scholes optionvaluation model and the assumptions noted in the following table.
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       **Three Months**  **Ended**  **March 31, 2006**Expected life 6.25 yearsExpected volatility  81.5%Risk-free interest rate 4.39% to 4.75%Dividend yield  0%   The expected life of the stock options was calculated using the shortcut method allowed by theprovisions of SFAS 123R and interpreted by SAB 107. The expected volatility is based on thehistoric volatility of our publicly-traded stock which we believe will be representative ofthe volatility over the expected term of the options. The risk-free interest rate is based onthe rates paid on securities issued by the U.S. Treasury with a term approximating theexpected life of the option. The dividend yield is based on the projected annual dividendpayment per share, divided by the stock price at the date of grant.  The status of our stock option plans at March 31, 2006, and changes during the quarter endedMarch 31, 2006, is summarized below:                       **Weighted**       **Weighted**  **Average**       **Average**  **Remaining**   **Number**  **Exercise Price**  **Contractual**   **of Shares**  **per Share**  **Term (in years)** Outstanding at January 1, 2006  4,108,058  $3.47     Granted  488,939  $2.53     Exercised  (8,213) $0.75     Forfeited or expired  (143,633) $3.79                              Outstanding at March 31, 2006  4,445,151  $3.36   8.19                          Vested and expected to vest at March 31, 2006  4,122,970  $3.35   8.12                          Vested and exercisable at March 31, 2006  2,143,855  $3.23   7.17                At March 31, 2006 we had 3,374,271 options outstanding that were “in the money” with anaggregate intrinsic value of $2,962,000 and 1,534,681 exercisable stock options with anaggregate intrinsic value of $2,210,000.   During the first quarter of fiscal 2006, the weighted-average grant-date fair value of eachstock option granted was $1.87 per share. The total intrinsic value of stock options exercisedduring the first quarter of fiscal 2006 was $14,000. The vesting period for stock optionsgranted in the first quarter of fiscal 2006 was 48 months.   As of March 31, 2006, there was $4,018,000 of total unrecognized compensation cost related tounvested stock options, which is expected to be recognized over a remaining weighted-averagevesting period of 2.6 years. The total grant-date fair value of stock options vested duringthe quarter ended March 31, 2006 was $547,000.   On February 17, 2006, we entered into a new employment agreement with our Chairman pursuant towhich we extended the exercise period of his outstanding stock options. As a result of thismodification, we recognized an additional compensation expense of $118,000 for the quarterended March 31, 2006.   **Employee Stock Purchase Plan**   In 2004, we created a plan for all eligible employees to purchase our stock bi-annually at 85%of the lower of the fair market value of our common stock on the date of the offering or thepurchase date. Employees elect, subject to certain limitations, to
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  withhold funds from their wages to purchase shares on each bi-annual purchase date. Theoffering period is a two year period which resets at any purchase date where the fair marketvalue of our common stock is less than the fair market value at the original offering date.The current offering period began on August 1, 2005 and the remaining purchase dates duringthis period are July 31, 2006, January 31, 2007 and July 31, 2007. Eligible employees canenter at the beginning of a purchase period and are permitted to cancel participation in theoffering before each bi-annual purchase date and obtain a refund of the amounts withheld fromtheir wages.   Prior to the adoption of SFAS 123R, the 2004 ESPP was accounted for under APB 25 and we werenot required to record compensation expense for the 2004 ESPP. Under the provisions of SFAS123R, the 2004 ESPP is a compensatory plan, and as such, we will recognize expense for sharesexpected to vest after January 1, 2006.   We estimate the number of shares to be purchased at each balance sheet date based on thecurrent amount of employee withholdings and the remaining purchase dates within the offeringperiod. The fair value of share options expected to vest is estimated using the grant-datefair value plus any added fair value resulting from any reset purchase date using theBlack-Scholes option valuation model. Share options for new employees entering the 2004 ESPPon February 1, 2006 were estimated using the Black-Scholes option valuation model and theassumptions noted in the following table.       **Three Months**  **Ended**  **March 31, 2006**Expected life 1.25 yearsExpected volatility  81.5%Risk-free interest rate  4.48%Dividend yield  0%   At adoption of SFAS 123R, we expected that 161,688 shares would be purchased under the 2004ESPP through the offering period which expires on July 31, 2007. An additional 3,408 shareswith a grant-date fair value of $1.23 were added for employees that entered the 2004 ESPP onFebruary 1, 2006. On January 31, 2006, 40,422 shares were purchased under the 2004 ESPP for$76,000, with an intrinsic value of $27,000 at the purchase date. Employees forfeited 1,737shares expected to be purchased during the quarter ended March 31, 2006.   At March 31, 2006 we had 122,937 share options outstanding under the 2004 ESPP with a weightedaverage grant date fair value of $2.36 per share and an aggregate intrinsic value of $111,000.   As of March 31, 2006, there was $250,000 of total unrecognized compensation cost related toshare options under the 2004 ESPP which is expected to be recognized over the remainingweighted-average vesting period of 10 months. **(4)** **Net Loss Per Share**   Basic net loss per share is calculated by dividing net loss attributable to the holders of ourcommon stock by the weighted average number of shares of common stock outstanding during theperiod. Diluted net loss per share is computed by dividing net loss attributable to holders ofour common stock by the weighted average number of shares of common stock and the dilutivepotential common stock equivalents then outstanding. Potential common stock equivalents consistof stock options and warrants. The weighted average anti-dilutive shares for the three-monthperiods ended March 31, 2006 and 2005 are summarized as follows:
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           **Three Months Ended**   **March 31,**   **2006**  **2005** Common stock options  4,294,428   2,899,078 Warrants1   5,913,267   119,907        Total  10,207,695   3,018,985          1 Includes 5,639,232 warrants issued in our September 2005 private placement. See Note 8.                Since we had a net loss in each of the periods reported, basic and diluted net loss per share isthe same. As a result, the computation of diluted net loss per share excludes the effect of thepotential exercise of stock options to purchase shares of common stock and warrants to purchaseshares of common stock, because the effect would be anti-dilutive. **(5)** **Marketable Securities**   Our marketable securities are debt securities primarily consisting of government obligations,mortgage-backed securities, and corporate debt securities. We classify all of our marketablesecurities as available-for-sale, as defined by Statement of Financial Accounting Standards(SFAS) No. 115, *Accounting for Certain Investments in Debt and Equity Securities*.Available-for-sale securities are carried at fair value, with unrealized gains and lossesreported as a component of stockholders’ equity in accumulated other comprehensive loss.Interest income, realized gains and losses, and declines in value judged to beother-than-temporary on securities are included in our statements of operations.   The following is a summary of our available-for-sale investments in debt securities that weinclude in current assets on our balance sheets at fair value:                   **March 31, 2006**  **December 31, 2005**   **Fair**  **Unrealized**  **Fair**  **Unrealized**   **Value**  **Loss**  **Value**  **Loss**       **(in thousands)**     Corporate debt securities $500  $2  $1,003  $6 Commercial paper  989   1   —   — Obligations of US government agencies  —   —   2,399   3 Mortgage-backed and asset-backed securities  995   4   1,144   8      Marketable securities due over 90 days $2,484  $7  $4,546  $17                  Commercial paper  11,940   3   19,156   6 Obligations of US government agencies  18,415   4   12,289   —      Marketable securities due in 90 days or less * $30,355  $7  $31,445  $6                       Total marketable securities $32,839  $14  $35,991  $23                  * Classified as cash and cash equivalents on the balance sheets.                  The amortized cost and fair value of our available-for-sale investments in debt securities bystated maturity at March 31, 2006 is as follows:           **Cost**  **Fair value**   **(in thousands)** Due in 90 days or less * $30,362  $30,355 Due after 90 days, up to one year  990   989 Due after one year, up to two years  —   — Due after two years  1,501   1,495          $32,853  $32,839                  * Classified as cash and cash equivalents on the balance sheets.               
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  We evaluate declines in the fair value of our investments in available-for-sale marketablesecurities to determine if these declines are other-than-temporary. If a decline in fair valueis determined to be other-than-temporary, an impairment charge would be recorded and a new costbasis in the investment would be established. Gain or loss on the sale of marketable securitiesis determined using the specific identification method. **(6)** **Comprehensive Loss**   Comprehensive loss includes net loss and unrealized gains and losses on available-for-salemarketable securities. Cumulativeunrealized gains and losses on available-for-sale marketable securities are reflected asaccumulated other comprehensive loss in stockholders’ equity on our balance sheets. For thethree months ended March 31, 2006, comprehensive loss was $8.2 million, which includes our netloss of $8.2 million, and an unrealized gain on available-for-sale marketable securities of$9,000. For the three months ended March 31, 2005, comprehensive loss was $8.4 million, whichincludes our net loss of $8.4 million and an unrealized loss on available-for-sale marketablesecurities of $7,000.**(7)** **License Agreements and Collaborations**   *Bayer AG in-license*   In June 2001, we entered into an agreement with Bayer for an exclusive, worldwide,sub-licensable license under certain Bayer patents and know-how to MEM 1003 for the treatment ofhuman peripheral and CNS-related disorders. As of March 31, 2006, we have paid $2.0 million inupfront and milestone payments to Bayer. We are required to make additional payments of up to$18.0 million upon our achievement of specified milestones. We are also obligated to payroyalties during the term of the agreement based on a specified percentage of worldwide netsales of products covered by the license agreement, which increases at increasing net saleslevels and varies depending on whether the sales are made by us or by a sub-licensee.   *Hoffmann-LaRoche (2002 Roche Agreement)*   In July 2002, we entered into an agreement with Roche for the development of PDE4 inhibitors forthe treatment of neurological and psychiatric indications, and potentially other indications.Under this Agreement, we granted Roche a worldwide, exclusive, sub-licensable license to ourpatent rights and know-how with respect to any PDE4 inhibitor for the prevention and treatmentof diseases, in all indications, for either human or veterinary use. Under this Agreement, Rocheprovided us with research and development funding, initially for a two-year period, which wasextended in August 2004 for an additional two years. In August 2005, we amended the 2002 RocheAgreement to reacquire the right to develop and commercialize MEM 1414 and MEM 1917, followingRoche’s earlier decision not to pursue further clinical development of these candidates, andRoche received an option, exercisable following the completion of Phase 2 clinical trials foreach drug candidate, to continue that drug candidate’s development and commercialization. IfRoche exercises its option to obtain an exclusive license to MEM 1414 and/or MEM 1917 andcontinues the development and commercialization of either drug candidate, we will be entitled toreceive development-related milestone payments for specified events occurring after theinitiation of Phase 3 clinical trials and royalties based on worldwide sales. In addition,under certain circumstances, we will have the option to co-promote MEM 1414 and MEM 1917 in theUS or in the US and the EU. Roche maintains its exclusive, worldwide license to develop andcommercialize all other drug candidates from our PDE4 inhibitor program. In February 2006, inconnection with an amendment to our original 2003 Roche Agreement, we further amended the 2002Roche Agreement to terminate Roche’s obligation to make research and development fundingpayments in support of the PDE4 research collaboration. Rochemaintains its exclusive, worldwide license to develop andcommercialize candidates from the PDE4 inhibitor program.   Roche has paid us a total of $26.0 million through March 31, 2006 under the 2002 RocheAgreement, comprised of an upfront license fee of $8.0 million, research and development fundingof $14.0 million and milestone payments totalling $4.0 million. Roche is obligated to makefuture payments to us if specified developmental milestones are achieved.   During each of the three month periods ended March 31, 2006 and March 31, 2005, we recognizedrevenue of $1.1 million and $1.3 million, respectively, under the 2002 Roche Agreement,representing the upfront license payment and milestone payments, which are being amortized overthe expected period for the development of the first compound under the 2002 Roche Agreement,and research and development funding.
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  *Hoffmann-LaRoche (Amended and Restated 2003 Roche Agreement)*   In August 2003, we entered into a second collaboration with Roche for the development ofnicotinic alpha-7 agonists for the treatment of CNS indications including schizophrenia andAlzheimer’s disease (the“2003 Roche Agreement”). This agreement was amended and restated on February27, 2006. Under the terms of the Amended and Restated 2003 Roche Agreement, we have granted toRoche a worldwide, exclusive, sub-licensable license to all of our patent rights and know-howwith respect to our nicotinic alpha-7 agonists, other than MEM 3454, for the prevention andtreatment of diseases, in all indications, for either human or veterinary use. With respect toMEM 3454, Roche has the option to obtain a license following our completion of the Phase 2aclinical trial for this drug candidate. Under the terms of the Amended and Restated 2003 RocheAgreement, we willreceive an aggregate of $1.8 million of research and development funding in 2006. Subject to thedetermination by the parties that certain specified preclinical criteria have been achieved, wewill be eligible to receive an aggregate of approximately $2.3 million (based on 1 USD: 1.31 CHF)in research and development funding in 2007.   Roche has paid us a total of $28.0 million through March 31, 2006 under the Amended andRestated 2003 Roche Agreement, comprised of an upfront license fee of $10.0 million, an equityinvestment of $10.0 million, research and development funding of $6.0 million and a milestonepayment of $2.0 million. Roche is obligated to make future payments to us if specifieddevelopmental milestones are achieved. During each of the three month periods ended March 31,2006 and March 31, 2005, we recognized revenue of $0.2 million and $1.1 million, respectively,under the Amended and Restated 2003 Roche Agreement, representing the upfront license payment,research and development funding and milestone payments. Revenue is being recognized over theexpected period for the development of the first compound under the Amended and Restated 2003 Roche Agreement    *Amgen Inc. (2005 Amgen Agreement)*   On October 14, 2005, we entered into a Collaboration and License Agreement with Amgen for thedevelopment of PDE10 inhibitors for neurological and psychiatric disorders. Under the terms ofthe agreement, we have received a $5.0 million up-front fee and $0.7 million in research anddevelopment funding to date. We and Amgen are conducting a collaborative preclinical researchprogram relating to PDE10 inhibitors for a two-year period in accordance with a predefinedresearch workplan. Subject to Amgen’s right to terminate the agreement or terminate specifiedrights thereunder, we are entitled to receive (i) $3.3 million in research funding during thefirst year of the research collaboration and (ii) a minimum of $1.8 million in research fundingduring the second year of the research collaboration. Amgen is also obligated to make milestonepayments to us upon the achievement of pre-specified research, development, regulatory approvaland sales milestones relating to PDE10 inhibitors.   We are recognizing revenue over the two-year agreement period based on the level of actualresearch efforts expended in a period as compared to our estimated efforts over the full period.During the three month period ended March 31, 2006, we recognized revenue of $1.5 millionrepresenting the upfront license payment and research and development funding.   *The Stanley Medical Research Institute (SMRI Development Agreement)*   On December 20, 2005, we entered into a development agreement with SMRI for the development ofMEM 1003 as a treatment for bipolar disorder or schizophrenia. Under the terms of the SMRIDevelopment Agreement, we are eligible to receive up to $3.2 million in funding from SMRI tosupport the development of MEM 1003 for the treatment of bipolar disorder or schizophrenia overthe development term of three years, which term may be extended for additional one-year periods.As of March 31, 2006, we received $960,000 in exchange for the issuance of 440,367 shares of ourcommon stock and a warrant to purchase 154,128 shares of our common stock at an exercise price of$2.62 per share that becomes exercisable on June 17, 2006 and expires on December 19, 2010. Weare eligible to receive the remaining $2.2 million as milestone payments upon the achievement ofcertain milestones related to the Phase 2a trial in bipolar disorder, which we plan to commenceduring the second quarter of 2006. If we fail to achieve the third milestone by December 31,2007, we will be required to refund to SMRI the portion of the $2.2 million of developmentfunding advanced by SMRI as of that date. **(8)** **September 2005 Private Placement**   On September 23, 2005, we completed a private placement in which we issued 16,112,158 sharesof common stock, at a price of $1.90 per share, and warrants to purchase an aggregate of5,639,232 shares of common stock, resulting in net proceeds of $29.0 million.
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  The warrants are currently exercisable, have a five-year term and an exercise price pershare of $2.22. In accordance with EITF No. 00-19, the warrants have been recorded as along-term liability and valued at fair value on the date of issuance. The fair value of thewarrants on the date of issuance was $6.8 million and was determined using the Black-Scholesmodel with the following assumptions: dividend yield of 0%; estimated volatility of 80%; riskfree interest rate of 4.07% and a contractual life of five years.   As required under the terms of the Securities Purchase Agreement, pursuant to which theprivate placement was consummated, we filed a registration statement with the Securities andExchange Commission (SEC) to register for resale the shares of common stock and the shares ofcommon stock issuable upon the exercise of the warrants sold in the private placement. Theregistration statement became effective on November 7, 2005.   In addition, we agreed to use our reasonable best efforts to keep the registration statementeffective until the earlier of two years after the effective date of the registration statementor the date on which the shares of common stock and the shares of common stock issuable uponexercise of the warrants become eligible for resale pursuant to Rule 144(k) under the SecuritiesAct of 1933, as amended. If we suspend or otherwise fail to maintain effectiveness, we will haveto pay each purchaser liquidated damages in an amount equal to 1.0% of the purchase price paid bysuch purchaser for the securities in the private placement for each 30-day period during whichsuch registration statement is suspended or otherwise not effective.   The fair value of the warrant liability is recalculated at each balance sheet date, with thenon-cash change in the fair value reported on the consolidated statement of operations. We haverecorded an unrealized loss on the warrants of $2.3 million for the three month period endedMarch 31, 2006. This amount will be adjusted at the end of each quarter to reflect any change infair value at such date.
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**Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations**This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)is intended to provide information to help you better understand and evaluate our financialcondition and results of operations. We recommend that you read this section in conjunction withour financial statements and notes to financial statements in Item 1 and with our Annual Report onForm 10-K for the year ended December 31, 2005.Some of the statements contained in this Quarterly Report on Form 10-Q are forward-lookingstatements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended,and are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995.These statements are based on our current expectations, assumptions, estimates and projectionsabout our business and our industry, and involve known and unknown risks, uncertainties, and otherfactors that may cause our or our industry’s results, levels of activity, performance orachievements to be materially different from any future results, levels of activity, performance orachievements expressed or implied in, or contemplated by, the forward-looking statements. Wegenerally identify these statements by words or phrases such as “believe,” “anticipate,” “expect,”“intend,” “plan,” “will,” “may,” “should,” “estimate,” “predict,” “potential,” “continue,” or thenegative of such terms or other similar expressions. Our actual results and the timing of eventsmay differ significantly from the results discussed in the forward-looking statements, and youshould not place undue reliance on these statements. Factors that might cause such a differenceinclude those discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K forthe year ended December 31, 2005, as well as those discussed in Part II, “Item 1A. Risk Factors” inthis Quarterly Report on Form 10-Q. We disclaim any intent or obligation to update anyforward-looking statements as a result of developments occurring after the period covered by thisreport or otherwise.**OVERVIEW**Since our incorporation in March 1997, we have devoted substantially all of our resources to thediscovery and development of innovative drug candidates for the treatment of a broad range of CNSconditions, many of which exhibit significant impairment of memory and other cognitive functions.These conditions include neurological diseases associated with aging, such as Alzheimer’s disease,and also include certain psychiatric disorders such as schizophrenia, bipolar disorder, anddepression. We currently have a number of clinical and preclinical drug candidates in development,as well as other drug discovery programs, addressing specific CNS targets. We do not currentlyhave any commercial products for sale and do not anticipate having any commercial products for salewithin the foreseeable future. We seek to leverage our pipeline of early development candidatesthrough collaborations with leading pharmaceutical and biotechnology companies.We have entered into two separate collaborations with Roche for clinical development, one for PDE4inhibitors and the other for nicotinic alpha-7 agonists. As of March 31, 2006, we had received$54.0 million in upfront licensing fees, research and development funding, milestone payments andan equity investment under these collaborations.Under our 2002 Roche Agreement, Roche provided us with research and development funding, initiallyfor a two-year period, which was extended in August 2004 for an additional two years. In February2006, in connection with an amendment to the 2003 Roche Agreement, we further amended the 2002Roche Agreement to terminate Roche’s obligation to make research and development funding paymentsin support of the PDE4 research collaboration. In August 2005, we amended the 2002 Roche Agreementto reacquire the right to develop and commercialize MEM 1414 and MEM 1917, the two named drugcandidates under that agreement, following Roche’s earlier decision not to pursue further clinicaldevelopment of these candidates. We have evaluated the data that we received from Roche and arecurrently exploring the potential for a new collaboration for MEM 1414 and MEM 1917. We believethat any further development of MEM 1414 and MEM 1917 will be funded largely through such acollaboration.In February 2006, we amended and restated our original 2003 Roche Agreement. Under the terms ofthe Amended and Restated 2003 Roche Agreement, we have granted to Roche a worldwide, exclusive,sublicensable license to all of our patent rights and know-how with respect to our nicotinicalpha-7 agonists, other than MEM 3454, for the prevention and treatment of diseases, in allindications, for either human or veterinary use. With respect to MEM 3454, Roche has the option toobtain a license following our completion of a Phase 2a clinical trial for this drug candidateunder the Agreement. Roche maintains this license option by paying pre-specified license rightsmaintenance fees to us. We will receive an aggregate of $1.8 million of research and developmentfunding in 2006. Subject to the determination by the parties that certain specified preclinicalcriteria have been achieved, we will be eligible to receive an aggregate of approximately $2.3million in research and development funding in 2007. On May 3, 2005, we announced that we hadreceived a $2.0 million milestone payment from Roche related to MEM 3454, a drug candidate beingdeveloped under our Amended and Restated 2003 Roche Agreement. Roche elected to make this firstmilestone payment in order
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to maintain its option to obtain an exclusive license for MEM 3454. The payment was triggered byour preclinical work on MEM 3454, which satisfied a set of criteria that was pre-defined by Roche,and the initiation of a Phase 1 clinical trial for MEM 3454 in February 2005.On October 14, 2005, we entered into the 2005 Amgen Agreement for the development of PDE10inhibitors for neurological and psychiatric disorders. To date, we have received a $5.0 millionup-front fee and $0.7 million in research and development funding to date. Under the terms of the2005 Amgen Agreement, Amgen is obligated to make milestone payments to us if we achievepre-specified research, development, regulatory approval and sales milestones for certain PDE10inhibitors to be developed under the agreement. In addition, we are eligible to receive royaltiesthat will increase with increasing sales levels on worldwide sales of marketed products from thecollaboration.On December 20, 2005, we entered into a development agreement with SMRI, pursuant to which we planto conduct a Phase 2a bipolar disorder clinical trial of MEM 1003. Under the terms of thedevelopment agreement, we are eligible to receive up to $3.2 million in funding from SMRI tosupport the development of MEM 1003 for the treatment of bipolar disorder or schizophrenia over thedevelopment term of three years, which term may be extended for additional one-year periods. Wereceived $960,000 of this funding in exchange for the issuance of 440,367 shares of our commonstock and a warrant to purchase 154,128 shares of our common stock at an exercise price of $2.62per share that becomes exercisable on June 17, 2006 and expires on December 19, 2010. We areeligible to receive the remaining $2.2 million as milestone payments upon our achievement ofcertain milestones related to the Phase 2a trial in bipolar disorder. If we fail to achieve thethird milestone by December 31, 2007, we will be required to refund to SMRI the portion of the $2.2million of development funding advanced by SMRI as of that date.On September 23, 2005, we completed a private placement in which we issued 16,112,158 shares ofcommon stock, at a price of $1.90 per share, and warrants to purchase an aggregate of 5,639,232shares of common stock, resulting in net proceeds of $29.0 million. We refer to this as ourSeptember 2005 Private Placement.Since our inception, we have incurred substantial losses, and as of March 31, 2006, we had anaccumulated deficit of $160.3 million, of which $19.5 million related to preferred stock dividendsthat were forfeited upon the conversion of our redeemable convertible preferred stock upon theclosing of our initial public offering on April 8, 2004. These losses and accumulated deficit haveresulted from the significant costs incurred in the research and development of our compounds andtechnologies, including payroll and payroll-related costs, manufacturing costs of preclinical andclinical grade materials, facility and facility-related costs, preclinical study costs, clinicaltrial costs, and general and administrative costs. We expect that our losses will continue for theforeseeable future as we continue to support our research, development and clinical trialactivities to support our drug discovery and development programs.Under our June 2001 agreement with Bayer for the in-license of MEM 1003, we had paid $2.0 millionin upfront and milestone payments as of March 31, 2006. We are required to make additionalpayments to Bayer of up to $18.0 million in the event that we achieve specified milestones and topay royalties on sales of any products incorporating MEM 1003.Because asubstantial portion of our revenues for the foreseeable future will depend on achievingdevelopment and clinical milestones, and potentially, from entering into new collaborations, ourrevenue may vary substantially from year-to-year and quarter-to-quarter. Our operating expensesmay also vary substantially from year-to-year and quarter-to-quarter based on the timing and levelof our preclinical and clinical activities performed directly by us versus by our collaborationpartners. We have funded our MEM 1003 program in Alzheimer’s disease  on our own and, as part ofthat program, are currently funding a multi-center Phase 2a clinicaltrial for MEM 1003in Alzheimer’s disease, whilecontinuing to explore the potential for a collaboration for this drug candidate. We cannot assureyou that we will be successful in entering into a collaboration for MEM 1003 on favorable terms, ifat all. If, following the completion of a Phase 2a trial, we have been unable to find acollaboration partner for MEM 1003, we may, at that time, choose to continue the development of MEM1003 at our own expense. If we do so, our requirements for capital may substantially increase. Webelieve that period-to-period comparisons of our results of operations are not meaningful becauseof the range of factors that could affect our results from one year or quarter to the next andshould not be relied on as indicative of our future performance.**CRITICAL ACCOUNTING POLICIES**Our discussion and analysis of our financial condition and results of operations is based on ourfinancial statements, which have been prepared in accordance with accounting principles generallyaccepted in the United States of America (US GAAP). The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts of assets,
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liabilities, revenues and expenses. On an ongoing basis, we evaluate our estimates and judgments,including those related to revenue recognition, accrued expenses, research and development and thefair value of our equity securities. We base our estimates on historical experience and on variousother assumptions that we believe to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from these estimates underdifferent assumptions or conditions.We believe the following critical accounting policies affect the judgments and estimates used inthe preparation of our financial statements.***Revenue recognition***We recognize revenue relating to our collaborations in accordance with the SEC’s Staff AccountingBulletin No. 104, Revenue Recognition. Revenues under such collaborations may include the receiptof non-refundable license fees, milestone payments and research and development funding. Deferredrevenue consists of payments received in advance of revenue recognition under such collaborations.Given the various types of payments to us under our collaboration agreements, we must evaluatethese agreements to determine units of accounting for revenue recognition purposes. Under theterms of our 2002 Roche Agreement, because we have licensed to Roche certain intellectual propertyand we have continuing performance obligations, we are recognizing the non-refundable upfrontlicense fees and performance milestone payments as revenue ratably over the period in which weexpect to obtain FDA approval of the first compound to be developed under the collaboration. As aresult of Roche’s decision, in April 2005, not to pursue the further development of the two nameddrug candidates under our PDE4 inhibitor collaboration, MEM 1414 and its back-up MEM 1917, we havereassessed the expected period for the development of the first compound under the 2002 RocheAgreement. Solely for purposes of revenue recognition under this agreement, we have estimated theperiod until approval by the FDA of the first compound under this collaboration as ending in thesecond quarter of 2014.We applythe provisions of EITF No. 00-21, *Accounting for Revenue Arrangements with MultipleDeliverables*, prospectively to the original 2003 Roche Agreement using a single unit of accounting,since under that agreement, Roche had the right to enter into a license. As of December 31, 2005,revenue under the original 2003 Roche Agreement was recognized over the five-year period that Rochehad to obtain a sub-licensable license to our patent rights and know-how for any nicotinic alpha-7agonist that we developed. Revenue was being recognized over this period based on the level ofeffort expended in a period as compared to our estimated effort over the full five-year period.Milestone payments and research and development funding received under the original 2003 RocheAgreement were recognized prospectively over the remaining term of the agreement based on level ofeffort. On February 27, 2006, we amended and restated the 2003 Roche Agreement to grant to Roche aworldwide, exclusive, sublicensable license to all of our patent rights and know how with respectto our nicotinic alpha-7 agonists, other than MEM 3454. With respect to MEM 3454, Roche continuesto have the option to obtain a license to MEM 3454 following our completion of a Phase 2a clinicaltrial for this drug candidate. We are recognizing the non-refundable upfront license fees,performance milestone payments, and research funding received as revenue over the expected period for the development of the firstcompound under the Amended and Restated 2003 Roche Agreement. Solelyfor purposes of revenue recognition under this agreement, we have estimated thedevelopment period of the first compound under this collaboration as endingin the third quarter of 2013.In accordance with EITF No. 00-21, under the terms of our 2005 Amgen Agreement, we are recognizingthe non-refundable upfront license fee and performance milestone payments as revenue over thetwo-year term of the agreement. We will recognize revenue over the two-year term based on the levelof effort expended in a period as compared to our estimated efforts over the full period.We periodically review the estimated development periods for our compounds and our estimatedresearch efforts and, to the extent such estimates change, the impact of such change is recordedprospectively. Payments received from our collaboration partners for research and developmentfunding that are deemed to be a separate unit of accounting, as defined by EITF No. 00-21, arerecognized as such research and development services are performed. Otherwise, the payments arerecognized over the term of the applicable collaboration agreement or drug candidate’s estimatedapproval period.***Share-Based Compensation***Effective January 1, 2006, we began recording compensation expense associated with stock optionsand other forms of equity compensation in accordance with SFAS 123R. Prior to January 1, 2006, weaccounted for stock options according to the provisions
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of APB 25 and related interpretations, and therefore, no related compensation expense was recordedfor awards granted with no intrinsic value. We adopted the modified prospective transition methodprovided for under SFAS 123R and consequently, we have not retroactively adjusted results fromprior periods. Under this transition method, compensation cost associated with stock optionsrecognized in the first quarter of fiscal 2006 includes: 1) quarterly amortization related to theremaining unvested portion of all stock option awards granted prior to January 1, 2006, based onthe grant-date fair value estimated in accordance with the original provisions of SFAS 123; and 2)quarterly amortization related to all stock option awards granted on or subsequent to January 1,2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R.The compensation expense recognized in the statements of operations during the quarter endedMarch 31, 2006 for stock options was $716,000. Of the $716,000 of stock option compensation expenserecognized in the first quarter of fiscal 2006, $399,000 was a component of general andadministrative expenses and $317,000 was a component of research and development expenses. Cashreceived from options exercised and from stock purchased under our 2004 ESPP for the quarter endedMarch 31, 2006, was $80,000. We issue new shares upon the exercise of stock options.We continue to estimate the fair value of each stock option award on the date of grant using theBlack-Scholes option valuation model. We now estimate stock option forfeitures based on historicalretention data and adjust the rate to expected forfeitures periodically. The adjustment of theforfeiture rate will result in a cumulative catch-up adjustment in the period the forfeitureestimate is changed.***Accrued expenses***As part of the process of preparing financial statements, we are required to estimate accruedexpenses. This process involves identifying services that have been performed on our behalf andestimating the level of service performed and the associated cost incurred for such service wherewe have not been invoiced or otherwise notified of actual cost. This is done as of each balancesheet date in our financial statements. Examples of estimated accrued expenses include: Ø professional service fees, such as attorneys’ and accountants’ fees;  Ø preclinical and clinical contract research organization fees;  Ø fees to be paid to data management organizations and investigators in conjunction with clinical trials; and  Ø fees to be paid to contract manufacturers in conjunction with the production of theclinical supply of our drug candidates.In connection with the above services, our estimates are most affected by our projections of thetiming of services provided relative to the actual level of services performed by such serviceproviders. The majority of our service providers invoice us monthly in arrears for servicesperformed. In the event that we do not identify certain costs that have begun to be incurred or weunder- or over-estimate the level of services performed or the costs of such services, our actualexpenses could materially differ from such estimates. The date on which certain services commence,the level of services performed on or before a given date, and the cost of such services are oftensubjective determinations. We make these judgments based upon the facts and circumstances known tous in accordance with US GAAP.***Research and development expense***Research and development expense consists primarily of costs associated with our internal researchand development activities, including salaries and related expenses for personnel, costs offacilities and equipment, fees paid to contract research organizations and consultants inconnection with our preclinical studies and clinical trials, including for services such as theindependent monitoring of our clinical trials and the evaluation of data from our clinical trials,costs of materials used in research and development, upfront and milestone payments under ourin-licensing agreement, consulting, license and sponsored university-based research fees paid tothird parties, and depreciation of capital assets used to develop our drug candidates.
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**RESULTS OF OPERATIONS****Three Months Ended March 31, 2006 compared to Three Months Ended March 31, 2005*****Revenue***We do not currently have any commercial products for sale and do not anticipate having anycommercial products for sale within the foreseeable future. To date, our revenue has been derivedfrom our collaborations with Roche and Amgen. Any additional revenue that we may receive in thefuture is expected to consist primarily of upfront license fees, milestone payments, research anddevelopment funding and royalty payments from either Roche, Amgen or from other collaborations weenter into.Revenue for the three month period ended March 31, 2006 was $2.8 million, representing thecurrently recognizable portion of upfront license fees, milestone payments, and research anddevelopment funding from our collaboration agreements with Roche and Amgen. This represented a 14%increase from revenue of $2.4 million for the three months ended March 31, 2005, primarilyattributable to revenue from our 2005 Amgen Agreement.***Research and development expense***Research and development expense decreased by $2.1 million, or 23%, to $6.8 million forthe three month period ended March 31, 2006 from $8.9 million for the three months ended March 31,2005. The current period includes a non-cash charge of $0.3 million related to our adoption of SFAS123R that was offset by reduced spending of $2.2 million on clinical and outside research cost and$0.2 million relating to personnel cost and lab materials and supplies.***General and administrative expense***General and administrative expense increased by $0.1 million, or 8%, to $2.2 million for the threemonth period ended March 31, 2006 from $2.1 million for the three months ended March 31, 2005. Thecurrent period includes a non-cash charge of $0.4 million related to our adoption of SFAS 123R thatwas partially offset by reduced personnel related cost of $0.3 million.***Change in fair value of warrants***In connection with our September 2005 Private Placement, we issued warrants to purchase anaggregate of 5,639,232 shares of our common stock at an exercise price of $2.22 per share. Inaccordance with EITF No. 00-19, the warrants have been recorded as a liability and valued at fairvalue on the date of issuance. For the period ended March 31, 2006, as a result of an increase inthe fair market value of our common stock, we recognized an unrealized loss of $2.3 million inaccordance with EITF No. 00-19. Refer to Note 8, “September 2005 Private Placement.”***Interest income and interest expense***Interest income increased by $233,000, or 112%, to $441,000 during the three month period endedMarch 31, 2006, from the three months ended March 31, 2005. Interest expense decreased by $14,000,or 19%, to $59,000 during the three month period ended March 31, 2006, from the three months endedMarch 31, 2005. The increase in interest income was attributable to higher average investmentbalances and interest rates during the 2006 period. The decrease in interest expense was relatedto lower outstanding obligations resulting from the repayment of equipment notes in 2005 and 2006.***Income taxes***For the three months ended March 31, 2006 and March 31, 2005, we recognized $2,000 in state incometaxes.***Liquidity and capital resources***We have financed our operations since inception through the sale of equity securities, paymentsreceived under our collaboration and development agreements, equipment financings and interestincome. From inception through March 31, 2006, we have raised net proceeds of $163.2 million fromthe sale of equity securities. In addition, we have received $29.0 million in upfront andmilestone payments, $18.9 million in research and development funding, $10.3 million from equipmentfinancings, $1.7 million from the reimbursement of external research costs and $5.1 million ininterest income. To date, inflation has not had a material effect on our business.
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At March 31, 2006, cash, cash equivalents and marketable securities were $36.5 million as comparedto $44.1 million at December 31, 2005. Our cash, cash equivalents and marketable securities arehighly liquid investments and consist of term deposits and investments in money market funds withcommercial banks and financial institutions, short-term commercial paper, corporate debtsecurities, mortgage-backed securities and government obligations.Net cash used in operating activities was $7.2 million for the three month period ended March 31,2006. This primarily reflects the net loss of $8.2 million, a decrease of $2.0 million in deferredrevenue and working capital uses of $0.5 million, offset by an unrealized loss on warrants of $2.3million, a non-cash stock based compensation charge of $0.7 million, and depreciation expense of$0.5 million. Net cash provided by investing activities for the period ended March 31, 2006 was$2.0 million, which represents a decrease in our net investment in marketable securities of $2.1million, offset by funds used for capital expenditures of $0.1 million. Net cash utilized byfinancing activities during the period ended March 31, 2006 was $0.3 million which consisted of$0.4 million used in the repayment of equipment notes, offset by $0.1 million of proceeds from theissuance of common stock.We expect to incur losses from operations for the foreseeable future. We expect to incurincreasing research and development expenses, including expenses related to additional preclinicaltesting and clinical trials. We are funding or are contemplating funding the development ofseveral of our drug candidates and programs. We believe that our existing cash and cashequivalents, and marketable securities, together with payments required to be made by ourcollaboration partners will be sufficient to fund our operating expenses, repayment of equipmentnotes and capital equipment requirements through the first quarter of 2007. Our future cashrequirements will depend on many factors, including: Ø the number of compounds and drug candidates that we advance through the development process;  Ø whether we are able to enter into collaborations and the terms of any such collaboration;  Ø the scope and results of our and our collaborators’ clinical trials;  Ø potential in-licensing or acquisition of other compounds or technologies;  Ø the costs involved in utilizing third party contract research organizations for preclinical studies and clinical trials;  Ø the timing of, and the costs involved in, obtaining regulatory approvals;  Ø the availability of third parties, and the cost, to manufacture compounds for clinical trial supply;  Ø the costs involved in preparing, filing, prosecuting, maintaining and enforcingpatent claims and other patent-related costs, including litigation costs and the resultsof such litigation; and  Ø the cost of commercialization activities, including product marketing, sales anddistribution.Currently we have no committed sources of capital. To the extent our capital resources areinsufficient to meet future capital requirements, we will need to raise additional capital byselling equity or by incurring additional indebtedness to fund our operations. We cannot assure youthat additional equity or debt financing will be available on acceptable terms, if at all. Ifadequate funds are not available, we may be required to delay, reduce the scope of or eliminate ourresearch and development programs, reduce our commercialization efforts, or obtain funds througharrangements with collaborators or others that may require us to relinquish rights to certain drugcandidates that we might otherwise seek to develop or commercialize independently. Additionally,any future equity funding may dilute the ownership of our equity investors.***New Accounting Pronouncement***Effective January 1, 2006, we began recording compensation expense associated with stock optionsand other forms of equity compensation in accordance with SFAS 123R. Prior to January 1, 2006, weaccounted for stock options according to the provisions of APB 25 and related interpretations, andtherefore no related compensation expense was recorded for awards granted with no intrinsic value.We adopted the modified prospective transition method provided for under SFAS 123R, and,consequently, have not retroactively adjusted results from prior periods. Under this transitionmethod, compensation cost associated with stock options
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recognized in the first quarter of fiscal 2006 includes: 1) quarterly amortization related to theremaining unvested portion of all stock option awards granted prior to January 1, 2006, based onthe grant-date fair value estimated in accordance with the original provisions of SFAS 123; and 2)quarterly amortization related to all stock option awards granted on or subsequent to January 1,2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R.As a result of the adoption of SFAS 123R, the compensationexpense recognized in the statements of operations during the quarter ended March 31, 2006 for stock options was $716,000.SFAS 123R requires that cash flows resulting from tax deductions in excess of the cumulativecompensation cost recognized for options exercised (excess tax benefits) be classified as financingcash flows. We have sufficient net operating loss carryforwards to generally eliminate cashpayments for income taxes. Therefore, no cash has been retained as a result of excess tax benefitsrelating to share based payments made to directors and employees.**Item 3. Quantitative and Qualitative Disclosures About Market Risk**We do not use derivative financial instruments for speculation or trading purposes. However, weare exposed to market risk related to changes in interest rates. We currently do not hedgeinterest rate exposure. Our current policy is to maintain an investment portfolio consistingmainly of U.S. money market funds, government obligations, mortgage-backed securities, andcorporate debt securities, directly or through managed funds. Our cash is deposited in andinvested through highly rated financial institutions in North America. Our marketable securitiesare subject to interest rate risk and will fall in value if market interest rates increase. Ifmarket interest rates were to increase immediately and uniformly by 10% from levels at March 31,2006, we estimate that the fair value of our investment portfolio would decline by an immaterialamount. There has been no material change to our market risk since December 31, 2005.**Item 4. Controls and Procedures*****Evaluation of disclosure controls and procedures***Based on their evaluation as of March 31, 2006, our Chief Executive Officer and Principal FinancialOfficer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e)and 15d-15(e) of the Securities Exchange Act of 1934, as amended) were sufficiently effective toensure that the information required to be disclosed by us in this Quarterly Report on Form 10-Qwas recorded, processed, summarized and reported within the time periods specified in the SEC’srules and Form 10-Q.***Change in internal control over financial reporting***There were no changes in our internal control over financial reporting during the quarter endedMarch 31, 2006 that have materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.***Limitations on the effectiveness of controls***Our disclosure controls and procedures are designed to provide reasonable, not absolute, assurancethat the objectives of our disclosure control system are met. Because of inherent limitations inall control systems, no evaluation of controls can provide absolute assurance that all controlissues, if any, within a company have been detected.
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**PART II. OTHER INFORMATION.****Item 1A. Risk Factors***In additionto the other information set forth in this report, you should carefully consider therisk factor discussed below and those discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K forthe year ended December 31, 2005. These risk factors couldmaterially affect our business, financial condition or futureresults. The risks described in our Annual Report on Form 10-K, asupdated below, are not the only risksfacing our Company. Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially adversely affect our business, financialcondition and/or operating results.*Inour Annual Report on Form 10-K, in the risk factor titled,*“If our clinical trials or those of our collaborators areunsuccessful, or if we experience significant delays in thesetrials, our ability to commercialize our products will beimpaired,”* we stated that we anticipated commencing the Phase 2a bipolardisorder clinical trial for MEM 1003 during the first half of 2006.While we believe that this time frame may still be achievable, wecurrently anticipate that it is more likely that the Phase 2a bipolardisorder clinical trial will commence in the third quarter of 2006and, as we have previously reported, be completed in the first halfof 2007. We cannot assure you that we will be successful incommencing and completing this clinical trial in the time frame thatwe have planned, or at all.**Item 6. Exhibits**   10.1* Amended and Restated Strategic Alliance Agreement dated as ofFebruary 27, 2006, among F. Hoffmann-La Roche Ltd, Hoffmann-La RocheInc. and the Registrant.   31.1 Certification by the Chief Executive Officer pursuant to Rule13a-14(a) under the Securities Exchange Act of 1934   31.2 Certification by the Principal Financial Officer pursuant to Rule13a-14(a) under the Securities Exchange Act of 1934   32.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 * Confidential treatment requested as to certain portions, which portions are omitted and filedseparately with the SEC.
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**SIGNATURES**     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereunto duly authorized.       MEMORY PHARMACEUTICALS CORP.       By: /s/ Joseph M. Donabauer         Joseph M. Donabauer    Vice President & Controller    (Principal Financial and AccountingOfficer and