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United States SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-K
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2006
 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 No. 0-12943
 CYPRESS BIOSCIENCE, INC.
  
 Delaware
    
    22-2389839(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)4350 Executive Drive, Suite 325San Diego, California(Address of principal executive
    
    92121offices)
    
    (Zip Code)
 (858) 452-2323
  Title of Each Class:
    
    Name of Exchange on which RegisteredCommon Stock $.001 Par Value
    
    The NASDAQ Stock Market
 NONE
 o þ
 o þ
 þ o
 o
  o þ o
 o þ




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DOCUMENTS INCORPORATED BY REFERENCE




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##### 



CYPRESS BIOSCIENCE, INC.
FORM 10-K
INDEX
 PagePART IItem 1 Business
    
    
    1Item 1A Risk Factors
    
    
    13Item 1B Unresolved Staff Comments
    
    
    28Item 2 Properties
    
    
    28Item 3 Legal Proceedings
    
    
    28Item 4 Submission of Matters to a Vote of Security Holders
    
    
    28PART IIItem 5 Market for our Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    30Item 6 Selected Financial Data
    
    
    32Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    32Item 7A Quantitative and Qualitative Disclosures about Market Risk
    
    
    42Item 8 Financial Statements and Supplementary Data
    
    
    42Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    42Item 9A Controls and Procedures
    
    
    43Item 9B Other Information
    
    
    45PART IIIItem 10 Directors, Executive Officers and Corporate Governance
    
    
    46Item 11 Executive Compensation
    
    
    46Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    46Item 13 Certain Relationships, Related Transactions and Director Independence
    
    
    46Item 14 Accounting Fees and Services
    
    
    46PART IVItem 15 Exhibits, Financial Statement Schedules
    
    
    47Signatures
    
    
    49EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  i.




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PART I
 Except for the historical information contained herein, the information contained herein
contains forward-looking statements within the meaning of Section 27A of the Securities Act of
1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended, including, in
particular, statements about our plans, strategies and prospects. These statements, which may
include words such as may, will, expect, believe, intend, plan, anticipate,
estimate, or similar words, are based on our current beliefs, expectations and assumptions and
are subject to a number of risks and uncertainties. Although we believe that our beliefs,
expectations and assumptions reflected in these statements are reasonable, our actual results and
financial performance may prove to be very different from what we might have predicted on the date
of this Form 10-K . Factors that could cause or contribute to differences include, but are not
specifically limited to, our ability to develop milnacipran for Fibromyalgia Syndrome, our ability
to acquire and develop any compounds or products to treat any other indications we may pursue in a
timely manner, or at all, as well as the other risks detailed in this Form 10-K and in our other
SEC filings.
 
 Item 1. Business
 Company Overview
   1.




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Milnacipran for the Treatment of FMS
 Milnacipran
  2.




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Milnacipran Development Status
 Results of Phase II Trial
  Results of First Phase III Trial
  3.




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4.




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Ongoing Phase III Trials
   Licenses and Collaborations
 Milnacipran Agreements
 Pierre Fabre Agreements
   5.




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Forest Laboratories Agreement
   6.




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Collegium Agreement
  Mirtazapine Agreement with Organon
  Other Potential Uses of Milnacipran
  Patents, Trademarks and Proprietary Technology
  7.




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Competition
  8.




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Manufacturing and Supply
  9.




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Government Regulation
   
    
    completion of preclinical laboratory tests, animal pharmacology and toxicology
studies and formulation studies performed in compliance with the FDAs Good Laboratory
Practice, or GLP regulations;
    
    the submission of an investigational new drug application, or IND, to the FDA
for human clinical testing that must be accepted by the FDA before human clinical
trials may commence;
    
    performance of adequate and well-controlled human clinical trials to establish
the safety and efficacy of the product candidate for the proposed indication of use;
    
    the submission of an NDA to the FDA; and
    
    FDA approval of the NDA prior to any commercial sale or shipment of the drug.
   
    
    ensure receipt from participants of signed consents that inform them of risks;
    
    detail the protocol and objectives of the study;
 10.




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
    
    detail the parameters to be used to monitor safety; and
    
    detail the efficacy criteria to be evaluated.
    
    
    obtain initial indications of the efficacy of the drug for specific, targeted indications;
    
    determine dosage tolerance and optimal dosage; and
    
    identify possible adverse affects and safety risks.
   11.




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Employees
  Available Information
 www.cypressbio.com
 12.




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Item 1A. Risk Factors
 Milnacipran is our only product and if the results from the second Phase III clinical trial do not
meet statistical significance, our development program may be terminated and we would have no
products in our pipeline.
  There are limited data regarding milnacipran as a treatment of FMS and it may not work for FMS,
especially in light of the results from our first Phase III clinical trial, or there may be safety
issues with its use in this patient population.
   13.




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We are dependent on our collaboration with Forest Laboratories to develop and commercialize
milnacipran and to obtain regulatory approval. Events or circumstances may occur that delay or
prevent the development and commercialization of milnacipran.
   
    
    Forest Laboratories could stop either or both of the ongoing phase III
trials of milnacipran for the treatment of FMS or any other clinical
trials for milnacipran or abandon or underfund the development of
milnacipran, repeat or conduct additional clinical trials or require a
new formulation of milnacipran for clinical testing, or delay the
commencement of any additional clinical trials for milnacipran for the
treatment of FMS;
    
    We and Forest Laboratories could disagree as to development plans,
including the number and timing of clinical trials or regulatory
approval strategy, or as to which additional indications for
milnacipran should be pursued, if any, and therefore milnacipran may
never be developed for any indications other than FMS;
    
    Forest Laboratories could independently develop, develop with third
parties or acquire products that could compete with milnacipran,
including drugs approved for other indications used by physicians
off-label for the treatment of FMS;
    
    Forest Laboratories could fail to devote sufficient resources to the
development, approval, commercialization, or marketing and
distribution of any products developed under our collaboration
agreement, including by failing to develop specialty sales forces if
such sales forces are necessary for the most effective distribution of
any approved product; and
    
    Disputes regarding the collaboration agreement that delay or terminate
the development, commercialization or receipt of regulatory approvals
of milnacipran, may delay or prevent the achievement of clinical or
regulatory objectives that would result in the payment of milestone
payments or result in significant litigation or arbitration.
 14.




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We rely upon an exclusive license from Pierre Fabre in order to develop and sell our milnacipran
product candidate, and our ability to pursue the development and commercialization of milnacipran
for the treatment of FMS depends upon the continuation of our license from Pierre Fabre.
  We rely upon Pierre Fabre as our exclusive supplier of the compound used as the active ingredient
in our milnacipran product candidate and if Pierre Fabre fails to supply us sufficient quantities
of the active ingredient it may delay or prevent us from developing and commercializing
milnacipran.
  15.




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Our agreements with Pierre Fabre and Forest Laboratories restrict our ability to develop specified
compounds, which limits how we can expand our product candidates.
  Our relationship with Organon may terminate.
  Provisions in our collaboration agreement with Forest Laboratories and our license agreement with
Pierre Fabre may prevent or delay a change in control.
  16.




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We have limited experience in identifying, completing and integrating acquisitions, including
acquisitions of product candidates, and other targets, and we may incur unexpected costs and
disruptions to our businesses if we make mistakes in our selection of future acquisitions or fail
to integrate any future acquisitions.
  
    
    higher development costs than we anticipate;
    
    higher than expected licensing or acquisition and integration costs;
    
    exposure to liabilities of licensed or acquired intellectual property,
compounds or products;
    
    disruption of our business and diversion of our managements time and
attention to developing licensed or acquired compounds or products;
    
    incurrence of dilutive issuances of securities or substantial debt to
pay for licensing or acquisitions; and
    
    impairment of relationships with key collaborators, suppliers or
customers of any acquired businesses due to changes in management or
ownership.
  We are at an early stage of development and we do not have and may never develop any commercial
drugs or other products that generate revenues.
  17.




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The FDA approval of milnacipran or any future product candidate is uncertain and will involve the
commitment of substantial time and resources.
   
    
    a product candidate may not be safe or effective;
    
    we may not achieve statistical significance for the primary endpoint;
    
    FDA officials may interpret data from preclinical testing and clinical
trials in different ways than we interpret such data;
    
    the FDA might not approve our manufacturing processes or facilities,
or the processes or facilities of any future collaborators or contract
manufacturers, including Pierre Fabres facility for the manufacture
of the active ingredient in milnacipran; and
    
    the FDA may change its approval policies or adopt new regulations.
 We have agreed to pay certain external expenses associated with our second Phase III clinical trial
evaluating milnacipran for FMS, currently being run by Forest Laboratories, and we may never be
reimbursed for these amounts.
  18.




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If we receive regulatory approval for milnacipran or any other future product candidate, we will be
subject to ongoing FDA obligations and continuing regulatory review.
  We rely on third parties to conduct all of our clinical trials. If these third parties do not
successfully carry out their contractual duties or meet expected deadlines, we may not be able to
obtain regulatory approval for or commercialize milnacipran or any of our other future product
candidates.
  Even if our product candidates are approved, the market may not accept these products.
  19.




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
    
    timing of market entry relative to competitive products;
    
    extent of marketing efforts by us and third-party distributors or agents retained by us;
    
    rate of adoption by healthcare practitioners;
    
    rate of a products acceptance by the target community;
    
    availability of alternative therapies;
    
    price of our product relative to alternative therapies;
    
    availability of third-party reimbursement; and
    
    the prevalence or severity of side effects or unfavorable publicity concerning our products or similar products.
  Our competitors may develop and market products that are less expensive, more effective or safer,
which may diminish or eliminate the commercial success of any products we may commercialize.
 , .
  20.




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We have the right to co-promote milnacipran, but we do not have the marketing, sales or
distribution experience or capabilities.
  We are subject to uncertainty relating to health care reform measures and reimbursement policies
which, if not favorable to our product candidates, could hinder or prevent our product candidates
commercialization success.
  
    
    our ability to set a price we believe is fair for our products;
    
    our ability to generate revenues and achieve or maintain profitability;
    
    the future revenues and profitability of our potential customers, suppliers and collaborators; and
    
    the availability of capital.
  We rely on our employees and consultants for their scientific and technical expertise in connection
with our business operations.
  21.




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We may be subject to product liability claims that could cause us to incur liabilities beyond our
insurance coverage.
  We have a history of operating losses and we may never be profitable.
  We will need substantial additional funding and may be unable to raise capital when needed, which
could force us to scale back or discontinue the completion of any proposed acquisitions or
adversely affect our ability to realize the expected benefits of any completed acquisitions.
  Raising additional funds by issuing securities or through collaboration and licensing arrangements
may cause dilution to existing stockholders, restrict our operations or require us to relinquish
propriety rights.
  22.




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We may lose our net operating loss carryforwards, which could prevent us from offsetting future
taxable income.
  Our stock price has been very volatile and will likely continue to be volatile.
  
    
    the results of our second Phase III clinical trial for milnacipran and any other clinical trials for milnacipran;
    
    developments in our relationship with Forest Laboratories, including the termination of our agreement;
    
    developments in our relationship with Pierre Fabre, including the termination of our agreement;
    
    our entering into, or failing to enter into, an agreement for the acquisition of any products or companies, or an agreement
with any corporate collaborator;
    
    our available cash;
    
    announcements of technological innovations or new products by us or our competitors;
    
    developments in our patent or other proprietary rights;
    
    fluctuations in our operating results;
    
    litigation initiated by or against us;
    
    developments in domestic and international governmental policy or regulation; and
    
    economic and other external factors or other disaster or crisis.
 23.




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The concentration of ownership among our existing officers, directors and principal stockholders
may result in the entrenchment of management, prevent other stockholders from influencing
significant corporate decisions and depress our stock price.
  We expect to continue incurring significant costs as a result of enacted and proposed changes in
laws and regulations relating to corporate governance matters.
  Accounting pronouncements may affect our future financial position and results of operations.
  24.




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Risks Related to Our Intellectual Property
 We rely primarily on method of use patents to protect our proprietary technology for the
development of milnacipran, and our ability to compete may decrease or be eliminated if we are not
able to protect our proprietary technology.
     25.




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Our ability to compete may decline if we do not adequately protect our proprietary rights.
   
    
    we may not have been the first to make the inventions covered by our pending patent applications or issued patents;
    
    we may not have been the first to file patent applications for our product candidates or the technologies we rely upon;
    
    others may independently develop similar or alternative technologies or duplicate any of our technologies;
    
    our disclosures in patent applications may not be sufficient to meet the statutory requirements for patentability;
    
    any or all of our pending patent applications may not result in issued patents;
    
    we may not seek or obtain patent protection in all countries that will eventually provide a significant business
opportunity;
    
    any patents issued to us or our collaborators may not provide a basis for commercially viable products, may not provide us
with any competitive advantages or may be challenged by third parties;
    
    some of our proprietary technologies may not be patentable;
    
    others may design around our patent claims to produce competitive products which fall outside of the scope of our patents;
or
    
    others may identify prior art which could invalidate our patents.
  26.




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A dispute concerning the infringement or misappropriation of our proprietary rights or the
proprietary rights of others could be time consuming and costly and an unfavorable outcome could
harm our business.
  
    
    payment of damages, potentially treble damages, if we are found to
have willfully infringed such parties patent rights;
    
    injunctive or other equitable relief that may effectively block our
ability to further develop, commercialize and sell products; or
    
    we or our collaborators having to enter into license arrangements that
may not be available on commercially acceptable terms, if at all.
  The patent applications of pharmaceutical and biotechnology companies involve highly complex legal
and factual questions, which could negatively impact our patent position.
  27.




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Item 1B. Unresolved Staff Comments
  
 Item 2. Properties
  
 Item 3. Legal Proceedings
  
 Item 4. Submission of Matters to a Vote of Security Holders
  28.




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Executive Officers
  NAME
    
    AGE
    
    POSITIONJay D. Kranzler, M.D., Ph.D.
    
    
    49
    
    
    Chief Executive Officer and Chairman of the Board of DirectorsSabrina Martucci Johnson
    
    
    40
    
    
    Chief Financial Officer, Executive Vice President and Chief
Business OfficerR. Michael Gendreau, M.D., Ph.D.
    
    
    51
    
    
    Vice President of Clinical Development and Chief Medical Officer
 JAY D. KRANZLER, M.D., Ph.D.,
 SABRINA MARTUCCI JOHNSON
 R. MICHAEL GENDREAU, M.D., Ph.D.,
 29.




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PART II
 
 Item 5. Market for our Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
  Price Range of Common StockHigh
    
    LowYear Ended December 31, 2006:First Quarter
    
    $
    6.32
    
    
    $
    5.47Second Quarter
    
    
    7.85
    
    
    
    5.84Third Quarter
    
    
    7.33
    
    
    
    5.46Fourth Quarter
    
    
    8.67
    
    
    
    7.11Year Ended December 31, 2005:First Quarter
    
    $
    14.05
    
    
    $
    9.09Second Quarter
    
    
    13.65
    
    
    
    8.50Third Quarter
    
    
    14.68
    
    
    
    5.41Fourth Quarter
    
    
    6.15
    
    
    
    4.42
  Equity Compensation Plan Information
  Number of SharesRemainingNumber of Shares
    
    
    
    
    
    Available forto be Issued Upon
    
    Weighted Average
    
    Future IssuanceExercise of
    
    Exercise Price of
    
    Under EquityOutstanding
    
    Outstanding
    
    CompensationOptions
    
    Options
    
    Plans (b)Equity compensation
plans approved
by stockholders (a)
    
    
    3,787,323
    
    
    $
    7.19
    
    
    
    3,000,416Equity compensation
plans not
approved by
stockholders
    
    
    
    
    
    
    
    
    
    
    
 
 (a)
    
    Includes our 1996 Equity Incentive Plan and our 2000 Equity Incentive Plan.(b)
    
    In February 2001, our shareholders approved a provision to amend the 2000
Equity Incentive Plan, whereby the total number of shares reserved for issuance under the 2000
Equity Incentive Plan and the 1996 Equity Incentive Plan, in the aggregate, are increased quarterly
such that the number equals 21.1% of the number of shares of our common stock issued and
outstanding as of the end of that day. 30.




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13869
    
    Prepared by CRSP (www.crsp.uchicago.edu), Center for Research in Security Prices, Graduate School of Business, The University of Chicago. Used with permission. All rights reserved.
    
    ©Copyright 2007
 31.




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Item 6. Selected Financial Data
  Years Ended December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002Statement of Operations Data:Revenues:Revenues under collaborative agreement
    
    $
    4,322,468
    
    
    $
    8,384,636
    
    
    $
    14,414,619
    
    
    $
    
    
    
    $
    Revenue from Fresenius agreement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,400,0004,322,468
    
    
    
    8,384,636
    
    
    
    14,414,619
    
    
    
    
    
    
    
    6,400,000Costs and expenses:Research and development
    
    
    9,184,404
    
    
    
    15,839,737
    
    
    
    15,650,328
    
    
    
    11,644,494
    
    
    
    5,178,853General and administrative
    
    
    8,379,031
    
    
    
    5,448,160
    
    
    
    11,762,813
    
    
    
    4,336,014
    
    
    
    3,123,465Compensation expense (benefit) -
variable stock options
    
    
    
    
    
    
    (1,749,135
    )
    
    
    (699,033
    )
    
    
    5,879,277
    
    
    
    (688,376
    )17,563,435
    
    
    
    19,538,762
    
    
    
    26,714,108
    
    
    
    21,859,785
    
    
    
    7,613,942Other income (expense):Interest income
    
    
    4,993,635
    
    
    
    2,525,327
    
    
    
    1,092,404
    
    
    
    121,679
    
    
    
    199,678Interest expense
    
    
    
    
    
    
    (2,382
    )
    
    
    (5,826
    )
    
    
    (9,097
    )
    
    
    (33,529
    )Gain (loss) on disposal of assets
    
    
    
    
    
    
    4,186
    
    
    
    (2,095
    )
    
    
    4,931
    
    
    
    (1,090
    )4,993,635
    
    
    
    2,527,131
    
    
    
    1,084,483
    
    
    
    117,513
    
    
    
    165,059Net loss
    
    $
    (8,247,332
    )
    
    $
    (8,626,995
    )
    
    $
    (11,215,006
    )
    
    $
    (21,742,272
    )
    
    $
    (1,048,883
    )Net loss per share  basic and diluted
    
    $
    (0.26
    )
    
    $
    (0.28
    )
    
    $
    (0.40
    )
    
    $
    (1.21
    )
    
    $
    (0.09
    )Shares used in computing net loss per
share  basic and diluted
    
    
    32,094,785
    
    
    
    31,105,271
    
    
    
    27,764,975
    
    
    
    17,924,353
    
    
    
    11,572,101
 As of December 31,2006
    
    2005
    
    2004
    
    2003
    
    2002Balance Sheet Data:Cash, cash equivalents and short-term
investments
    
    $
    102,778,328
    
    
    $
    109,613,278
    
    
    $
    112,023,998
    
    
    $
    23,524,646
    
    
    $
    12,209,383Total assets
    
    
    103,824,941
    
    
    
    110,791,798
    
    
    
    118,389,524
    
    
    
    23,806,681
    
    
    
    12,477,519Total stockholders equity
    
    
    87,097,297
    
    
    
    89,975,440
    
    
    
    94,173,809
    
    
    
    22,129,122
    
    
    
    11,785,137Working capital
    
    
    99,508,212
    
    
    
    105,536,094
    
    
    
    112,837,533
    
    
    
    22,049,874
    
    
    
    11,680,864
 
 Item 7. Managements Discussion and Analysis of Financial Condition and Results of
Operations
 overview
  32.




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33.




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Results of Operations
 Comparison of Years Ended December 31, 2006 and 2005
 Revenues
   34.




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Research and Development
   General and Administrative
   35.




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Compensation Benefit  Variable Stock Options
 Share-Based Payment Accounting for Certain
Transaction Involving Stock Compensation  An Interpretation of APB 25
 Interest Income
  Comparison of Years Ended December 31, 2005 and 2004
 Revenues
  Research and Development
  36.




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General and Administrative
   Compensation Benefit  Variable Stock Options
  Interest Income
  37.




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Liquidity and Capital Resources
      Less than1 year
    
    1 - 3 years
    
    After 4 yearsTotal
    
    (2007)
    
    (2008 - 2010)
    
    (2011 +)Operating leases
    
    $
    1,114,391
    
    
    $
    188,274
    
    
    $
    590,559
    
    
    $
    335,558Purchase obligations (1)
    
    
    748,001
    
    
    
    748,001
    
    
    
    
    
    
    
    Total
    
    $
    1,862,392
    
    
    $
    936,275
    
    
    $
    590,559
    
    
    $
    335,558
 
 (1)
    
    Purchase obligations include agreements to purchase goods or services, including consulting
services, that are enforceable and legally binding on us and that specify all significant
terms. This includes contracts that are cancelable with notice and the payment of an early
termination penalty. Purchase obligations exclude agreements that are cancelable without
penalty and also exclude liabilities to the extent presented on the balance sheet as of
December 31, 2006.  38.




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
    
    the extent to which we acquire or invest in other products and businesses;
    
    the costs of in-licensing drug candidates;
    
    the ability of Forest Laboratories and us to reach milestones, and other events or developments under our collaboration
agreement;
    
    the costs and timing of development and regulatory approvals for milnacipran; and
    
    the costs of commercialization of any future products.
  39.




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Critical Accounting Policies and Estimates
  Revenue Recognition
 Revenue Recognition in Financial
Statements
 Research and Development Expenses
  40.




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Share-Based Compensation
 Share-Based Payment
     41.




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New Accounting Pronouncements
 Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109
 Fair Value Measurements
 
 Item 7A. Quantitative and Qualitative Disclosure about Market Risk
  
 Item 8. Financial Statements and Supplementary Data
  
 Item 9 . Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
  42.




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Item 9A. Controls and Procedures
 Conclusions Regarding the Effectiveness of Disclosure Controls and Procedures
   Managements Report on Internal Control Over Financial Reporting
 Internal Control  Integrated Framework Internal Control  Integrated Framework
  Changes in Internal Control Over Financial Reporting
  43.




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Report of Independent Registered Public Accounting Firm
 
 .
    .
  /s/ Ernst & Young LLP 
 44.




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Item 9B. Other Information
  45.




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PART III
 
 Item 10. Directors, Executive Officers and Corporate Governance
  www.cypressbio.com
 
 Item 11. Executive Compensation
  
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
  
 Item 13. Certain Relationships, Related Transactions and Director Independence
  
 Item 14. Principal Accounting Fees and Services
  46.




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PART IV
 
 Item 15. Exhibits, Financial Statement Schedules
     ExhibitNo.
    
    Description
    
    Incorporated by Reference to3.1
    
    Second Amended and Restated Certificate of
Incorporation
    
    Appendix C to Definitive Proxy Statement filed
with the Securities and Exchange Commission on
August 11, 20033.2
    
    Second Amended and Restated By-Laws
    
    Appendix D to Definitive Proxy Statement filed
with the Securities and Exchange Commission on
August 11, 20034.1
    
    Form of Stock Certificate
    
    Exhibit 4.1 to Form S-1 Registration Statement
No. 33-4122510.1
    
    1996 Equity Incentive Plan (the
1996 Plan)()
    
    Exhibit 99.2 to Form 10-Q for the quarter ended
March 31, 1996 (File No. 0-12943)10.2
    
    Form of Incentive Stock Option Agreement under
the 1996 Plan()
    
    Exhibit 99.3 to Form 10-Q for the quarter ended
March 31, 1996 (File No. 0-12943)10.3
    
    Form of Non-Statutory Stock Option Agreement
under 1996 Equity Incentive Plan()
    
    Exhibit 99.4 to Form 10-Q for the quarter ended
March 31, 1996 (File No. 0-12943)10.4
    
    Incentive Stock Option and Appreciation Plan,
as amended June 29, 1992()
    
    Exhibit 99.4 to Form S-8 Registration Statement
No. 333-0677110.5
    
    Form of Stock Option Agreement for issuances
of all non-plan options()
    
    Exhibit 99.8 to Form S-8 Registration Statement
No. 333-0677110.6
    
    Amended and Restated License and Distribution
Agreement dated January 19, 2001 among the
Registrant, Fresenius HemoCare, Inc. and
Fresenius HemoCare GmbH(*)
    
    Exhibit 2.2 to Form 8-K filed on January 23, 200110.7
    
    2000 Equity Incentive Plan()
    
    Exhibit 10.25 to Form 10-K for the year ended
December 31, 200010.8
    
    Form of Stock Option Agreement for use with
the 2000 Equity Incentive Plan()
    
    Exhibit 10.26 to Form 10-K for the year ended
December 31, 200010.9
    
    Letter Amendment dated February 1, 2002 to the
Amended and Restated License Agreement dated
January 19, 2001 among the Registrant,
Fresenius HemoCare, Inc. and Fresenius
HemoCare GmbH
    
    Exhibit 10.24 to Form 10-K for the year ended
December 31, 200110.10
    
    Reformulation and New Product Agreement dated
August 22, 2002 between the Registrant and
Collegium Pharmaceuticals, Inc.(*)
    
    Exhibit 10.2 to Form 10-Q for the quarter ended
September 30, 200210.11
    
    Common Stock Issuance Agreement dated October
31, 2002 between the Registrant and Collegium
Pharmaceuticals, Inc.(*)
    
    Exhibit 10.3 to Form 10-Q for the quarter ended
September 30, 200210.12
    
    Equity Investment Agreement dated June 6, 2003
between the Registrant and Pierre Fabre
Medicament
    
    Exhibit 10.2 to Form 10-Q for the quarter ended
June 30, 2003
 47.




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##### Table of Contents



ExhibitNo.
    
    Description
    
    Incorporated by Reference to10.13
    
    Warrant to purchase Common Stock of the
Registrant issued to Pierre Fabre Medicament
on June 6, 2003
    
    Exhibit 10.3 to Form 10-Q for the quarter ended
June 30, 200310.14
    
    Amended and Restated Employment Agreement
dated August 11, 2003 between the Registrant
and Jay D. Kranzler, M.D., Ph.D()
    
    Exhibit 10.4 to Form 10-Q for the quarter ended
June 30, 200310.15
    
    Third Restated License Agreement dated January
9, 2004 between the Registrant and Pierre
Fabre Medicament(*)
    
    Exhibit 10.23 to the Form 10-K for the year
ended December 31, 2003.10.16
    
    First Restated Trademark Agreement dated
January 9, 2004 between the Registrant and
Pierre Fabre Medicament(*)
    
    Exhibit 10.24 to the Form 10-K for the year
ended December 31, 2003.10.17
    
    Purchase and Supply Agreement dated January 9,
2004 between the Registrant and Pierre Fabre
Medicament(*)
    
    Exhibit 10.25 to the Form 10-K for the year
ended December 31, 2003.10.18
    
    License and Collaboration Agreement dated
January 9, 2004 between the Registrant and
Forest Laboratories(*)
    
    Exhibit 10.26 to the Form 10-K for the year
ended December 31, 2003.10.19
    
    Side Letter dated January 9, 2004 among the
Registrant, Forest Laboratories and Pierre
Fabre Medicament(*)
    
    Exhibit 10.27 to the Form 10-K for the year
ended December 31, 2003.10.20
    
    Letter Agreement dated January 9, 2004 among
the Registrant, Forest Laboratories and Pierre
Fabre Medicament(*)
    
    Exhibit 10.28 to the Form 10-K for the year
ended December 31, 2003.10.21
    
    2005 Bonus Plan()
    
    Exhibit 10.24 to the Form 10-K for the year
ended December 31, 200410.22
    
    Amendment to Forest Agreement(*)
    
    Exhibit 10.1 to Form 10-Q for the quarter ended
June 30, 200510.23
    
    License and Collaboration Agreement dated June
29, 2005 between Organon (Ireland) Ltd. and
Cypress(*)
    
    Exhibit 10.1 to Form 10-Q for the quarter ended
September 30, 200510.24
    
    2006 Bonus Plan()
    
    Exhibit 10.27 to the Form 10-K for the year
ended December 31, 200510.25
    
    First Amendment to Office Lease
    
    Exhibit 10.28 to Form 10-Q for the quarter ended
September 30, 200610.26
    
    First Amendment dated January 26, 2007 to the
Amended and Restated Employment Agreement
dated August 11, 2003 between the Registrant
and Jay D. Kranzler, M.D., Ph.D
    
    Exhibit 10.1 to the Form 8-K filed on January
30, 2007.21.1
    
    Subsidiaries of the registrant
    
    The registrant has no subsidiaries23.1
    
    Consent of Independent Registered Public
Accounting Firm24.1
    
    Power of Attorney
    
    Reference is made to page 4931.1
    
    Certification of Chief Executive Officer
pursuant to Section 302 of the Public Company
Accounting Reform and Investor Protection Act
of 2002 (18 U.S.C. §1350, as adopted)31.2
    
    Certification of Chief Financial Officer
pursuant to Section 302 of the Public Company
Accounting Reform and Investor Protection Act
of 2002 (18 U.S.C. §1350, as adopted)32.1
    
    Certification of Chief Executive Officer and
Chief Financial Officer pursuant to Section
906 of the Public Company Accounting Reform
and Investor Protection Act of 2002 (18 U.S.C.
§1350, as adopted)
 
 *
    
    Confidential Treatment has been granted to certain portions of this agreement.
    
    Indicates management contract or compensatory plan or arrangement. 48.




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##### Table of Contents



SIGNATURES
  Cypress Bioscience, Inc.Date: March 14, 2007
    By:
    /s/  Jay D. KranzlerChief Executive Officer andChairman of the Board Date: March 14, 2007
    By:
    /s/ Sabrina Martucci JohnsonChief Financial Officer andExecutive Vice President POWER OF ATTORNEY
   Signature
    
    Title
    
    Date/s/ Jay D. Kranzler

Jay D. Kranzler, M.D., Ph.D.
    
    Chief Executive Officer and
Chairman of the Board
(Principal Executive Officer)
    
    March 14, 2007/s/ Sabrina Martucci Johnson

Sabrina Martucci Johnson
    
    Chief Financial Officer,
Executive Vice President and
Chief Business Officer
(Principal Financial and
Accounting Officer)
    
    March 14, 2007/s/ Samuel D. Anderson

Samuel D. Anderson
    
    Director
    
    March 14, 2007/s/ Jon W. McGarity

Jon W. McGarity
    
    Director
    
    March 14, 2007/s/ Jean-Pierre Millon

Jean-Pierre Millon
    
    Director
    
    March 14, 2007
 49.




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##### Table of Contents



Signature
    
    Title
    
    Date/s/ Perry B. Molinoff

Perry B. Molinoff
    
    Director
    
    March 14, 2007/s/ Daniel H. Petree

Daniel H. Petree
    
    Director
    
    March 14, 2007/s/ Jack H. Vaughn

Jack H. Vaughn
    
    Director
    
    March 14, 2007
 50.




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
 INDEX TO FINANCIAL STATEMENTS
 Report of Independent Registered Public Accounting Firm
    
    F-2Balance Sheets as of December 31, 2006 and 2005
    
    F-3Statements of Operations for the years ended December 31, 2006, 2005 and 2004
    
    F-4Statements of Stockholders Equity for the years ended December 31, 2006, 2005 and 2004
    
    F-5Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004
    
    F-7Notes to Financial Statements
    
    F-8
 F-1




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
    Share-Based Payment
  /s/ Ernst & Young LLP 
 F-2




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
 
 BALANCE SHEETS
 As of December 31,2006
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    11,561,950
    
    
    $
    5,213,587Short-term investments
    
    
    91,216,378
    
    
    
    104,399,691Receivable from Forest Laboratories
    
    
    350,372
    
    
    
    534,933Prepaid expenses and other current assets
    
    
    598,999
    
    
    
    561,330Total current assets
    
    
    103,727,699
    
    
    
    110,709,541Property and equipment, net
    
    
    65,780
    
    
    
    50,795Other assets
    
    
    31,462
    
    
    
    31,462Total assets
    
    $
    103,824,941
    
    
    $
    110,791,798LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    373,556
    
    
    $
    347,946Accrued compensation
    
    
    91,556
    
    
    
    58,594Accrued liabilities
    
    
    99,375
    
    
    
    726,907Payable to Forest Laboratories
    
    
    530,000
    
    
    
    915,000Current portion of deferred revenue
    
    
    3,125,000
    
    
    
    3,125,000Total current liabilities
    
    
    4,219,487
    
    
    
    5,173,447Deferred rent
    
    
    8,157
    
    
    
    17,911Deferred revenue, net of current portion
    
    
    12,500,000
    
    
    
    15,625,000Commitments and contingenciesStockholders equity:Preferred
stock, $.001 par value; 15,000,000 shares authorized; no shares
issued and outstanding
    
    
    
    
    
    
    Common stock, $.001 par value;
60,000,000 shares of common stock
authorized; 32,169,380 and 31,920,632
shares issued and
outstanding at December 31, 2006
and 2005, respectively
    
    
    32,169
    
    
    
    31,921Additional paid-in capital
    
    
    240,594,665
    
    
    
    235,202,784Accumulated other comprehensive income
    
    
    837,172
    
    
    
    860,112Accumulated deficit
    
    
    (154,366,709
    )
    
    
    (146,119,377
    )Total stockholders equity
    
    
    87,097,297
    
    
    
    89,975,440$
    103,824,941
    
    
    $
    110,791,798
 See accompanying notes to the financial statements.
 F-3




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
 
 STATEMENTS OF OPERATIONS
 Years Ended December 31,2006
    
    
    2005
    
    
    2004Revenues under collaborative agreement
    
    $
    4,322,468
    
    
    $
    8,384,636
    
    
    $
    14,414,619Costs and expenses:Research and development
    
    
    9,184,404
    
    
    
    15,839,737
    
    
    
    15,650,328General and administrative
    
    
    8,379,031
    
    
    
    5,448,160
    
    
    
    11,762,813Compensation benefit  variable
stock options
    
    
    
    
    
    
    (1,749,135
    )
    
    
    (699,033
    )Total costs and expenses
    
    
    17,563,435
    
    
    
    19,538,762
    
    
    
    26,714,108Loss from operations
    
    
    (13,240,967
    )
    
    
    (11,154,126
    )
    
    
    (12,299,489
    )Other income (expense):Interest income
    
    
    4,993,635
    
    
    
    2,525,327
    
    
    
    1,092,404Interest expense
    
    
    
    
    
    
    (2,382
    )
    
    
    (5,826
    )Gain (loss) on disposal of assets
    
    
    
    
    
    
    4,186
    
    
    
    (2,095
    )Total other income
    
    
    4,993,635
    
    
    
    2,527,131
    
    
    
    1,084,483Net loss
    
    $
    (8,247,332
    )
    
    $
    (8,626,995
    )
    
    $
    (11,215,006
    )Net loss per share- basic and diluted
    
    $
    (0.26
    )
    
    $
    (0.28
    )
    
    $
    (0.40
    )Shares used in computing net loss
per share  basic and diluted
    
    
    32,094,785
    
    
    
    31,105,271
    
    
    
    27,764,975
 See accompanying notes to the financial statements.
 F-4




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
 
 STATEMENTS OF STOCKHOLDERS EQUITY
 YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
 AccumulatedOtherCommon Stock
    
    Additional
    
    Shareholder
    
    Comprehensive
    
    AccumulatedShares
    
    Par Value
    
    Paid-in Capital
    
    Receivable
    
    Income
    
    Deficit
    
    TotalBalance at December 31, 2003
    
    
    22,184,952
    
    
    $
    22,185
    
    
    $
    148,509,080
    
    
    $
    (189,973
    )
    
    $
    65,206
    
    
    $
    (126,277,376
    )
    
    $
    22,129,122Issuance of stock in secondary offering, net
of placement fees
    
    
    6,900,000
    
    
    
    6,900
    
    
    
    74,211,997
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    74,218,897Issuance of stock upon options exercised
    
    
    885,135
    
    
    
    885
    
    
    
    1,780,285
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,781,170Issuance of stock upon warrants exercised
    
    
    384,939
    
    
    
    385
    
    
    
    1,192,872
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,193,257Compensation related to stock options and
warrants issued to consultants for services
    
    
    
    
    
    
    
    
    
    
    6,355,545
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,355,545Issuance of stock to match 401(k)
contributions
    
    
    8,968
    
    
    
    9
    
    
    
    123,754
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    123,763Stock benefit on variable employee stock
options
    
    
    
    
    
    
    
    
    
    
    (699,033
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (699,033
    )Payment of shareholder receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    189,973
    
    
    
    
    
    
    
    
    
    
    
    189,973Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,215,006
    )
    
    
    (11,215,006
    )Unrealized gain on short-term investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    96,121
    
    
    
    
    
    
    
    96,121Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,118,885
    )Balance at December 31, 2004
    
    
    30,363,994
    
    
    
    30,364
    
    
    
    231,474,500
    
    
    
    
    
    
    
    161,327
    
    
    
    (137,492,382
    )
    
    
    94,173,809Issuance of stock upon options exercised
    
    
    361,958
    
    
    
    362
    
    
    
    1,097,506
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,097,868Issuance of stock upon warrants exercised
    
    
    1,179,048
    
    
    
    1,179
    
    
    
    2,767,336
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,768,515Issuance of warrants in connection with
Organon agreement
    
    
    
    
    
    
    
    
    
    
    615,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    615,000Compensation related to stock options and
warrants issued to consultants for services
    
    
    
    
    
    
    
    
    
    
    864,191
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    864,191Issuance of stock to match 401(k)
contributions
    
    
    15,632
    
    
    
    16
    
    
    
    133,386
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    133,402Stock benefit on variable employee stock
options
    
    
    
    
    
    
    
    
    
    
    (1,749,135
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,749,135
    )Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,626,995
    )
    
    
    (8,626,995
    )Unrealized gain on short-term investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    698,785
    
    
    
    
    
    
    
    698,785Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,928,210
    )Balance at December 31, 2005
    
    
    31,920,632
    
    
    
    31,921
    
    
    
    235,202,784
    
    
    
    
    
    
    
    860,112
    
    
    
    (146,119,377
    )
    
    
    89,975,440
 F-5




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##### Table of Contents



AccumulatedOtherCommon Stock
    
    Additional
    
    Shareholder
    
    Comprehensive
    
    AccumulatedShares
    
    Par Value
    
    Paid-in Capital
    
    Receivable
    
    Income
    
    Deficit
    
    TotalIssuance of stock upon options exercised
    
    
    227,836
    
    
    
    227
    
    
    
    467,567
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    467,794Share-based compensation for options issued
to
non-employees
    
    
    
    
    
    
    
    
    
    
    143,756
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    143,756Share-based compensation for options issued
to
employees
    
    
    
    
    
    
    
    
    
    
    4,638,078
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,638,078Issuance of stock to match 401(k)
contributions
    
    
    20,912
    
    
    
    21
    
    
    
    142,480
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    142,501Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,247,332
    )
    
    
    (8,247,332
    )Unrealized loss on short-term investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (22,940
    )
    
    
    
    
    
    
    (22,940
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,270,272
    )Balance at December 31, 2006
    
    
    32,169,380
    
    
    $
    32,169
    
    
    $
    240,594,665
    
    
    $
    
    
    
    $
    837,172
    
    
    $
    (154,366,709
    )
    
    $
    87,097,297
 See accompanying notes to the financial statements.
 F-6




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
 
 STATEMENTS OF CASH FLOWS
 Years Ended December 31,2006
    
    
    2005
    
    
    2004Operating ActivitiesNet loss
    
    $
    (8,247,332
    )
    
    $
    (8,626,995
    )
    
    $
    (11,215,006
    )Adjustments
to reconcile net loss to net cash (used in) provided by operating activities:Depreciation and amortization
    
    
    31,846
    
    
    
    30,127
    
    
    
    45,653Warrants issued in connection with licensing agreement
    
    
    
    
    
    
    615,000
    
    
    
    Share-based compensation for options issued to non-employees
    
    
    143,756
    
    
    
    864,191
    
    
    
    6,355,545Share-based compensation for stock and options issued to employees
    
    
    4,780,579
    
    
    
    133,402
    
    
    
    123,763Share-based compensation benefit on variable employee options
    
    
    
    
    
    
    (1,749,135
    )
    
    
    (699,033
    )(Gain) loss on disposal of property and equipment
    
    
    
    
    
    
    (4,186
    )
    
    
    2,095Changes in operating assets and liabilities:Prepaid expenses and other current assets
    
    
    (37,669
    )
    
    
    40,391
    
    
    
    (452,183
    )Receivable from Forest Laboratories
    
    
    184,561
    
    
    
    5,122,031
    
    
    
    (5,656,964
    )Accounts payable and other accrued liabilities
    
    
    (568,960
    )
    
    
    (349,833
    )
    
    
    (126,556
    )Payable to Forest Laboratories
    
    
    (385,000
    )
    
    
    115,000
    
    
    
    800,000Deferred rent
    
    
    (9,754
    )
    
    
    (2,654
    )
    
    
    4,186Deferred revenue
    
    
    (3,125,000
    )
    
    
    (3,125,000
    )
    
    
    21,875,000Net cash (used in) provided by operating activities
    
    
    (7,232,973
    )
    
    
    (6,937,661
    )
    
    
    11,056,500Investing ActivitiesPurchases of short-term investments
    
    
    (446,810,627
    )
    
    
    (456,312,296
    )
    
    
    (540,338,663
    )Proceeds from sale of short-term investments
    
    
    459,971,000
    
    
    
    456,332,000
    
    
    
    459,379,000Purchase of property and equipment
    
    
    (46,831
    )
    
    
    (37,536
    )
    
    
    (22,092
    )Proceeds from sale of property and equipment
    
    
    
    
    
    
    36,179
    
    
    
    Net cash provided by (used in) investing activities
    
    
    13,113,542
    
    
    
    18,347
    
    
    
    (80,981,755
    )Financing ActivitiesProceeds from exercise of stock options and warrants
    
    
    467,794
    
    
    
    3,866,383
    
    
    
    2,974,427Proceeds from secondary offering of common stock, net
    
    
    
    
    
    
    
    
    
    
    74,218,897Proceeds from payment of shareholder receivable
    
    
    
    
    
    
    
    
    
    
    189,973Payments on capital lease obligation
    
    
    
    
    
    
    (36,870
    )
    
    
    (14,474
    )Net cash provided by financing activities
    
    
    467,794
    
    
    
    3,829,513
    
    
    
    77,368,823Increase (decrease) in cash and cash equivalents
    
    
    6,348,363
    
    
    
    (3,089,801
    )
    
    
    7,443,568Cash and cash equivalents at beginning of the year
    
    
    5,213,587
    
    
    
    8,303,388
    
    
    
    859,820Cash and cash equivalents at end of the year
    
    $
    11,561,950
    
    
    $
    5,213,587
    
    
    $
    8,303,388Supplemental disclosure of cash flow informationInterest paid
    
    $
    
    
    
    $
    2,382
    
    
    $
    5,826
 See accompanying notes to the financial statements.
 F-7




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
 
 NOTES TO FINANCIAL STATEMENTS
 1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
 The Company
  Accounting Estimates in the Preparation of Financial Statements
  Cash and Cash Equivalents
  Short-Term Investments
   December 31, 2006Amortized
    
    
    Unrealized
    
    
    UnrealizedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueU.S. government and agency debt
    
    $
    78,926,651
    
    
    $
    829,793
    
    
    $
    
    
    
    $
    79,756,444Commercial paper
    
    
    10,952,555
    
    
    
    8,806
    
    
    
    
    
    
    
    10,961,361Certificates of deposit
    
    
    500,000
    
    
    
    
    
    
    
    (1,427
    )
    
    
    498,573$
    90,379,206
    
    
    $
    838,599
    
    
    $
    (1,427
    )
    
    $
    91,216,378
 F-8




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##### Table of Contents



December 31, 2005Amortized
    
    
    Unrealized
    
    
    UnrealizedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueU.S. government and agency debt
    
    $
    100,839,457
    
    
    $
    866,172
    
    
    $
    
    
    
    $
    101,705,629Certificates of deposit
    
    
    2,700,122
    
    
    
    
    
    
    
    (6,060
    )
    
    
    2,694,062$
    103,539,579
    
    
    $
    866,172
    
    
    $
    (6,060
    )
    
    $
    104,399,691
 Concentrations of Credit Risk
  Property and Equipment
  Long-Lived Assets
  Fair Value of Financial Instruments
  Revenue Recognition
 Revenue Recognition in Financial Statements
 Comprehensive Income (Loss)
 Comprehensive
Income
 F-9




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##### Table of Contents



Research and Development
   Share-Based Compensation
 Accounting for Stock Issued to Employees , Accounting for Stock-Based Compensation . ,
 Share-Based Payment ,
 Accounting for
Equity Instruments That are Issued to Other Than Employees for Acquiring or in Conjunction with
Selling Goods or Services
 Net Loss Per Share
  F-10




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##### Table of Contents



Pro Forma Financial Information for Periods Prior to 2006
  2005
    
    
    2004Net loss, as reported
    
    $
    (8,626,995
    )
    
    $
    (11,215,006
    )Add: Stock-based employee compensation
benefit included in reported net loss
    
    
    (1,749,135
    )
    
    
    (699,033
    )Deduct: Additional stock-based employee
compensation determined under fair value
based methods
    
    
    (4,540,250
    )
    
    
    (2,725,218
    )Pro forma net loss
    
    $
    (14,916,380
    )
    
    $
    (14,639,257
    )Net loss per sharebasic and diluted, as
reported
    
    $
    (0.28
    )
    
    $
    (0.40
    )Pro forma net loss per sharebasic and diluted
    
    $
    (0.48
    )
    
    $
    (0.53
    )
 Impact of Recently Issued Accounting Standards
 Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109
 Fair Value Measurements
 F-11




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##### Table of Contents



2. STOCKHOLDERS EQUITY
 Authorized Shares
  Shelf Registration
  Warrants
    3. SHARE-BASED COMPENSATION
 Share-Based Compensation Plans
 2000 EQUITY INCENTIVE PLAN
  F-12




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##### Table of Contents



1996 EQUITY INCENTIVE PLAN
  Stock Options
  Years Ended December 31,2006
    
    2005
    
    2004Risk-free interest rate
    
    
    4.7
    %
    
    
    3.5
    %
    
    
    2.6
    %Expected volatility
    
    
    82
    %
    
    
    95
    %
    
    
    112
    %Expected option term (in years)
    
    
    5.7
    
    
    
    4.0
    
    
    
    4.0Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
   F-13




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##### Table of Contents



2000
    
    
    1996
    
    
    
    
    
    
    
    
    
    
    WeightedEquity
    
    
    Equity
    
    
    
    
    
    
    Number of
    
    
    AverageIncentive
    
    
    Incentive
    
    
    Other
    
    
    Options Under
    
    
    ExercisePlan Options
    
    
    Plan Options
    
    
    Options
    
    
    All Plans
    
    
    PricesBalance December 31,
2003
    
    
    2,556,506
    
    
    
    745,879
    
    
    
    3,125
    
    
    
    3,305,510
    
    
    $
    3.18Granted
    
    
    459,863
    
    
    
    
    
    
    
    
    
    
    
    459,863
    
    
    
    12.61Exercised
    
    
    (536,502
    )
    
    
    (374,723
    )
    
    
    
    
    
    
    (911,225
    )
    
    
    2.40Canceled
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Expired
    
    
    
    
    
    
    
    
    
    
    (3,125
    )
    
    
    (3,125
    )
    
    
    18.00Balance December 31,
2004
    
    
    2,479,867
    
    
    
    371,156
    
    
    
    
    
    
    
    2,851,023
    
    
    
    4.93Granted
    
    
    830,125
    
    
    
    
    
    
    
    
    
    
    
    830,125
    
    
    
    13.35Exercised
    
    
    (270,003
    )
    
    
    (91,955
    )
    
    
    
    
    
    
    (361,958
    )
    
    
    3.03Canceled
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Expired
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance December 31,
2005
    
    
    3,039,989
    
    
    
    279,201
    
    
    
    
    
    
    
    3,319,190
    
    
    
    7.25Granted
    
    
    839,693
    
    
    
    
    
    
    
    
    
    
    
    839,693
    
    
    
    5.88Exercised
    
    
    (95,433
    )
    
    
    (202,939
    )
    
    
    
    
    
    
    (298,372
    )
    
    
    2.91Canceled
    
    
    (35,929
    )
    
    
    
    
    
    
    
    
    
    
    (35,929
    )
    
    
    8.96Expired
    
    
    (32,884
    )
    
    
    (4,375
    )
    
    
    
    
    
    
    (37,259
    )
    
    
    14.62Balance December 31,
2006
    
    
    3,715,436
    
    
    
    71,887
    
    
    
    
    
    
    
    3,787,323
    
    
    $
    7.19
  Weighted
    
    
    
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    
    
    
    AverageRemaining
    
    Weighted
    
    
    
    
    
    Exercise PriceRange of
    
    Options
    
    Contractual
    
    Average
    
    Options
    
    of OptionsExercise Prices
    
    Outstanding
    
    Life in Years
    
    Exercise Price
    
    Exercisable
    
    Exercisable$0.00  $2.00
    
    
    8,872
    
    
    
    4.7
    
    
    $
    1.30
    
    
    
    8,872
    
    
    $
    1.30$2.01  $3.00
    
    
    560,961
    
    
    
    6.1
    
    
    $
    2.51
    
    
    
    532,676
    
    
    $
    2.51$3.01  $4.00
    
    
    546,159
    
    
    
    5.3
    
    
    $
    3.29
    
    
    
    544,707
    
    
    $
    3.29$4.01  $6.00
    
    
    1,284,842
    
    
    
    7.8
    
    
    $
    5.24
    
    
    
    889,366
    
    
    $
    5.12$6.01  $11.00
    
    
    189,523
    
    
    
    8.7
    
    
    $
    7.76
    
    
    
    79,261
    
    
    $
    9.07$11.01  $15.00
    
    
    1,125,315
    
    
    
    7.8
    
    
    $
    13.10
    
    
    
    697,136
    
    
    $
    13.05$15.01  $20.00
    
    
    71,339
    
    
    
    6.4
    
    
    $
    15.04
    
    
    
    65,536
    
    
    $
    15.04$20.01  $25.00
    
    
    312
    
    
    
    1.5
    
    
    $
    22.25
    
    
    
    312
    
    
    $
    22.253,787,323
    
    
    
    7.2
    
    
    $
    7.19
    
    
    
    2,817,866
    
    
    $
    6.57
  F-14




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##### Table of Contents



Years Ended December 31,2006
    
    2005
    
    2004Risk-free interest rate
    
    
    4.7
    %
    
    
    3.6
    %
    
    
    2.6
    %Expected volatility
    
    
    80
    %
    
    
    92
    %
    
    
    112
    %Expected option term (in years)
    
    
    5.4
    
    
    
    4.0
    
    
    
    4.0Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
 Stock Option Cancel and Re-Grant Program
    4. SIGNIFICANT LICENSING AND COLLABORATION AGREEMENTS
 License and Collaboration Agreement with Organon
  F-15




---



##### Table of Contents



License and Collaboration Agreement with Forest Laboratories
   F-16




---



##### Table of Contents



Licensing Agreement with Pierre Fabre
 Accounting for Research and Development Costs
   F-17




---



##### Table of Contents



Reformulation and New Product Agreement
  5. INCOME TAXES
  2006
    
    
    2005Net operating loss carryforwards
    
    $
    24,445,000
    
    
    $
    23,329,000Deferred revenue
    
    
    6,367,000
    
    
    
    7,640,000Capitalized research and development
    
    
    8,273,000
    
    
    
    6,035,000Capitalized intangibles
    
    
    4,016,000
    
    
    
    4,426,000Tax credits
    
    
    2,222,000
    
    
    
    2,273,000Share-based compensation expense
    
    
    1,559,000
    
    
    
    Other
    
    
    41,000
    
    
    
    276,00046,923,000
    
    
    
    43,979,000Valuation allowance
    
    
    (46,923,000
    )
    
    
    (43,979,000
    )$
    
    
    
    $
    
    F-18




---



##### Table of Contents



6. RELATED PARTY TRANSACTIONS
     7. RETIREMENT PLAN
  8. COMMITMENTS AND CONTINGENCIES
  F-19




---



##### Table of Contents



OperatingYears Ending December 31,
    
    Leases2007
    
    $
    188,2742008
    
    
    190,0452009
    
    
    196,8532010
    
    
    203,6612011
    
    
    210,468Thereafter
    
    
    125,090Total minimum lease payments
    
    $
    1,114,391
  9. QUARTERLY INFORMATION (UNAUDITED)
  2006First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    QuarterRevenues
    
    $
    1,216,140
    
    
    $
    1,015,305
    
    
    $
    1,144,208
    
    
    $
    946,815Total costs and expenses
    
    $
    5,766,058
    
    
    $
    4,452,730
    
    
    $
    4,046,415
    
    
    $
    3,298,232Other income
    
    $
    1,016,489
    
    
    $
    1,231,146
    
    
    $
    1,477,690
    
    
    $
    1,268,310Net loss (1)
    
    $
    (3,533,429
    )
    
    $
    (2,206,279
    )
    
    $
    (1,424,517
    )
    
    $
    (1,083,107
    )Net loss per share  basic and diluted
    
    $
    (0.11
    )
    
    $
    (0.07
    )
    
    $
    (0.04
    )
    
    $
    (0.03
    )Shares used in calculating per share
amounts  basic and diluted
    
    
    32,018,307
    
    
    
    32,072,345
    
    
    
    32,135,189
    
    
    
    32,151,392
 
 (1)
    
    During the first, second, third and fourth quarters, the Company recognized stock-based
compensation related to employee stock options of $1,190,109, $1,156,978, $1,142,402 and
$1,148,589, respectively, in connection with the adoption of FAS 123R in 2006. 2005First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    QuarterRevenues
    
    $
    3,210,590
    
    
    $
    2,332,863
    
    
    $
    1,575,000
    
    
    $
    1,266,183Total costs and expenses
    
    $
    5,511,289
    
    
    $
    7,892,330
    
    
    $
    2,462,103
    
    
    $
    3,673,040Other income
    
    $
    551,419
    
    
    $
    694,164
    
    
    $
    671,752
    
    
    $
    609,796Net loss (1)
    
    $
    (1,749,280
    )
    
    $
    (4,865,303
    )
    
    $
    (215,351
    )
    
    $
    (1,797,061
    )Net loss per share  basic and diluted
    
    $
    (0.06
    )
    
    $
    (0.16
    )
    
    $
    (0.01
    )
    
    $
    (0.06
    )Shares used in calculating per share
amounts  basic and diluted
    
    
    30,391,504
    
    
    
    30,481,785
    
    
    
    31,627,157
    
    
    
    31,901,659
 
 (1)
    
    During the first, second, third and fourth quarters, the Company recognized non-cash
compensation expense (benefit) for variable stock options of $(1,392,060), $1,148,732,
$(1,580,894) and $75,087, respectively, related to the variable accounting treatment for
options issued pursuant to the cancel and re-grant program in June 2001. F-20