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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, 2008
 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
    
    92121(Address of principal executive offices)
    
    (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
  Large accelerated filer o
    
    Accelerated Filer þ
    
    Non-accelerated filer o
    
    Smaller reporting company o(Do not check if a smaller reporting company)
 o þ
   DOCUMENTS INCORPORATED BY REFERENCE
 
 *
    
    Calculated based on 33,587,453 shares of common stock held as of June 30, 2008 by
non-affiliates and a per share market price of $7.19. Excludes 4,295,621 shares of common
stock held by directors and executive officers and stockholders whose ownership exceeds ten
percent of the common stock outstanding at June 30, 2008, who are deemed to be affiliates only
for purposes of this calculation. Exclusion of such shares should not be construed to indicate
that any such person possesses the power, direct or indirect, to direct or cause the direction
of the management or policies of the Registrant or that such person is controlled by or under
common control with the Registrant.




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##### 



CYPRESS BIOSCIENCE, INC.
FORM 10-K
INDEX
 PagePART IItem 1 Business
    
    
    1Item 1A Risk Factors
    
    
    13Item 1B Unresolved Staff Comments
    
    
    32Item 2 Properties
    
    
    32Item 3 Legal Proceedings
    
    
    32Item 4 Submission of Matters to a Vote of Security Holders
    
    
    32PART IIItem 5 Market for our Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    34Item 6 Selected Financial Data
    
    
    36Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    37Item 7A Quantitative and Qualitative Disclosures about Market Risk
    
    
    46Item 8 Financial Statements and Supplementary Data
    
    
    46Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    46Item 9A Controls and Procedures
    
    
    46Item 9B Other Information
    
    
    48PART IIIItem 10 Directors, Executive Officers and Corporate Governance
    
    
    49Item 11 Executive Compensation
    
    
    49Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    49Item 13 Certain Relationships, Related Transactions and Director Independence
    
    
    49Item 14 Accounting Fees and Services
    
    
    49PART IVItem 15 Exhibits, Financial Statement Schedules
    
    
    50Signatures
    
    
    52EX-10.19EX-10.20EX-10.21EX-21.1EX-23.1EX-31.1EX-31.2EX-32
  Avise PG SM Avise
MCV SM .  Savella TM
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##### Table of Contents



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, should, 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 commercialize Savella, our ability to create a
successful commercial organization, our ability to market our personalized medicine services, 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
  Savella Savella in vitro Savella Avise PG Avise MCV Savella
 Avise PG Avise MCV Savella Savella Savella Savella
  1




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Savella Savella Savella
 Savella Savella Savella
 Savella Savella
 Savella www.clinicaltrials.gov
  Savella (milnacipran HCl) for the Management of Fibromyalgia
 Savella
 Savella Savella in vitro Savella
 2




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##### Table of Contents



Ongoing Phase IV Trials
 Savella www.clinicaltrials.gov Savella
 Personalized Medicine Services
 Avise MCV
 Avise MCV Avise MCV Avise MCV . Avise MCV .
 Avise PG
 Avise PG Avise PG
 Other Personalized Medicine Services
  3




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Licenses, Collaborations and Acquisitions
 Milnacipran Agreements
 Pierre Fabre Agreements
    Forest Laboratories Agreement
 Savella
 4




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Savella
  Savella Savella Savella Savella Savella Savella
 Savella
 Collegium Agreement
  5




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Acquisition of Proprius
 Merger Agreement
   
 
 Avise MCV Avise PG Avise
MCV Avise PG
  6




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Agreement with AlphaRx
  Patents, Trademarks and Proprietary Technology
  Avise PG Avise MCV Avise PG
  7




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Competition
   Savella ® ® Savella Savella
  Savella
 8




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##### Table of Contents



Manufacturing and Supply
 Savella Savella Savella Savella Savella Savella Savella
   Government Regulation
 Therapeutic Products
   
    
    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.
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
    
    ensure receipt from participants of signed consents that inform them of risks;
    
    detail the protocol and objectives of the study;
    
    detail the parameters to be used to monitor safety; and
    
    detail the safety and 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.
  10




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Savella
 Savella  Savella
    11




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Personalized Medicine Services
  Avise MCV Avise PG
   12




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
    
    exclusion from participation in Medicare/Medicaid programs;
    
    asset forfeitures;
    
    civil and criminal fines and penalties; and
    
    the loss of various licenses, certifications and authorizations necessary to operate
our business.
  Employees
  Available Information
 www.cypressbio.com
 
 Item 1A. Risk Factors
  Risks related to our business
 We may not be successful in creating a successful commercial infrastructure.
 Savella Savella Savella Savella  Savella Savella Savella
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Savella Savella Savella
  We may encounter challenges is our personalized medicine services business.
  
    
    higher development or commercialization costs than we anticipate for the personalized
medicine services;
    
    challenges with running a service business;
    
    higher than expected licensing and integration costs;
    
    exposure to liabilities of licensed and acquired intellectual property, compounds,
products and services;
    
    disruption of our business and diversion of our managements time and attention as part
of integrating Proprius business with our operations; and
    
    potential significant impairement charges related to goodwill.
  14




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If third-party payers, including managed care organizations and Medicare, do not provide
reimbursement for Avise PG or Avise MCV, their commercial success could be compromised.
 Avise PG Avise MCV
 
    
    not experimental or investigational,
    
    medically necessary,
    
    appropriate for the specific patient and diagnosis,
    
    cost-effective,
    
    supported by peer-reviewed publications, and
    
    included in clinical practice guidelines.
 Avise PG Avise MCV
  Avise PG Avise MCV
 We have recently substantially increased the size of our organization and will continue to need to
increase the size of our organization, and we may experience difficulties in managing growth.
 Savella Savella Savella
 
    
    manage our internal development and commercialization efforts for our personalized
medicine services and Savellaeffectively while carrying out our contractual obligations to
collaborators and other third parties and complying with all applicable laws, rules and
regulations;
    
    continue to improve our operational, financial and management controls, reporting
systems and procedures; and
    
    attract and retain sufficient numbers of talented employees.
  15




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We are dependent on our collaboration with Forest Laboratories to commercialize Savella and to
obtain regulatory approval.
 Savella . Savella Savella Savella Savella
  
    
    Forest Laboratories could fail to devote sufficient resources to the commercialization,
marketing and distribution of Savellaor any other products developed under our
collaboration agreement, including by failing to develop or expand sales forces if such
sales forces appear necessary for the most effective promotion of Savellaor any other
approved product;
    
    We and Forest Laboratories could disagree as to post approval development plans,
including the number and timing of clinical trials, or as to which additional indications
for Savellashould be pursued, if any, and therefore Savellamay never
be sold for any indications other than FM;
    
    Forest could fail to comply with applicable regulatory guidelines with respect to the
marketing and manufacturing of Savellawhich could result in administrative or judicially
imposed sanctions, including warning letters, civil and criminal penalties, injunctions,
product seizures or detention, product recalls, total or partial suspension of production
and refusal to approve any new drug applications.
    
    Forest Laboratories could independently develop, develop with third parties or acquire
products that could compete with Savella, including drugs approved for other indications
used by physicians off-label for the treatment of FM;
    
    Forest Laboratories could abandon or underfund the post approval development of
Savella, repeat or conduct additional clinical trials or require a new formulation of
milnacipran for further clinical testing, or delay the commencement of any post approval
clinical trials for Savellafor the management of FM; and
    
    Disputes regarding the collaboration agreement that delay or terminate the post
approval development or commercialization, 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.
 Savella
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All of our personalized medicine services are performed at a single laboratory and, in the event
this facility was to be affected by man-made or natural disasters, our operations could be severely
impaired.
   Failure to timely or accurately bill for our personalized medicine services could have a material
adverse effect on our net revenues and bad debt expense.
   
    
    exclusion from participation in Medicare/Medicaid programs;
    
    asset forfeitures;
    
    civil and criminal fines and penalties; and
    
    the loss of various licenses, certificates and authorizations necessary to operate our
business.
  17




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We have a financial risk related to collections for our services.
  We rely upon an exclusive license from Pierre Fabre in order to develop and sell Savella, and our
ability to pursue the further development and commercialization of Savella for the management of FM
depends upon the continuation of our license from Pierre Fabre.
 Savella
 We rely upon Pierre Fabre as our exclusive supplier of the active ingredient in Savella
and if Pierre Fabre fails to supply us sufficient quantities of the active ingredient it
may delay or prevent us from commercializing Savella.
 Savella Savella Savella Savella
 Savella
 18




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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.
  Provisions in our collaboration agreement with Forest Laboratories and our license agreement with
Pierre Fabre may prevent or delay a change in control.
 Savella Savella
 We are at an early stage of commercialization and we may never generate any significant revenues.
 Savella Savella Savella
 Avise PG Avise MCV
 Savella Savella
 19




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Our failure to comply with the HIPAA security and privacy regulations and other state regulations
may increase our operational costs.
  
 
 
 
  Our business presents the risk of product liability claims.
 Savella Savella Savella
 The FDA approval of any future product candidate is uncertain and will involve the commitment of
substantial time and resources.
   20




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
    
    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, clinical trials, and/or
pharmacovigilance data 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;
    
    the FDA may change its approval policies or adopt new regulations; and
    
    the FDA may request additional data.
 In light of our regulatory approval for Savella and if we ever receive regulatory approval for any
other future product candidate, and secure and maintain regulatory approvals related to our
personalized medicine services, we will be subject to ongoing FDA, CLIA and state regulatory
obligations and continuing regulatory review by applicable regulatory authorities.
 Savella Savella Savella Savella
 If advances in technology allow others to perform and/or provide personalized medicine services
which are similar to or better than ours or to perform such services in a more efficient or
cost-effective manner than is currently possible, our personalized medicine services may not meet
with demand in the marketplace or the demand for these services may decrease.
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The FDA may decide to exercise enforcement discretion and require FDA approval or clearance of our
personalized medicine services.
 Avise MCV Avise PG,
 Avise MCV  Avise PG
 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 any of our other future product candidates.
  22




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Even if our product candidates are approved, the market may not accept these products or service or
our existing products and services.
 Avise PG Avise MCV, Savella
 
    
    timing of market entry relative to competitive services and products;
    
    extent of marketing efforts by us and with respect to Savella, the marketing efforts of
Forest Laboratories;
    
    rate of adoption by healthcare practitioners;
    
    rate of a products acceptance by the target community;
    
    availability of alternative therapies;
    
    price of our services and products 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.
 Avise PG Avise MCV Savella
 Our competitors may develop and market products and services that are less expensive, more
effective or safer, which may diminish or eliminate the commercial success of any products or
services we may commercialize.
   Savella ® ® Savella Savella ® ® Savella Savellas
 23




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Savella
 We are subject to uncertainty relating to health care reform measures and reimbursement policies
which, if not favorable to our products or services or product candidates, could hinder or prevent
the commercial success of our products, services or product candidates.
  
    
    our ability to set a price we believe is fair for our products and services;
    
    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.
 Savella Savella
  24




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We rely on our employees and consultants for their scientific and technical expertise in connection
with our business operations.
 Savella,
  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.
 Savella
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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.
 Savella
 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.
  The investment of our cash balance and short-term investments are subject to risks which may cause
losses and affect the liquidity of these investments.
  We may lose our net operating loss carryforwards, which could prevent us from offsetting future
taxable income.
  26




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Our stock price has been very volatile and will likely continue to be volatile.
  
    
    the commercial sales of Savella;
    
    development of our personalized medicine services and other product candidates;
    
    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, product candidates 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.
 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.
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Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition
of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our
stockholders to replace or remove our current management.
  We expect to continue incurring significant costs as a result of enacted and proposed changes in
laws and regulations relating to corporate governance matters.
  If we fail to maintain proper and effective internal controls, our ability to produce accurate
financial statements could be impaired, which could adversely affect our operating results, our
ability to operate our business and investors view of us.
  28




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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 sales of
Savella, and our ability to compete may decrease or be eliminated if we are not able to protect our
proprietary technology.
 Savella
 Avise PG Avise MCV Avise PG
  Savella Savella
 29




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Savella
  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 products and
services and product and service 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 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.
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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, services and product and service candidates; or
    
    we or our collaborators having to enter into license arrangements that may not be
available on commercially acceptable terms, if at all. As a result, we could be prevented
from commercializing current or future products, services and product and service
candidates.
 The patent applications of pharmaceutical, biotechnology and personalized medicine companies
involve highly complex legal and factual questions, which could negatively impact our patent
position.
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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
  Executive Officers
  NAME
    
    AGE
    
    POSITIONJay D. Kranzler, M.D., Ph.D.
    
    
    51
    
    
    Chief Executive Officer and Chairman of the Board of DirectorsR. Michael Gendreau, M.D., Ph.D.
    
    
    53
    
    
    Vice President of Clinical Development and Chief Medical
OfficerSabrina Martucci Johnson
    
    
    42
    
    
    Executive Vice President, Chief Operating Officer and Chief
Financial OfficerSrinvas Rao
    
    
    40
    
    
    Chief Scientific OfficerMichael Walsh
    
    
    49
    
    
    Executive Vice President and Chief Commercial OfficerDenise Wheeler
    
    
    39
    
    
    General Counsel
 Jay D. Kranzler
  R. Michael Gendreau
  32




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Sabrina Martucci Johnson
  Srinivas Rao
  Michael Walsh
  Denise Wheeler
 LP
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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, 2008:First Quarter
    
    $
    11.09
    
    
    $
    6.66Second Quarter
    
    
    8.85
    
    
    
    6.17Third Quarter
    
    
    9.13
    
    
    
    5.45Fourth Quarter
    
    
    7.41
    
    
    
    4.90Year Ended December 31, 2007:First Quarter
    
    $
    9.20
    
    
    $
    6.91Second Quarter
    
    
    18.20
    
    
    
    7.34Third Quarter
    
    
    15.60
    
    
    
    11.45Fourth Quarter
    
    
    15.48
    
    
    
    10.85
  Recent Sales of Unregistered Securities
  34




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Stock Performance Graph and Cumulative Total Return
  
 35




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Item 6. Selected Financial Data
  Years Ended December 31,2008
    
    
    2007
    
    
    2006
    
    
    2005
    
    
    2004Statement of Operations Data:Revenues:Revenues under collaborative agreement
    
    $
    17,159,099
    
    
    $
    13,940,603
    
    
    $
    4,322,468
    
    
    $
    8,384,636
    
    
    $
    14,414,619Operating expenses:Cost of personalized medicine testing
services
    
    
    267,361
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Research and development
    
    
    9,671,076
    
    
    
    7,710,684
    
    
    
    9,184,404
    
    
    
    15,839,737
    
    
    
    15,650,328Selling, general and administrative
    
    
    17,602,820
    
    
    
    10,027,358
    
    
    
    8,379,031
    
    
    
    5,448,160
    
    
    
    11,762,813In-process research and development
    
    
    12,590,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Compensation expense (benefit) 
variable stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,749,135
    )
    
    
    (699,033
    )40,131,257
    
    
    
    17,738,042
    
    
    
    17,563,435
    
    
    
    19,538,762
    
    
    
    26,714,108Other income (expense):Interest income
    
    
    4,746,547
    
    
    
    7,285,023
    
    
    
    4,923,290
    
    
    
    3,501,381
    
    
    
    1,092,404Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,382
    )
    
    
    (5,826
    )Gain (loss) on disposal of assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,186
    
    
    
    (2,095
    )4,746,547
    
    
    
    7,285,023
    
    
    
    4,923,290
    
    
    
    3,503,185
    
    
    
    1,084,483Net income (loss)
    
    $
    (18,225,611
    )
    
    $
    3,487,584
    
    
    $
    (8,317,677
    )
    
    $
    (7,650,941
    )
    
    $
    (11,215,006
    )Net income (loss) per share  basic
    
    $
    (0.48
    )
    
    $
    0.10
    
    
    $
    (0.26
    )
    
    $
    (0.25
    )
    
    $
    (0.40
    )Shares used in computing net income
(loss) per share  basic
    
    
    37,733,737
    
    
    
    35,205,783
    
    
    
    32,094,785
    
    
    
    31,105,271
    
    
    
    27,764,975Net income (loss) per share  diluted
    
    $
    (0.48
    )
    
    $
    0.10
    
    
    $
    (0.26
    )
    
    $
    (0.25
    )
    
    $
    (0.40
    )Shares used in computing net income
(loss) per share  diluted
    
    
    37,733,737
    
    
    
    36,616,091
    
    
    
    32,094,785
    
    
    
    31,105,271
    
    
    
    27,764,975
 As of December 31,2008
    
    2007
    
    2006
    
    2005
    
    2004Balance Sheet Data:Cash, cash equivalents
and short-term
investments
    
    $
    145,494,605
    
    
    $
    181,806,574
    
    
    $
    102,778,328
    
    
    $
    109,613,278
    
    
    $
    112,023,998Total assets
    
    
    174,592,523
    
    
    
    182,699,850
    
    
    
    103,824,941
    
    
    
    110,791,798
    
    
    
    118,389,524Total stockholders equity
    
    
    159,915,208
    
    
    
    168,014,978
    
    
    
    87,097,297
    
    
    
    89,975,440
    
    
    
    94,173,809Working capital
    
    
    138,751,122
    
    
    
    177,975,517
    
    
    
    99,508,212
    
    
    
    105,536,094
    
    
    
    112,837,533
 36




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##### Table of Contents



Item 7. Managements Discussion and Analysis of Financial Condition and Results of
Operations
 overview
  Savella Savella in vitro Savella Avise PG Avise MCV Savella
 Avise PG Avise MCV Savella Savella Savella Savella
    37




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##### Table of Contents



Savella Savella Savella
 Savella Savella Savella
 Savella Savella
 Savella www.clinicaltrials.gov
  Results of Operations
 Comparison of Years Ended December 31, 2008 and 2007
 Revenues
 Savella Savella Savella Savella
 38




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##### Table of Contents



Cost of Personalized Medicine Testing Services
  Research and Development
 Savella Savella
 Savella
 Selling, General and Administrative
  In-Process Research and Development
  39




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##### Table of Contents



Interest Income
  Comparison of Years Ended December 31, 2007 and 2006
 Revenues
 Savella Savella Savella Savella Savella
 Research and Development
 Savella Savella Savella
 40




---



##### Table of Contents



General and Administrative
  Interest Income
  Liquidity and Capital Resources
     41




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##### Table of Contents



Less than1 year
    
    1  3 years
    
    3  5 years
    
    More than 5Total
    
    (2009)
    
    (2010  2012)
    
    (2013  2015)
    
    years (2016 +)Operating leases
    
    $
    818,113
    
    
    $
    271,360
    
    
    $
    546,753
    
    
    $
    
    
    
    $
    Purchase obligations (1)
    
    
    558,728
    
    
    
    558,728
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    1,376,841
    
    
    $
    830,088
    
    
    $
    546,753
    
    
    $
    
    
    
    $
    
 
 (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 accrued liabilities to the extent presented on the balance sheet as
of December 31, 2008.   Savella Savella
 42




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##### Table of Contents




    
    the costs of establishing a commercial infrastructure;
    
    the costs and timing of development and regulatory approvals for all our products and
services;
    
    the costs associated with operating a clinical laboratory;
    
    the extent to which we acquire or invest in other products, product candidates and
businesses;
    
    the costs of in-licensing drug candidates;
    
    the ability of Forest Laboratories and us to reach sales milestones and other events
under our collaboration agreement; and
    
    the costs of commercialization of any future products and services.
   Critical Accounting Policies and Estimates
  Revenue Recognition
 Revenue Recognition in Financial
Statements
 43




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##### Table of Contents



Research and Development Expenses
  Share-Based Compensation
 Share-Based Payment Accounting
for Stock-Based Compensation
   44




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##### Table of Contents



Goodwill
 , Goodwill and Other Intangible Assets
 New Accounting Pronouncements
 Accounting for Collaborative Arrangements
 Business Combinations
 Noncontrolling Interests in Consolidated Financial
Statements  an amendment of Accounting Research Bulletin No. 51
 45




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##### Table of Contents



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
  
 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
  46




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##### Table of Contents



Report of Independent Registered Public Accounting Firm on Internal Control Over Financial
Reporting
 
 .
      /s/ Ernst & Young LLP 
 47




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##### Table of Contents



Item 9B. Other Information
  48




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##### Table of Contents



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
  49




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##### Table of Contents



PART IV
 
 Item 15. Exhibits, Financial Statement Schedules
     ExhibitNo.
    
    Description
    
    Incorporated by Reference to2.1
    
    Agreement and Plan of Merger
dated February 23, 2008 by among
the Registrant, Propel
Acquisition Sub, Inc., Proprius,
Inc. and Michael J. Walsh, as the
Stockholders Representative(*)
    
    Exhibit 2.1 to Form 8-K filed on March 5, 20083.1
    
    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
    
    Third Amended and Restated By-Laws
    
    Exhibit 3.1 to Form 8-K filed on July 27, 20074.1
    
    Form of Stock Certificate
    
    Exhibit 4.1 to Form S-1 Registration
Statement No. 33-4122510.1
    
    2000 Equity Incentive Plan()
    
    Exhibit 10.25 to Form 10-K for the year ended
December 31, 200010.2
    
    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, 200010.3
    
    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, 200210.4
    
    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, 200210.5
    
    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, 200310.6
    
    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, 200310.7
    
    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, 2003.10.8
    
    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, 2003.10.9
    
    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.
 50




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##### Table of Contents



ExhibitNo.
    
    Description
    
    Incorporated by Reference to10.10
    
    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, 2003.10.11
    
    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, 2003.10.12
    
    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, 2003.10.13
    
    Amendment to Forest Agreement(*)
    
    Exhibit 10.1 to Form 10-Q for the quarter
ended June 30, 200510.14
    
    First Amendment to Office Lease
    
    Exhibit 10.28 to Form 10-Q for the quarter
ended September 30, 200610.15
    
    2008 Bonus Plan()
    
    Exhibit 10.1 to the Form 8-K filed on January
28, 200810.16
    
    Employment Agreement dated
February 23, 2008 between the
Registrant and Michael J. Walsh
    
    Exhibit 10.1 to the Form 8-K filed on
February 25, 200810.17
    
    Non-Competition Agreement dated
February 23, 2008 among the
Registrant, Proprius, Inc. and
Michael J. Walsh
    
    Exhibit 10.3 to the Form 8-K filed on
February 25, 200810.18
    
    Form of Retention Agreement among
the Registrant, Proprius, Inc.
and the Key Employee as defined
therein
    
    Exhibit 10.4 to the Form 8-K filed on
February 25, 200810.19
    
    Amended and Restated Employment
Agreement dated December 31, 2008
between the Registrant and Dr.
Jay Kranzler()10.20
    
    Amended and Restated Severance
Benefits Plan adopted on December
31, 2008()10.21
    
    Amended and Restated Employment
Agreement dated December 31, 2008
between the Registrant and Denise
Wheeler()21.1
    
    Subsidiaries of the registrant23.1
    
    Consent of Independent Registered
Public Accounting Firm24.1
    
    Power of Attorney
    
    Reference is made to the signature page of
this report31.1
    
    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
    
    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. 51




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##### Table of Contents



SIGNATURES
  Cypress Bioscience, Inc.Date: March 16, 2009
    By:
    /s/ Jay D. KranzlerChief Executive OfficerDate: March 16, 2009
    By:
    /s/ Sabrina Martucci JohnsonChief Financial Officer, ChiefOperating Officer and Executive 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 16, 2009/s/ Sabrina Martucci Johnson

Sabrina Martucci Johnson
    
    Chief Financial Officer,
Chief Operating Officer and Executive Vice
President
(Principal Financial and Accounting Officer)
    
    March 16, 2009/s/ Roger Hawley

Roger Hawley
    
    Director
    
    March 16, 2009/s/ Amir H. Kalali

Amir H. Kalali
    
    Director
    
    March 16, 2009/s/ Jon W. McGarity

Jon W. McGarity
    
    Director
    
    March 16, 2009/s/ Jean-Pierre Millon

Jean-Pierre Millon
    
    Director
    
    March 16, 2009/s/ Perry B. Molinoff

Perry B. Molinoff
    
    Director
    
    March 16, 2009/s/ Tina S. Nova

Tina S. Nova
    
    Director
    
    March 16, 2009/s/ Daniel H. Petree

Daniel H. Petree
    
    Director
    
    March 16, 2009
 52




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 Report of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Balance Sheets as of December 31, 2008 and 2007
    
    
    F-3Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006
    
    
    F-4Consolidated Statements of Stockholders Equity for the years ended December 31, 2008, 2007 and 2006
    
    
    F-5Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-7
 F-1




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
      
 F-2




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
 
 CONSOLIDATED BALANCE SHEETS
 As of December 31,2008
    
    
    2007ASSETSCurrent assets:Cash and cash equivalents
    
    $
    52,490,414
    
    
    $
    70,093,425Short-term investments
    
    
    93,004,191
    
    
    
    111,713,149Receivable from Forest Laboratories
    
    
    165,880
    
    
    
    142,750Prepaid expenses and other current assets
    
    
    1,048,668
    
    
    
    651,144Total current assets
    
    
    146,709,153
    
    
    
    182,600,468Property and equipment, net
    
    
    1,088,749
    
    
    
    79,382Goodwill
    
    
    26,465,627
    
    
    
    Other assets
    
    
    328,994
    
    
    
    20,000Total assets
    
    $
    174,592,523
    
    
    $
    182,699,850LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    2,055,567
    
    
    $
    443,734Accrued compensation
    
    
    1,055,056
    
    
    
    307,164Accrued liabilities
    
    
    377,992
    
    
    
    522,637Payable to Forest Laboratories
    
    
    1,118,000
    
    
    
    Current portion of deferred revenue
    
    
    3,351,416
    
    
    
    3,351,416Total current liabilities
    
    
    7,958,031
    
    
    
    4,624,951Deferred rent
    
    
    16,452
    
    
    
    5,673Deferred revenue, net of current portion
    
    
    6,702,832
    
    
    
    10,054,248Commitments 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 authorized; 37,906,994
and 37,423,584 shares issued and
outstanding at December 31, 2008 and
2007, respectively
    
    
    37,907
    
    
    
    37,424Additional paid-in capital
    
    
    327,595,174
    
    
    
    317,891,137Accumulated other comprehensive income
    
    
    481,154
    
    
    
    59,833Accumulated deficit
    
    
    (168,199,027
    )
    
    
    (149,973,416
    )Total stockholders equity
    
    
    159,915,208
    
    
    
    168,014,978$
    174,592,523
    
    
    $
    182,699,850
 See accompanying notes to the consolidated financial statements.
 F-3




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 Years Ended December 31,2008
    
    
    2007
    
    
    2006Revenues under collaborative agreement
    
    $
    17,159,099
    
    
    $
    13,940,603
    
    
    $
    4,322,468Operating expenses:Cost of personalized medicine services
    
    
    267,361
    
    
    
    
    
    
    
    Research and development
    
    
    9,671,076
    
    
    
    7,710,684
    
    
    
    9,184,404Selling, general and administrative
    
    
    17,602,820
    
    
    
    10,027,358
    
    
    
    8,379,031In-process research and development
    
    
    12,590,000
    
    
    
    
    
    
    
    Total operating expenses
    
    
    40,131,257
    
    
    
    17,738,042
    
    
    
    17,563,435Loss from operations
    
    
    (22,972,158
    )
    
    
    (3,797,439
    )
    
    
    (13,240,967
    )Interest income
    
    
    4,746,547
    
    
    
    7,285,023
    
    
    
    4,923,290Net income (loss)
    
    $
    (18,225,611
    )
    
    $
    3,487,584
    
    
    $
    (8,317,677
    )Net income
(loss) per share  basic
    
    $
    (0.48
    )
    
    $
    0.10
    
    
    $
    (0.26
    )Shares used
in computing net income (loss) per share  basic
    
    
    37,733,737
    
    
    
    35,205,783
    
    
    
    32,094,785Net income
(loss) per share  diluted
    
    $
    (0.48
    )
    
    $
    0.10
    
    
    $
    (0.26
    )Shares used
in computing net income (loss) per share  diluted
    
    
    37,733,737
    
    
    
    36,616,091
    
    
    
    32,094,785
 See accompanying notes to the consolidated financial statements.
 F-4




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
 AccumulatedOtherCommon Stock
    
    Additional
    
    Comprehensive
    
    AccumulatedShares
    
    Par Value
    
    Paid-in Capital
    
    Income (Loss)
    
    Deficit
    
    TotalBalance at December 31, 2005
    
    
    31,920,632
    
    
    $
    31,921
    
    
    $
    235,202,784
    
    
    $
    (115,942
    )
    
    $
    (145,143,323
    )
    
    $
    89,975,440Issuance 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,317,677
    )
    
    
    (8,317,677
    )Unrealized gain on short-term
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    47,405
    
    
    
    
    
    
    
    47,405Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,270,272
    )Balance at December 31, 2006
    
    
    32,169,380
    
    
    
    32,169
    
    
    
    240,594,665
    
    
    
    (68,537
    )
    
    
    (153,461,000
    )
    
    
    87,097,297Issuance of stock in secondary offering,
net of offering costs
    
    
    4,700,000
    
    
    
    4,700
    
    
    
    69,871,454
    
    
    
    
    
    
    
    
    
    
    
    69,876,154Issuance of stock upon options exercised
    
    
    535,736
    
    
    
    536
    
    
    
    2,126,480
    
    
    
    
    
    
    
    
    
    
    
    2,127,016Issuance of stock upon warrants exercised
    
    
    3,729
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4Share-based compensation for options
issued to non-employees
    
    
    
    
    
    
    
    
    
    
    184,567
    
    
    
    
    
    
    
    
    
    
    
    184,567Share-based compensation for options
issued to employees
    
    
    
    
    
    
    
    
    
    
    4,935,160
    
    
    
    
    
    
    
    
    
    
    
    4,935,160Issuance of stock to match 401(k)
contributions
    
    
    14,739
    
    
    
    15
    
    
    
    178,811
    
    
    
    
    
    
    
    
    
    
    
    178,826Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,487,584
    
    
    
    3,487,584Unrealized gain on short-term
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    128,370
    
    
    
    
    
    
    
    128,370Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,615,954Balance at December 31, 2007
    
    
    37,423,584
    
    
    
    37,424
    
    
    
    317,891,137
    
    
    
    59,833
    
    
    
    (149,973,416
    )
    
    
    168,014,978Issuance of stock upon options exercised
    
    
    133,742
    
    
    
    134
    
    
    
    499,698
    
    
    
    
    
    
    
    
    
    
    
    499,832Issuance of stock upon warrants exercised
    
    
    300,000
    
    
    
    300
    
    
    
    1,472,400
    
    
    
    
    
    
    
    
    
    
    
    1,472,700Share-based compensation for options
issued to non-employees
    
    
    
    
    
    
    
    
    
    
    20,245
    
    
    
    
    
    
    
    
    
    
    
    20,245Share-based compensation for options
issued to employees
    
    
    
    
    
    
    
    
    
    
    7,356,623
    
    
    
    
    
    
    
    
    
    
    
    7,356,623Issuance of stock to match 401(k)
contributions
    
    
    49,668
    
    
    
    49
    
    
    
    355,071
    
    
    
    
    
    
    
    
    
    
    
    355,120Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (18,225,611
    )
    
    
    (18,225,611
    )Unrealized gain on short-term
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    421,321
    
    
    
    
    
    
    
    421,321Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (17,804,290
    )Balance at December 31, 2008
    
    
    37,906,994
    
    
    $
    37,907
    
    
    $
    327,595,174
    
    
    $
    481,154
    
    
    $
    (168,199,027
    )
    
    $
    159,915,208
 See accompanying notes to the consolidated financial statements.
 F-5




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Years Ended December 31,2008
    
    
    2007
    
    
    2006Operating ActivitiesNet income (loss)
    
    $
    (18,225,611
    )
    
    $
    3,487,584
    
    
    $
    (8,317,677
    )Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:Depreciation and amortization
    
    
    99,895
    
    
    
    37,990
    
    
    
    31,846In-process research and development
    
    
    12,590,000
    
    
    
    
    
    
    
    Accretion of debt discount on short-term investments
    
    
    (1,236,996
    )
    
    
    (4,134,496
    )
    
    
    (3,152,035
    )Share-based compensation for options issued to
non-employees
    
    
    20,245
    
    
    
    184,567
    
    
    
    143,756Share-based compensation for stock and options
issued to employees
    
    
    7,711,743
    
    
    
    5,113,986
    
    
    
    4,780,579Changes in operating assets and liabilities, net of
effects from purchase of Proprius:Prepaid expenses and other assets
    
    
    (697,518
    )
    
    
    (40,683
    )
    
    
    (37,669
    )Receivable from Forest Laboratories
    
    
    (23,130
    )
    
    
    207,622
    
    
    
    184,561Accounts payable and other accrued liabilities
    
    
    2,215,080
    
    
    
    709,048
    
    
    
    (568,960
    )Payable to Forest Laboratories
    
    
    1,118,000
    
    
    
    (530,000
    )
    
    
    (385,000
    )Deferred rent
    
    
    10,779
    
    
    
    (2,484
    )
    
    
    (9,754
    )Deferred revenue
    
    
    (3,351,416
    )
    
    
    (2,219,336
    )
    
    
    (3,125,000
    )Net cash provided by (used in) operating activities
    
    
    231,071
    
    
    
    2,813,798
    
    
    
    (10,455,353
    )Investing ActivitiesCash paid to acquire Proprius, net of cash acquired
    
    
    (39,084,627
    )
    
    
    
    
    
    
    Purchases of short-term investments
    
    
    (124,117,596
    )
    
    
    (162,574,366
    )
    
    
    (129,149,627
    )Proceeds from sale of short-term investments
    
    
    144,484,871
    
    
    
    125,210,000
    
    
    
    150,525,000Purchase of property and equipment
    
    
    (1,089,262
    )
    
    
    (51,592
    )
    
    
    (46,831
    )Net cash (used in) provided by investing activities
    
    
    (19,806,614
    )
    
    
    (37,415,958
    )
    
    
    21,328,542Financing ActivitiesProceeds from exercise of stock options and warrants
    
    
    1,972,532
    
    
    
    2,127,020
    
    
    
    467,794Proceeds from secondary offering of common stock, net
    
    
    
    
    
    
    69,876,154
    
    
    
    Net cash provided by financing activities
    
    
    1,972,532
    
    
    
    72,003,174
    
    
    
    467,794Increase (decrease) in cash and cash equivalents
    
    
    (17,603,011
    )
    
    
    37,401,014
    
    
    
    11,340,983Cash and cash equivalents at beginning of the year
    
    
    70,093,425
    
    
    
    32,692,411
    
    
    
    21,351,428Cash and cash equivalents at end of the year
    
    $
    52,490,414
    
    
    $
    70,093,425
    
    
    $
    32,692,411
 See accompanying notes to the consolidated financial statements.
 F-6




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##### Table of Contents



CYPRESS BIOSCIENCE, INC.
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
 The Company
  Principles of Consolidation
  Accounting Estimates in the Preparation of Financial Statements
  Cash and Cash Equivalents
  Short-Term Investments
 Accounting
for Certain Investments in Debt and Equity Securities
 Concentrations of Credit Risk
  Property and Equipment
  F-7




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##### Table of Contents



Goodwill
  Long-Lived Assets
  Fair Value of Financial Instruments
  Revenue Recognition
 Revenue Recognition in Financial Statements
  Cost of Personalized Medicine Services
  F-8




---



##### Table of Contents



Segment Reporting
  Comprehensive Income (Loss)
 Comprehensive
Income
 Research and Development
  Savella
 Share-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 Income (Loss) Per Share
  F-9




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##### Table of Contents



Income Taxes
  Accounting for
Uncertainty in Income Taxes  An Interpretation of FASB Statement No. 109
 Impact of Recently Issued Accounting Standards
 Accounting for Collaborative Arrangements
 Business Combinations
 Noncontrolling Interests in Consolidated Financial
Statements  an amendment of Accounting Research Bulletin No. 51
 F-10




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##### Table of Contents



Adoption of New Accounting Standards
 Fair Value Measurement
 The Fair Value Option
for Financial Assets and Financial Liabilities
 Accounting for
Nonrefundable Advance Payments for Goods and Services to Be Used in Future Research and Development
Activities
 2. SHORT-TERM INVESTMENTS
  December 31, 2008Amortized
    
    
    Unrealized
    
    
    UnrealizedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueU.S. government and agency debt
    
    $
    87,637,614
    
    
    $
    468,401
    
    
    $
    (11,312
    )
    
    $
    88,094,703Corporate debt securities
    
    
    600,000
    
    
    
    2,208
    
    
    
    
    
    
    
    602,208Commercial paper
    
    
    1,985,423
    
    
    
    8,763
    
    
    
    
    
    
    
    1,994,186Certificates of deposit
    
    
    2,300,000
    
    
    
    13,094
    
    
    
    
    
    
    
    2,313,094$
    92,523,037
    
    
    $
    492,466
    
    
    $
    (11,312
    )
    
    $
    93,004,191
 December 31, 2007Amortized
    
    
    Unrealized
    
    
    UnrealizedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueU.S. government and agency debt
    
    $
    98,037,775
    
    
    $
    112,030
    
    
    $
    (10,489
    )
    
    $
    98,139,316Commercial paper
    
    
    5,989,083
    
    
    
    
    
    
    
    (4,949
    )
    
    
    5,984,134Certificates of deposit
    
    
    7,600,000
    
    
    
    936
    
    
    
    (11,237
    )
    
    
    7,589,699$
    111,626,858
    
    
    $
    112,966
    
    
    $
    (26,675
    )
    
    $
    111,713,149
    Fair ValueDue within 1 year
    
    $
    77,409,343After 1 year but within 2 years
    
    
    15,594,848Total
    
    $
    93,004,191
 F-11




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##### Table of Contents



3. FAIR VALUE DISCLOSURES
   Fair Value Measurements at December 31, 2008Quoted Prices in
    
    
    Significant Other
    
    
    SignificantBalance as of
    
    
    Active Markets
    
    
    Observable Inputs
    
    
    UnobservableDescription
    
    December 31, 2008
    
    
    (Level 1)
    
    
    (Level 2)
    
    
    Inputs (Level 3)Financial instruments owned:Money market funds
    
    $
    52,468,475
    
    
    $
    52,468,475
    
    
    $
    
    
    
    $
    Certificates of deposit
    
    
    2,313,094
    
    
    
    2,313,094
    
    
    
    
    
    
    
    U.S. government and agency debt
    
    
    88,094,703
    
    
    
    
    
    
    
    88,094,703
    
    
    
    Corporate debt securities
    
    
    602,208
    
    
    
    
    
    
    
    602,208
    
    
    
    Commercial paper
    
    
    1,994,186
    
    
    
    
    
    
    
    1,994,186
    
    
    
    Total financial instruments owned
    
    $
    145,472,666
    
    
    $
    54,781,569
    
    
    $
    90,691,097
    
    
    $
    
 4. ACQUISITION OF PROPRIUS
 Savella
 F-12




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##### Table of Contents



Cash paid for Proprius business
    
    $
    37,633,247Estimated transaction costs
    
    
    1,451,380Total estimated purchase price
    
    $
    39,084,627
   Fair value of net tangible assets acquired
and liabilities assumed:Other assets
    
    $
    29,00029,000In-process research and development
    
    
    
    
    
    
    12,590,000Goodwill
    
    
    
    
    
    
    26,465,627Total purchase price
    
    
    
    
    
    $
    39,084,627
  F-13




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##### Table of Contents



Business Combinations
  Year EndedDecember 31,2008
    
    2007Revenue
    
    $
    17,159,099
    
    
    $
    13,940,603Net income (loss)
    
    $
    (6,190,173
    )
    
    $
    285,149Net income (loss) per share:Basic
    
    $
    (0.16
    )
    
    $
    0.01Diluted
    
    $
    (0.16
    )
    
    $
    0.01
  5. STOCKHOLDERS EQUITY
 Public Offering of Shares of Common Stock
  Warrants
  6. SHARE-BASED COMPENSATION
 Share-Based Compensation Plans
 2000 EQUITY INCENTIVE PLAN
  F-14




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##### Table of Contents



1996 EQUITY INCENTIVE PLAN
  Stock Options
  Years Ended December 31,2008
    
    2007
    
    2006Risk-free interest rate
    
    
    2.5
    %
    
    
    4.5
    %
    
    
    4.7
    %Expected volatility
    
    
    73
    %
    
    
    76
    %
    
    
    82
    %Expected option term (in years)
    
    
    6.0
    
    
    
    5.9
    
    
    
    5.7Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
   F-15




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##### Table of Contents



2000
    
    1996
    
    
    
    
    
    WeightedEquity
    
    Equity
    
    Number of
    
    AverageIncentive
    
    Incentive
    
    Options Under
    
    ExercisePlan Options
    
    Plan Options
    
    All Plans
    
    PricesBalance 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/Expired
    
    
    (68,813
    )
    
    
    (4,375
    )
    
    
    (73,188
    )
    
    
    11.84Balance December 31, 2006
    
    
    3,715,436
    
    
    
    71,887
    
    
    
    3,787,323
    
    
    
    7.19Granted
    
    
    1,187,249
    
    
    
    
    
    
    
    1,187,249
    
    
    
    8.78Exercised
    
    
    (550,136
    )
    
    
    (19,585
    )
    
    
    (569,721
    )
    
    
    4.23Canceled/Expired
    
    
    (73,363
    )
    
    
    (3,333
    )
    
    
    (76,696
    )
    
    
    13.69Balance December 31, 2007
    
    
    4,279,186
    
    
    
    48,969
    
    
    
    4,328,155
    
    
    
    7.91Granted
    
    
    2,924,174
    
    
    
    
    
    
    
    2,924,174
    
    
    
    8.00Exercised
    
    
    (109,251
    )
    
    
    (24,491
    )
    
    
    (133,742
    )
    
    
    3.74Canceled/Expired
    
    
    (144,064
    )
    
    
    (312
    )
    
    
    (144,376
    )
    
    
    11.24Balance December 31, 2008
    
    
    6,950,045
    
    
    
    24,166
    
    
    
    6,974,211
    
    
    $
    7.96
   Year Ended December 31,2008
    
    
    2007
    
    
    2006Cost of personalized medicine services
    
    $
    34,525
    
    
    $
    
    
    
    $
    Research and development expenses
    
    
    1,357,558
    
    
    
    817,430
    
    
    
    896,275Selling, general and administrative expenses
    
    
    5,964,540
    
    
    
    4,117,730
    
    
    
    3,741,803$
    7,356,623
    
    
    $
    4,935,160
    
    
    $
    4,638,078
    Years Ended December 31,2008
    
    2007
    
    2006Risk-free interest rate
    
    
    3.1
    %
    
    
    4.4
    %
    
    
    4.7
    %Expected volatility
    
    
    72
    %
    
    
    75
    %
    
    
    80
    %Expected option term (in years)
    
    
    5.8
    
    
    
    5.6
    
    
    
    5.4Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
 F-16




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##### Table of Contents



7. SIGNIFICANT LICENSING AND COLLABORATION AGREEMENTS
 License and Collaboration Agreement with Forest Laboratories
 Savella Savella Savella
 Savella Savella Savella Savella
 F-17




---



##### Table of Contents



Savella
 Licensing Agreement with Pierre Fabre
 Accounting for Research and Development Costs
   F-18




---



##### Table of Contents



Reformulation and New Product Agreement
  8. INCOME TAXES
   December 31,2008
    
    
    2007Unrecognized tax benefits as of the beginning of the year
    
    $
    913,000
    
    
    $
    913,000Increases related to prior year tax positions
    
    
    17,000
    
    
    
    Decreases related to expirations of prior year tax positions
    
    
    (5,000
    )
    
    
    Increases related to current year tax positions
    
    
    
    
    
    
    Settlements
    
    
    
    
    
    
    Other
    
    
    114,000
    
    
    
    Unrecognized tax benefits as of the end of the year
    
    $
    1,039,000
    
    
    $
    913,000
      F-19




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##### Table of Contents



2008
    
    
    2007Net operating loss carryforwards
    
    $
    25,423,000
    
    
    $
    23,208,000Deferred revenue
    
    
    4,097,000
    
    
    
    5,462,000Capitalized research and development
    
    
    9,022,000
    
    
    
    7,537,000Capitalized intangibles
    
    
    3,785,000
    
    
    
    3,544,000Tax credits
    
    
    1,290,000
    
    
    
    1,270,000Share-based compensation expense
    
    
    5,473,000
    
    
    
    3,029,000Other
    
    
    16,000
    
    
    
    37,00049,106,000
    
    
    
    44,087,000Valuation allowance
    
    
    (49,106,000
    )
    
    
    (44,087,000
    )$
    
    
    
    $
    
  2008
    
    
    2007
    
    
    2006Tax at federal statutory rate
    
    $
    (6,378,964
    )
    
    $
    1,220,654
    
    
    $
    (2,911,187
    )State income tax, net of federal benefits
    
    
    (1,047,243
    )
    
    
    200,397
    
    
    
    (477,934
    )In-process research and development
    
    
    5,129,921
    
    
    
    
    
    
    
    Share-based compensation
    
    
    729,670
    
    
    
    420,707
    
    
    
    377,130Other
    
    
    (44,282
    )
    
    
    156,252
    
    
    
    38,183Change in valuation allowance
    
    
    1,610,898
    
    
    
    (1,998,010
    )
    
    
    2,973,808$
    
    
    
    $
    
    
    
    $
    
   9. RELATED PARTY TRANSACTIONS
  10. RETIREMENT PLAN
  F-20




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##### Table of Contents



11. COMMITMENTS AND CONTINGENCIES
 Office Lease
   OperatingYears Ending December 31,
    
    Leases2009
    
    $
    271,3602010
    
    
    207,4282011
    
    
    214,2352012
    
    
    125,090Total minimum lease payments
    
    $
    818,113
  Licensing Agreements
 Savella
 12. QUARTERLY INFORMATION (UNAUDITED)
  2008First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    QuarterRevenues
    
    $
    14,215,700
    
    
    $
    1,014,794
    
    
    $
    979,310
    
    
    $
    949,295Total operating expenses
    
    $
    18,797,686
    
    
    $
    6,175,141
    
    
    $
    6,110,123
    
    
    $
    9,048,307Other income
    
    $
    1,701,005
    
    
    $
    1,169,137
    
    
    $
    1,018,590
    
    
    $
    857,815Net loss (1)
    
    $
    (2,880,981
    )
    
    $
    (3,991,210
    )
    
    $
    (4,112,223
    )
    
    $
    (7,241,197
    )Net loss per share  basic and diluted (2)
    
    $
    (0.08
    )
    
    $
    (0.11
    )
    
    $
    (0.11
    )
    
    $
    (0.19
    )Shares used in calculating per share amounts
 basic and diluted
    
    
    37,523,645
    
    
    
    33,641,610
    
    
    
    37,883,074
    
    
    
    37,883,334
 F-21




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##### Table of Contents



2007First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    QuarterRevenues
    
    $
    960,851
    
    
    $
    5,948,789
    
    
    $
    971,276
    
    
    $
    6,059,687Total operating expenses
    
    $
    3,464,854
    
    
    $
    5,160,868
    
    
    $
    3,879,746
    
    
    $
    5,232,574Other income
    
    $
    1,282,880
    
    
    $
    1,551,021
    
    
    $
    2,275,699
    
    
    $
    2,175,423Net income (loss) (3)
    
    $
    (1,221,123
    )
    
    $
    2,338,942
    
    
    $
    (632,771
    )
    
    $
    3,002,536Net income
(loss) per share  basic (2)
    
    $
    (0.04
    )
    
    $
    0.07
    
    
    $
    (0.02
    )
    
    $
    0.08Net income
(loss) per share  diluted (2)
    
    $
    (0.04
    )
    
    $
    0.07
    
    
    $
    (0.02
    )
    
    $
    0.08Shares used in calculating per share
amounts  basic
    
    
    32,262,555
    
    
    
    33,715,858
    
    
    
    37,360,788
    
    
    
    37,403,753Shares used in calculating per share
amounts  diluted
    
    
    32,262,555
    
    
    
    35,134,985
    
    
    
    37,360,788
    
    
    
    38,912,841
 
 (1)
    
    During the first quarter of 2008, the Company recognized a milestone payment of $10.0 million
upon NDA acceptance and $3.2 million also upon NDA acceptance as reimbursement for one-third
of the costs paid in connection with the second Phase III trial for Savella. Additionally,
the Company recognized a charge in the amount of $12.6 million during the first quarter of
2008 for in-process research and development in connection with the Proprius acquisition.(2)
    
    Net (loss) income per share is computed independently for each of the quarters presented.
Therefore, the sum of the quarterly net (loss) income per share may not necessarily equal the
total for the year.(3)
    
    During the second and fourth quarters of 2007, the Company recognized milestone payments of
$5.0 million as a consequence of the results of the second Phase III trial for Savellaand the
filing of an NDA for Savella, respectively. 13. SUBSEQUENT EVENTS
 FDA Approval of NDA for Savella
 Savella Savella
 Cellatope Transaction
  F-22