**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-K**
| **x**                                                 | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
|-------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
| ** **                                            | ** **                                                                                               |
| **For the  fiscal year ended December 31, 2006** |
| ** **                                            | ** **                                                                                               |
| **or**                                                |
| ** **                                            | ** **                                                                                               |
| **o**                                                 | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**For thetransition period from               to                **

**Commission File Number000-50791**

**SENOMYX,INC.**

(Exact name ofregistrant as specified in its charter)

| **Delaware**                                                     |   | **33-0843840**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation  or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **4767  Nexus Centre Drive  San Diego, California**              |   | **92121**                             |
| (Address of  principal executive offices)                        |   | (Zip Code)                            |

 

**(858)646-8300**Registrant’stelephone number, including area code

Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class       | ** ** | **Name of Exchange on Which Registered** |
|------------------------------------------|------------|-------------------------------------------------------------------|
| Common Stock,  par value $.001 per share |       | The NASDAQ Stock Market  LLC                                      |

 

Securities registered pursuant to Section 12(g) of the Act:**None**

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o      No x

Indicate by check if the registrant is not required tofile reports pursuant to Section 13 or Section 15(d) of the Act. Yes o      No x

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports) and (2) has been subject to such filing requirements for thepast 90 days. Yes x No o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. Large accelerated filer o          Acceleratedfiler x          Non-acceleratedfiler o

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

As of June 30, 2006, the aggregate market valueof the voting stock held by non–affiliates of the registrant, computed byreference to the last sale price of such stock as of such date on the NASDAQStock Market LLC, was approximately $328,386,000. Excludes an aggregate of7,113,375 shares of common stock held by officers and directors and by eachperson known by the registrant to own 5% or more of the outstanding commonstock as of June 30, 2006. Exclusion of shares held by any of thesepersons should not be construed to indicate that such person possesses thepower, direct or indirect, to direct or cause the direction of the managementor policies of the registrant, or that such person is controlled by or undercommon control with the registrant.

As of January 31, 2007, there were 30,168,283shares of the registrant’s Common Stock outstanding.

**DOCUMENTS INCORPORATEDBY REFERENCE**

Portions of theregistrant’s definitive Proxy Statement for the 2007 Annual Meeting ofStockholders to be filed with the Securities and Exchange Commission pursuantto Regulation 14A not later than 120 days after the end of the fiscal yearcovered by this Form 10-K, are incorporated by reference in Part III,Items 10-14 of this Form 10-K.

 

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**SENOMYX, INC.**

**AnnualReport on Form 10-KFor the Fiscal Year Ended December 31, 2006**

**TABLEOF CONTENTS**
| PART I   |   |                                                                                                                |   |   |
|---------------|--------|---------------------------------------------------------------------------------------------------------------------|--------|--------|
| Item  1.      |   | Business                                                                                                            |   |   |
| Item  1A.     |   | Risk Factors                                                                                                        |   |   |
| Item 1B.      |   | Unresolved  Staff Comments                                                                                          |   |   |
| Item  2.      |   | Properties                                                                                                          |   |   |
| Item 3.       |   | Legal Proceedings                                                                                                   |   |   |
| Item 4.       |   | Submission  of Matters to a Vote of Security Holders                                                                |   |   |
| PART II  |   |                                                                                                                |   |   |
| Item 5.       |   | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |   |   |
| Item 6.       |   | Selected Financial  Data                                                                                            |   |   |
| Item 7.       |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |   |   |
| Item 7A. |   | Quantitative  and Qualitative Disclosures 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                                                                                            |   |   |
| Item 9B.      |   | Other Information                                                                                                   |   |   |
| PART III |   |                                                                                                                |   |   |
| Item 10.      |   | Directors,  Executive Officers and Corporate Governance                                                             |   |   |
| Item 11.      |   | Executive  Compensation                                                                                             |   |   |
| Item 12.      |   | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    |   |   |
| Item 13.      |   | Certain  Relationships and Related Transactions, and Director Independence                                          |   |   |
| Item 14. |   | Principle  Accountant Fees and Services                                                                             |   |   |
| PART IV  |   |                                                                                                                |   |   |
| Item 15.      |   | Exhibits and  Financial Statement Schedules                                                                         |   |   |
|          |   |                                                                                                                |   |   |
| Signatures    |   |                                                                                                                |   |   |

 

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**SPECIAL NOTE REGARDINGFORWARD-LOOKING STATEMENTS**

*Thisannual report on Form 10-K contains forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended. Allstatements included or incorporated by reference in this annual report onForm 10-K other than statements of historical fact, are forward-lookingstatements. You can identify these and other forward-looking statements by theuse of words such as “may,” “will,” “could,” “anticipate,” “expect,” “intend,” “believe,”“continue” or the negative of such terms, or other comparable terminology.Forward-looking statements also include the assumptions underlying or relatingto such statements.*

*Ouractual results could differ materially from those anticipated in theseforward-looking statements as a result of various factors, including those setforth below under the caption “Risk Factors” in Part I Item 1A and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inPart II Item 7 of  this annual report onForm 10-K and elsewhere in this annual report on Form 10-K.  Readers are cautioned not to place unduereliance on forward-looking statements. The forward-looking statements speak only as of the date on which theyare made and we undertake no obligation to update such statements to reflectevents that occur or circumstances that exist after the date on which they aremade except as required by law.*

**PART I**

**Item 1.    *Business***

**Overview**

We are a leadingcompany focused on using proprietary taste receptor-based assays and screeningtechnologies to discover and develop novel flavors, flavor enhancers and tastemodulators, which we refer to as flavor ingredients, for the packaged food andbeverage industry. We believe our flavor ingredients will enable packaged foodand beverage companies to improve the nutritional profile of their productswhile maintaining or enhancing taste and generating cost of goods savings.**We license our flavor ingredients to our collaborators onan exclusive or co-exclusive basis, which we believe will provide thesecompanies with a competitive advantage. We have entered into product discoveryand development collaborations with six of the world’s leading packaged foodand beverage companies: Ajinomoto Co., Inc., Cadbury Schweppes, Campbell SoupCompany, The Coca-Cola Company, Kraft Foods Global, Inc. and Nestlé SA. Wecurrently anticipate that we will derive all of our revenues from existing andfuture collaborations. Depending upon the collaboration, our collaborationagreements provide for upfront fees, research and development funding,reimbursement of certain regulatory costs, milestone payments based upon ourachievement of research or development goals and, in the event ofcommercialization, royalties on sales of consumer products incorporating ourflavor ingredients. Senomyx’s current programs focus on the development ofsavory, sweet and salt flavor enhancers, high potency sweeteners and bittertaste modulators.

Flavor ingredientsare substances that impart or modulate tastes or aromas in foods and beverages.Individuals experience the sensation of taste when flavor ingredients in foodand beverage products interact with taste receptors in the mouth. A tastereceptor functions either by physically binding to a flavor ingredient in aprocess analogous to the way a key fits into a lock or by acting as a channelto allow ions to flow directly into a taste cell. As a result of theseinteractions, signals are sent to the brain where a specific taste sensation isregistered. There are currently five recognized primary senses of taste: umami,which is the savory taste of glutamate, sweet, salt, bitter and sour.

We are currentlypursuing the discovery and development of flavor ingredients through fiveprograms focused on savory, sweet, salt and bitter taste areas.  The goals of our savory program are toenhance the taste of naturally occurring glutamate and enable the reduction orelimination of added monosodium glutamate, or MSG. The goals of our sweetenhancer program are to enhance the taste of natural and artificial sweetenersand enable a significant reduction in added sweeteners. The goals of our saltprogram are to enhance the taste of salt and enable a significant reduction inadded salt. The goals of our bitter taste modulation program are to reduce orblock bitter taste and to improve the overall taste characteristics of 

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packagedfoods, beverages, over the counter, or OTC, health care products and pharmaceuticalproducts. The goals of our high potency sweetener program are to allow for thereduction of calories in packaged foods and beverages and to enable ourcollaborators to use product labeling referencing “natural flavors.”

Our internetaddress is www.senomyx.com. We post links on our website to the followingfilings as soon as reasonably practicable after they are electronically filedwith or furnished to the Securities and Exchange Commission, or SEC: annualreports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form8-K and any amendment to those reports filed or furnished pursuant to Section13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. All suchfilings are available through our website free of charge. Our filings may alsobe read and copied at the SEC’s Public Reference Room at 100 F Street, NEWashington, DC 20549. Information on the operation of the Public Reference Roommay be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains anInternet website that contains reports, proxy and information statements, andother information regarding issuers that file electronically with the SEC. Theaddress of that site is www.sec.gov.

**Industry Background**

***PackagedFood and Beverage Industry***

Packaged food andbeverage products include carbonated and non-carbonated beverages, frozenfoods, snack foods, ice cream, pasta, canned soup, pet food and numerous otherproducts. According to recent data from Euromonitor International, anindependent research organization, worldwide sales of packaged food andbeverage products in 2005, excluding pet food, were approximately $1.4trillion, of which $277 billion was generated in the United States. Thesefigures represent growth rates of approximately 6% and 3%, respectively, over2004 amounts.  Based on these estimates,of the worldwide total, sales of packaged foods were approximately $1.1trillion and sales of non-alcoholic beverages were approximately $319 billion.  Additionally, according to recent data fromEuromonitor, the worldwide sales of pet food products in 2005 wereapproximately $29.7 billion.  Based onrecent data from Euromonitor, Information Resources, Inc. and reports fromour collaborators, we estimate that our collaborators’ combined worldwide salesin 2005 of their products that fall within their exclusive or co-exclusiveproduct fields were over $59 billion. Our collaboration agreements provide thatwe will receive royalties of up to 4% on our collaborators’ sales of productscontaining our flavor ingredients. However, we do not anticipate that ourcollaborators will incorporate our flavor ingredients into all of theirproducts within their exclusive product fields.

Each of our flavoringredients addresses large, potentially overlapping markets. The followingtable sets forth the four primary taste areas on which we are focused and, foreach taste area, provides examples of product categories that could incorporateingredients in those taste areas, estimated worldwide sales and our estimatesof the worldwide sales for food and beverage products of our existingcollaborators in their exclusive or co-exclusive product fields.
| Taste Areas | ** ** | **Example Product Categories**                                                                                                                                                | ** ** | **2005 Estimated  Worldwide Sales(1)** | ** **  | **2005 Estimated  Revenues Of  Existing  Collaborators  In Exclusive  Product Fields(2)** | ** ** |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|-------------|---------------------------------------------------------------------------------------------------------------|------------|
|             |       |                                                                                                                                                                                    |       |                                             |        |                                                                                                          |       |
| Savory           |       | Ready  meals, sauces, spreads, frozen foods, beverages, meal replacements, soups,  pastas, dried foods, snack foods, processed meats, processed cheeses and  cracker products           |       | $                                                | 409 billion |                                                                                                          | $          | 18.4 billion |   |
|             |       |                                                                                                                                                                                    |       |                                             |        |                                                                                                          |       |
| Sweet            |       | Confectionaries,  cereal, ice cream, beverages, yogurt, dessert, spreads and bakery products                                                                                            |       | $                                                | 512 billion |                                                                                                          | $          | 21.8 billion |   |
|             |       |                                                                                                                                                                                    |       |                                             |        |                                                                                                          |       |
| Salt             |       | Product  categories are the same as those set forth for savory taste area plus canned  foods and bakery products                                                                        |       | $                                                | 419 billion |                                                                                                          | $          | 12.6 billion |   |
|             |       |                                                                                                                                                                                    |       |                                             |        |                                                                                                          |       |
| Bitter           |       | Products which contain  bitter tastants, including confectionary, beverages, ice cream, ready meals,  canned foods and soups, and products which utilize certain artificial  sweeteners |       | $                                                | 492 billion |                                                                                                          | $          | 6.7 billion |   |

 

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(1)          According to recent Euromonitor data for packaged food and beverages,excluding pharmaceutical and OTC health care applications.

(2)          Based on recent data from Euromonitor, Information Resources, Inc.and reports from our collaborators.

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***Flavorand High Potency Sweetener Industries***

Flavor ingredientsare used in a variety of packaged food and beverage products throughout theworld. Flavor ingredients can originate from either naturally occurring or chemicallysynthesized compounds.

While somepackaged food and beverage companies have their own internal research anddevelopment programs, most have traditionally relied on purchases of flavoringredients from third parties. Historically, flavor ingredients have been soldon a commodity basis by independent manufacturers who make their productsbroadly available to packaged food and beverage companies on a non-exclusivebasis. This has limited the ability of packaged food and beverage companies touse flavor ingredients to differentiate their brands from competitors.

Traditionally,flavor and high potency sweetener companies have discovered new flavoringredients primarily using inefficient, non-automated and labor-intensivetrial and error processes involving a limited number of trained taste testers.Using this approach, taste testers must physically taste each potential flavoringredient to assess the taste characteristics of the compound. Taste testerscan assess only a limited number of potential flavor ingredients at one timedue to the sensory fatigue that results from repeated tasting. As a result,only a small fraction of the available universe of ingredients can be testedeconomically.

In the UnitedStates, most flavor ingredients are regulated as Generally Recognized as Safe,or GRAS, substances under the provisions of the Federal Food, Drug and CosmeticAct, or FD&C Act. GRAS determinations for most new flavor ingredients aremade by an independent panel of scientists administered by the Flavor and ExtractManufacturers Association, or FEMA.  Fouringredients developed as part of our savory program have received FEMA GRASdetermination.  The process from selection for development until receiptof that determination took approximately 12 months.  Costs associated withthe FEMA GRAS process, including synthesis of material for regulatory studies,contract safety studies and preparation of the application, were less than $1million.  Once a flavor ingredient is determinedto be FEMA GRAS, it may be immediately incorporated into products for testmarketing and commercialization in the United States and in several othercountries. We expect that many of the flavor ingredients we develop in thefuture will require a similar amount of time and cost.  However, the length of time may varydepending on the properties of the flavor ingredient.  In the United States, most high potencysweeteners are currently regulated as food additives which require Food andDrug Administration, or FDA, approval prior to use in foods.

***FlavorIngredients as a Source of Competitive Advantage***

The packaged food and beverage industry is comprisedof a number of large and highly competitive market segments. Small market sharegains in specific large market segments can translate into significantadditional revenue for packaged food and beverage companies. For example,according to recent Euromonitor data, estimated 2005 worldwide sales of softdrinks were approximately $270 billion. Thus, an increase of a tenth of apercentage point in overall worldwide market share would result in additionalrevenue of approximately $270 million.

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As a result of these market opportunities, packagedfood and beverage companies are constantly seeking ways to differentiate theirproducts, demand for which can be greatly affected by very small actual orperceived improvements in flavor or health profiles. Flavor ingredients canpotentially provide an important way to differentiate a particular productthrough enhanced taste, improvements in nutritional profile or labeling, flavoringredient exclusivity and cost of goods savings.

·                     *Taste.*  Product tasteis a critical competitive factor for packaged food and beverage companies.These companies seek to use flavor ingredients to improve or maintain tastewhile improving the nutritional profile of packaged food and beverage productsor reducing ingredient costs.

·                  *Health Benefits.*  Packaged food and beverage companies areexploring ways to improve overall nutritional quality of their products. It iswidely accepted that poor diet contributes to adverse health conditions such ascardiovascular disease, diabetes and obesity. To address these concerns, manycompanies have introduced reduced calorie, reduced sodium and reduced fatcontent products to the market. Flavor ingredients with specific desiredcharacteristics provide an innovative way to reduce the levels of ingredientsthat may contribute to these concerns without compromising desirable tasteattributes.

·                  *Flavor Ingredient Exclusivity.*  Failure of packaged food and beveragecompanies to differentiate their brands from their competition, includingprivate label products, may result in significant loss of market share, pricepressure and erosion of profit margins. Packaged food and beverage companiesspend millions of dollars creating brands and brand images to compete withother products. Many of these competitive products contain the same or similarflavor ingredients. The limited availability of proprietary flavor ingredientsmakes it difficult for manufacturers to differentiate their products based onflavor ingredients.

·                  *Cost of Goods Savings.*  The packaged food and beverage industrypurchases enormous quantities of raw materials to produce their products.  According to the Food and AgricultureDivision of the United Nations, estimated worldwide sugar production in 2005was approximately 142.5 million metric tons, and consumption was over 145.1million metric tons.  The market value ofprocessed sugar produced worldwide is therefore in excess of $83 billion, basedon United States spot prices in January 2007. Similarly, according to JapanScan, a Datamonitor Service, worldwidedemand for MSG was nearly 1.6 million metric tons in 2005 at a cost of $2.3billion. Flavor ingredients can potentially facilitate a reduction in thequantity of these ingredients used in packaged food and beverage products,which could result in significant decreases in costs and associated increasesin profit margins.

**Our Solution**

We use ourproprietary taste receptor-based assays and screening technologies to discoverand develop novel flavor ingredients. We have developed proprietary tastereceptor-based assays that incorporate human taste receptors. We use theseassays in our high-throughput screening systems to rapidly and efficiently screenour compound libraries and identify large numbers of novel potential flavoringredients. We believe our approach improves the likelihood that ingredientswith the desired characteristics can be discovered and then optimized intonovel flavor ingredients.

We believe ourapproach will result in the discovery and development of flavor ingredientsthat will provide the following valuable solutions to the following keychallenges faced by the packaged food and beverage industry:

·                  *Maintaining and Improving Taste.*  We are developing flavor ingredients toenable our current and future collaborators to improve or maintain taste whileimproving the nutritional profile of packaged food and beverage products orreducing ingredient costs.

·                  *Reducing Sugar, Salt and MSG in Packaged Food andBeverage Products. *We aredeveloping flavor ingredients to enable our current and future collaborators tosignificantly reduce the levels 

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of sugar, salt and MSG inpackaged food and beverage products while maintaining or improving taste. Webelieve reducing the levels of such ingredients will improve the nutritionalprofile of packaged food and beverage products.

·                  *Blocking Undesirable Tastes.*  We are discovering flavor ingredients that webelieve will be useful in blocking bitter and other unwanted tastes associatedwith certain packaged food, beverage, OTC health care products andpharmaceutical products.

·                  *Obtaining Exclusive or Co-Exclusive Use ofProprietary Flavor Ingredients. *Weare able to offer our current and future collaborators exclusive orco-exclusive use of our proprietary flavor ingredients in defined packaged foodand beverage product categories. We believe this approach will assist ourcollaborators in differentiating their products from those of their competitors.

·                  *Reducing Cost of Goods. *We believe our proprietary flavoringredients will enable our current and future collaborators to reduce overallraw material ingredient costs, particularly for those products containing highlevels of natural and artificial sweeteners and MSG.

**Our Strategy**

Our goal is tobecome the leader in discovering, developing and commercializing new andimproved flavor ingredients. Key elements of our strategy include:

·                  *Collaborating With Leading Packaged Food and BeverageCompanies.  *We arecollaborating with leading packaged food and beverage companies to develop andcommercialize our product candidates. Our collaborators are responsible formarketing, selling and distributing their products incorporating our flavoringredients that are incorporated into their products. In addition, ourcollaborators are responsible for all manufacturing costs of our flavoringredients.  As a result, we expect tocommercialize our flavor ingredients without incurring significant sales,marketing, manufacturing and distribution costs. We currently havecollaborations with Ajinomoto, Cadbury Schweppes, Campbell, Coca-Cola, KraftFoods and Nestlé.

·                  *Developing Flavor Ingredients that are Eligible forFEMA GRAS Determination. *Ourprimary focus is on the development of flavor ingredients that will qualify fora FEMA GRAS determination.  Fouringredients developed as part of our savory program have received FEMA GRASdetermination.  The process from selection for development until receiptof that determination took approximately 12 months.  Costs associated withthe FEMA GRAS process, including synthesis of material for regulatory studies,contract safety studies and preparation of the application, were less than $1million.  We expect that future flavoringredients we develop will take a similar amount of time and cost a similaramount.  However, the length of time mayvary depending on the properties of the flavor ingredient.  Upon the GRAS determination, ourcollaborators can begin to test market and commercialize products incorporatingour flavor ingredients. In the event that a particular flavor ingredient is noteligible for FEMA GRAS determination, we may dedicate our development effortsto alternative ingredients.

·                  *Pursuing Additional Collaborations and MarketOpportunities. *We seek toestablish additional collaborations with leading packaged food and beveragecompanies to use flavor ingredients developed through our existing programs forexclusive or co-exclusive use within new packaged food and beverage productfields. We intend to receive from future collaborators up-front fees, researchand development funding, milestone payments and royalties on future sales ofproducts incorporating these flavor ingredients. In addition, we plan to targetfields in which our collaborators can incorporate more than one of our flavoringredients into a particular product.

·                  *Expanding Our Product Candidate Pipeline. *We will continue to focus on thediscovery and development of additional flavor ingredients based on additionaltaste receptors to address new taste areas. We believe potential new tastereceptors include the fat taste and cold taste receptors.  We also intend to improve the beneficialcharacteristics of our current product candidates through 

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the development ofnext-generation flavor ingredients. We will also continue to considerapplications of our current products and technologies outside of the packagedfood and beverage industry.

·                  *Maintaining and Expanding Our TechnologyPosition. *We believe our proprietarytaste receptor-based technologies, including our receptor discovery, assaydevelopment and high-throughput screening technologies and natural andsynthetic compound libraries provide us and our collaborators with significantcompetitive advantages. We intend to continue to develop and acquireproprietary technologies and related intellectual property rights to expand andenhance our ability to discover and develop new proprietary flavor ingredients.

**Our Discovery and Development Process**

The followingdiagram summarizes our discovery and development process.

The key elementsof our Discovery and Development process are:

·                  *Proprietary Taste Receptor-Based AssayDevelopment. *The first stepin our discovery and development process is to develop proprietary assays basedon human taste receptors. Our assays are tests that measure interactionsbetween the taste receptors and potential flavor ingredients. To date we havedeveloped assays to test for compounds that affect savory, sweet, salt andbitter taste.

·                  *High-Throughput Screening and Identification of LeadCompounds. *The next step inour discovery and development process is to use our proprietary tastereceptor-based assays to identify compounds that bind to human taste receptors,known as hits. We use automated high-throughput screening to rapidly evaluateour libraries of diverse synthetic and natural compounds.  A panel of taste testers then evaluates thetaste effect of the most potent hits. Based on this evaluation, we designatehits that exhibit a positive taste effect as proof-of-concept compounds. Wethen select the most promising of those proof-of-concept compounds, which wecall lead compounds, for optimization.

·                  *Optimization of Lead Compounds and Selection ofProduct Candidates. *The next stepin our discovery and development process is to chemically enhance, or optimize,our lead compounds to allow lower amounts of the compound to be used in thefinished product or improve the enhancement effect to meet the taste attributegoals of our collaborators. Optimization may also be required to enhance thesafety profile or to improve the physical properties of a compound so that itis stable under manufacturing, storage and food preparation conditions. Werefer to optimized compounds that provide desirable taste attributes inpackaged food and beverage product prototypes as product candidates.

·                  *Safety Studies and Regulatory Approval of ProductCandidates. *The next step inour discovery and development process is to select, in conjunction with ourcollaborators, one or more product candidates for commercialization. We thenevaluate the selected product candidate for safety. Following this evaluation,we submit the safety data along with the physical and chemical properties ofthe product candidate and a description of manufacturing and conditions ofintended use to the FEMA GRAS expert panel for review.  Four ingredients developed as part of oursavory program have received FEMA GRAS determination.  The process fromselection for development until receipt of that determination tookapproximately 12 months.  Costs associated with the FEMA GRAS process,including synthesis of material for regulatory studies, contract safety studiesand preparation of the application, were less than $1 million.  We expect that most of the flavor ingredientswe develop in the future will require a similar amount of time and cost.  

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However, the length oftime may vary depending on the properties of the flavor ingredient.  In the United States, most high potencysweeteners are currently regulated as food additives which require FDA approvalprior to use in foods.  However, noUnited States regulation precludes high potency sweeteners from beingdetermined to be GRAS.  The safety datarequirements for food additives and GRAS substances are the same and dependupon the anticipated human exposure to the substance or consumption, and thelevel of concern for potential toxicity based on the structure of thesubstance.  If a food additive petitionis required, there is a range of potential studies which may have an estimatedcost of up to $7 million and may take up to four years to complete.  Furthermore, additional studies adding costand time to approval may be required depending on the results of the initialsafety studies.  Outside the UnitedStates, the food additive approval process is generally similar to the FDA foodadditive petition process.

Followingregulatory approval, foods and beverages containing our proprietary flavoringredients can be immediately commercialized in the United States and severalother countries.  We intend to use thedata from the United States regulatory review to facilitate approval of ourflavor ingredients for use in products sold in additional countries.  We anticipate, however, that our collaboratorswill test market their products containing our flavor ingredients through aseries of consumer acceptance tests prior to initiating any wide-scalecommercialization.

**Our Discovery and Development Programs**

We are currentlypursuing the discovery and development of flavor ingredients through fiveprograms focused on savory, sweet, salt and bitter taste areas. 

***SavoryEnhancer Program***

The goals of oursavory program are to enhance the taste of naturally occurring glutamate andenable the reduction or elimination of added MSG and a related food additive,inosine monophosphate, or IMP. Using SavoryScreenHT, our high-throughput savoryreceptor-based assay system, we identified two product candidates, S336 andS807, that enhance the savory taste of glutamate.  S336 is approximately three times more potentthan S807 in taste tests and exhibits greater water solubility compared toS807, which is more fat soluble. Other characteristics, such as heat stabilityand ease of manufacturing by a simple synthesis process, are similar for thetwo ingredients. Our collaborator evaluated S336 and S807 for savory tasteenhancement in product prototypes, and formally selected both S336 and S807 fordevelopment in May 2004.

We completed thesafety assessment studies for S336 and S807 and submitted applications for GRASdetermination to the FEMA Expert Panel in December 2004.  In March 2005, S336 and S807 weredetermined to be GRAS.  In addition, twoother flavor enhancers, S263 and S976, which are related to S336, were alsodetermined by FEMA to be GRAS.  A moredetailed description of the FEMA GRAS process is provided in Item I, *Business — Regulatory Process*.  After we achieved FEMA GRAS status for thefour savory ingredients, our collaborator initiated product development effortsto identify initial applications, optimal concentrations and the development ofnew recipes.   That collaborator iscurrently preparing for initial commercialization of products containing a Senomyxsavory flavor enhancer.  A number ofdifferent products have been targeted for market launch in selected countriesover the course of 2007.  We expect theseproducts will be introduced into the marketplace on a rolling basis as the yearprogresses.

Asecond collaborator for the Savory Enhancer Program is conducting initial tastetests and product development work in preparation for potential future launchesof products containing Senomyx’s savory ingredients.

Concurrently, weare working to obtain global regulatory approvals in support of new businessdevelopment activities and commercialization strategies for subsequent productlaunches of our savory flavor enhancers in additional countries.

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***SweetEnhancer Program***

The goals of oursweet enhancer program are to enhance the taste of natural and artificialsweeteners and enable a significant reduction in added sweeteners. UsingSweetScreenHT, our high-throughput sweet receptor-based assay system, we haveidentified a number of proof-of-concept compounds that allow 30% to 40%reductions of added sugar in product prototypes.  During 2006, optimization was conducted toimprove the compounds’ potency and physical properties.  Compounds that demonstrated enhanced potencyin the receptor assay compared to previous lead compounds were subsequently evaluatedin taste tests.

We have identifiedcompounds that we believe may meet one collaborator’s requirements for productcandidates.  An initial safety study wascompleted successfully, allowing us and our collaborator to proceed withadditional product development work and sensory tests of compound-containingproduct prototypes.  Upon successfulcompletion of these activities, the collaborator plans to conduct consumerguidance taste tests.  The results ofthese tests will be used by the collaborator as the basis for the potentialselection of product candidates for further development.

Additional effortsare in progress to identify sweet enhancers for our other collaborators. Thiswork includes optimizing previously discovered enhancers, screening new naturaland synthetic libraries and the use of molecular modeling to design andoptimize additional sweet taste enhancers.

It is our goal toidentify a sweet product candidate and initiate development and safety studiesto achieve the first commercial sale of a product containing an ingredient fromthe Sweet Enhancer Program in 2008.

***Salt Enhancer Program***

The goal of oursalt enhancer program is to identify compounds that enhance the taste of saltand provide a significant reduction in sodium levels in a variety of foodswhile maintaining or improving the desired salt taste.  During 2006, we began work on theidentification of enhancers of the Delta form of the sodium ion channel,ENaC.  It is believed that Delta ENaC mayplay an important role in mediating salt taste in humans.  Compounds that enhance the in vitro activityof Delta ENaC have been identified, although these did not provide a tasteeffect.  We are continuing to identifyadditional enhancers of Delta ENaC to obtain compounds that provide a taste effect.  A complementary effort has been initiated tocharacterize alternative ion channels and receptors that may play a role insalt taste perception.  From thisscientific work, our scientists are generating potential targets forenhancement.

***BitterTaste Modulator Program***

The goal of our bittertaste modulator program is to identify compounds that modulate or eliminate thebitter taste associated with certain packaged food and beverage products, OTChealth care products and pharmaceutical products.  This involves the identification of tastereceptors that respond to bitter ingredients known to be present in a varietyof food and beverages, followed by the use of these receptors to discoverbitter taste blockers.  In 2006, wecontinued to make progress identifying taste receptors that respond to bitteringredients known to be present in a variety of food and beverages, followed bythe use of these receptors to discover bitter taste blockers.  Screening for blockers of certain bittertaste receptors has been initiated.  Fromthe screening efforts, we have identified specific antagonists that blockedtargeted bitter receptors in our in vitro assay.  The antagonist compounds are undergoing tastetests and optimization to increase potency in order to provide a taste effectby reducing bitterness.

***HighPotency Sweetener Program***

In the fourthquarter of 2006, we initiated a new scientific program for the discovery anddevelopment of high potency sweeteners. High potency sweeteners are flavor ingredients that are many timessweeter than sucrose and are essentially calorie free.  High potency sweeteners can originate fromeither naturally 

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occurringor chemically synthesized compounds.  High potency sweeteners have traditionally been discovered accidentallyor through modification of known sweet compounds.  The goal of our high potency sweetenerprogram is to identify novel no-calorie or low-calorie natural high potencysweeteners that provide improved taste and physical properties compared tocurrent sweeteners. The high potency sweetener program is progressing inparallel with our active efforts toward the discovery and development of sweettaste enhancers.  Our scientists haveused our proprietary screening assays to identify several natural ingredientsthat could potentially be developed as novel high potency sweeteners.

**Product Discovery and Development Collaborations**

We pursuecollaborations with leaders in the packaged food and beverage market. Undereach of our current product discovery and development collaboration agreements,we have agreed to conduct research and develop flavor ingredients in one ormore specified taste areas, such as savory, sweet, salt or bitter. Each ofthese collaborations is focused on one or more specific product fields, such asnon-alcoholic beverages, wet soups or frozen foods. To date, we have enteredinto product discovery and development collaborations with Ajinomoto, CadburySchweppes, Campbell, Coca-Cola, Kraft Foods and Nestlé.

All of our currentcollaboration agreements provide for research and development funding,milestone payments upon achievement of pre-defined research or developmenttargets, cost reimbursement and royalty payments based upon future productsales in the event the collaborator commercializes a product incorporating ourflavor ingredients. Certain of our current collaboration agreements alsoprovide for upfront fees.  The researchand development funding under each of these agreements is paid according to afixed payment schedule. Each of these collaborations provides us with a portionof the funding we require to pursue the discovery and development of flavoringredients for the applicable program. Under each of these agreements, we areprimarily responsible for the discovery and development phases and any associatedexpenses, while our collaborator is primarily responsible for selecting theconsumer products that may incorporate our flavor ingredients. Our collaboratoris also responsible for manufacturing, marketing, selling and distributing anyof these consumer products, and any associated expenses. Under most of ouragreements, we are primarily responsible for the regulatory approval phase anda portion of the associated expenses.  Webelieve our collaborations will allow us to benefit from our collaborators’well-established brand recognition, global market presence, established salesand distribution channels and other industry-specific expertise. Each of ourcollaborations is governed by a joint steering committee, consisting of anequal number of representatives of the collaborator and us. The steeringcommittees provide strategic direction and establish performance criteria forthe research, development and commercialization of our flavor ingredients. Alldecisions of the steering committees must be unanimous.

Each of ourcollaboration agreements provides that we will conduct research and developmenton flavor ingredients for use within clearly defined packaged food and beverageproduct fields on an exclusive or co-exclusive basis for the collaborator duringthe collaborative period specified in each of the agreements. Our currentproduct discovery and development collaborators are not prohibited fromentering into research and development collaboration agreements with thirdparties in any product field. Under the terms of each agreement, we will retainrights to flavor ingredients that we discover during the collaboration for usewith the collaborator, or for our use or with other collaborators outside ofthe defined product field. We will also retain rights to any flavor ingredientsthat we discover after the respective collaborative period. In addition, in thecase of certain of our agreements, if the collaborator terminates the agreementor fails after a reasonable time following regulatory approval or GRASdetermination to incorporate one or more of our flavor ingredients into aproduct, it will no longer be entitled to use, and we will have the right tolicense, the flavor ingredients to other packaged food and beverage companiesfor use in any product field.

Each of ouragreements terminates when we are no longer entitled to royalty payments underthe agreement. In addition, each agreement may be terminated earlier by mutualagreement or by either party in the event of a breach by the other party of itsobligations under the agreement.  Ourinitial agreement with Ajinomoto allows Ajinomoto to terminate the agreementwithout cause provided that it pay additional specified research funding if itterminates the agreement prior to March 23, 2009.  Our most recent agreement with Ajinomotogives Ajinomoto the right to terminate the agreement without cause provided 

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thatit pay additional specified research funding if it terminates the agreementprior to October 5, 2009.  CadburySchweppes may terminate its agreement without cause upon 90 days writtennotice.  Campbell may only terminate itsagreement without cause upon 60 days written notice, provided that it pay aspecified termination fee if it terminates the agreement prior to the end ofthe collaborative period. Our agreement with Coca-Cola permits Coca-Cola toterminate the agreement upon specified major corporate events.  The collaborative period may be terminated byCoca-Cola upon 60 days written notice upon payment of a specified earlyconclusion fee. In the event of early conclusion, Coca-Cola will no longer beentitled to use, and we will have the right to license, any flavors or flavorenhancers discovered prior to such early conclusion to third parties for use inany product field, provided that Coca-Cola would retain non-exclusive rights inthe field of non-alcoholic beverages with the exception of dry powderedbeverages.  Our agreement with KraftFoods may be terminated by our collaborator upon 60 days written notice,provided that it pay a specified termination fee if it terminates the agreementprior to the end of the research collaborative period. Our initial agreementwith Nestlé gives Nestlé the right to terminate the agreement without cause,provided that it pay additional specified research funding if it terminates theagreement prior to April 18, 2008.  Ourmost recent agreement with Nestlé gives Nestlé the right to terminate theagreement without cause on or after April 26, 2007 upon 90 days writtennotice, provided that it pay a specified termination fee if it terminates theagreement after April 26, 2007 but prior to the end of the collaborative period.

***Ajinomoto***

In March 2006, we enteredinto a collaborative research, development, commercialization and licenseagreement with Ajinomoto for the discovery and commercialization of novelflavor ingredients on an exclusive basis in the soup, sauce and culinary aids,and noodle product categories, and on a co-exclusive basis in the bouillonproduct category within Japan and other Asian markets.  Under the terms of the collaboration,Ajinomoto has agreed to pay us an upfront license fee and discovery and developmentfunding for up to three years.  In addition, we are eligible to receivemilestone payments upon achievement of specific product discovery anddevelopment goals.  Through December 31,2006, we have received $5.6 million in upfront fees and discovery anddevelopment funding.  If all milestonesare achieved, and including the $5.6 million in upfront fees and discovery anddevelopment funding paid through December 31, 2006, we may be entitled to up to$8.3 million in upfront fees, discovery and development funding and milestonepayments.  In addition, uponcommercialization, we are entitled to receive royalty payments based on salesof products containing flavor ingredients developed under the agreement untilthe expiration of relevant patents.  Wecannot assure you that we will receive any future milestone payments orroyalties under this collaboration.

In October 2006, we entered into a secondcollaborative research, commercialization and license agreement with Ajinomotofor the discovery and commercialization of specified natural flavoringredients.  Under the terms of the agreement, Ajinomoto has agreed topay us research funding for up to three years based on research progress duringthe collaborative period.  In addition, we are eligible to receivepayments upon achievement of specific milestones.  Through December 31, 2006 we have received$450,000 in discovery and development funding. If all milestones are achieved, and including the $450,000 in discoveryand development funding paid through December 31, 2006, we may be entitled toup to $2.8 million in discovery and development funding and milestonepayments.  In addition, uponcommercialization, we are entitled to receive royalty payments based on salesof products containing flavor ingredients developed under the agreement.  We cannot assure you that we will receive anyfuture milestone payments or royalties under this collaboration.

***CadburySchweppes***

In July 2005, weentered into a collaborative research and license agreement with Cadbury AdamsUSA, LLC, a Cadbury Schweppes company, for the discovery and commercializationof new flavor ingredients in the gum confectionary area.  Under the terms of the collaboration, CadburySchweppes has agreed to pay us research funding for up to two years based onresearch progress during the collaborative period. We are also eligible toreceive milestone payments upon our achievement of specific product discoveryand development goals. Through December 31, 2006, we have received $1.3million in research 

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funding.If all milestones are achieved, and including the $1.3 million in researchfunding paid through December 31, 2006, we may be entitled to up to $3.1million in research funding and milestone payments. In addition, in the eventof commercialization, we are entitled to receive royalties based on sales ofproducts containing new flavor ingredients developed under the agreement. Wecannot assure you that we will receive any future milestone payments orroyalties under this collaboration.

***CampbellSoup Company***

InMarch 2001, we entered into a collaboration agreement with Campbell, aglobal manufacturer and marketer of consumer food products, to work for athree-year collaborative period to discover specified flavors and flavorenhancers in the packaged food and beverage product fields of soups, includingfrozen soups. We later amended the agreement to add the product field ofspecified savory beverages in consideration for additional research anddevelopment payments and potential milestone and royalty payments.  In February 2006, we extended thecollaborative period until the earlier of March 2009 or submission for aGRAS determination, subject to earlier termination under specifiedcircumstances.

Under the terms ofthe collaboration, Campbell has agreed to pay to us certain research anddevelopment funding. We are also eligible to receive a milestone payment uponour achievement of a specific product development goal. ThroughDecember 31, 2006, we have received $9.7 million in research anddevelopment funding. If all milestones are achieved, and including the $9.7million in research and development funding paid through December 31,2006, we may be entitled to up to $13.1 million in research and developmentfunding and milestone payments. In addition, in the event of commercialization,we are entitled to receive royalties on future net sales of products containinga discovered flavor or flavor enhancer from the date of introduction of eachproduct in each country until 17 years thereafter or until the expiration ofrelevant patents in such country, whichever is earlier. We cannot assure youthat we will receive any future milestone payments or royalties under thiscollaboration.

***TheCoca-Cola Company***

InApril 2002, we entered into a collaboration agreement with Coca-Cola, theworld’s largest beverage company, to work for a three-year collaborative periodwith Coca-Cola for the discovery and development of specified new flavors andflavor enhancers in the product field of soft drinks and other non-alcoholicbeverages. In addition, we will work with Coca-Cola on a co-exclusive basiswith Kraft Foods for the discovery and development of flavor enhancers in aspecified food and beverage product field. In April 2004, we amended theagreement to extend the collaborative period until April 2008.

Under theagreement, Coca-Cola has agreed to pay certain research and development fundingover the collaborative period. We are also eligible to receive milestonepayments upon our achievement of specific product discovery and developmentgoals. Through December 31, 2006, we have received $9.5 million inresearch and development funding. If all milestones are achieved, and includingthe $9.5 million in research and development funding paid through December 31,2006, we may be entitled to up to $14.8 million. In addition, in the event ofcommercialization, we are entitled to receive royalties on future sales ofproducts containing a discovered flavor or flavor enhancer until the expirationof relevant patents. We cannot assure you that we will receive any futuremilestone payments or royalties under this collaboration.

***KraftFoods Global, Inc.***

InDecember 2000, we entered into a collaboration agreement with Kraft Foods,a global leader in branded foods and beverages. The collaborative period forthe original product discovery and development program expired on its own termsin December 2003. However, prior to December 2003 we amended ourcollaboration agreement to provide for a new collaborative program for thediscovery and development of novel flavor modifiers on a co-exclusive basiswith Coca-Cola in a specified food and beverage product field throughMay 2005. In April 2005 and July 2005 we further amended our collaborationagreement to extend the collaborative research phase for three months and anadditional two years through July 2007, respectively, and to expand thecollaborative program to include discovery and development of novel flavormodifiers on an exclusive basis in a specified product field in the dessertproduct category.  We are also 

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eligibleto receive milestone payments upon our achievement of specific productdiscovery and development goals. Through December 31, 2006, we havereceived $9.4 million in research and development funding, one milestonepayment of $250,000 and one milestone payment of $375,000. If all milestonesare achieved, and including all research and development funding paid orpayable, we may be entitled to up to $10.7 million. In addition, in the eventof commercialization, we are entitled to receive royalties on future net salesof products containing a discovered flavor modifier from the date ofintroduction of each product in each country until the earlier of 17 yearsthereafter or until the expiration of relevant patents in such country. We cannotassure you that we will receive any further milestone payments or royaltiesunder this collaboration.

In December 2005,we further amended the agreement to provide for a new three-year discovery anddevelopment collaboration.  In November2006, we further amended this agreement to revise the structure of the researchand development funding.  In this secondcollaboration, we will work with Kraft Foods on the discovery and developmentof novel flavor modifiers on a co-exclusive basis in the chilled and processedmeat product category within North America. Under the terms of the second collaboration, Kraft Foods has agreed topay us an initial license fee and incremental discovery and development fundingover the three-year period, subject to earlier termination under specifiedcircumstances.  In addition, we areeligible to receive milestone payments upon achievement of specific productdiscovery and development goals.  ThroughDecember 31, 2006, we have received $1.6 million in license fees and research anddevelopment funding.  If all milestonesare achieved, and including all license fees and research and developmentfunding payable, we may be entitled to up to $5.4 million.  In addition, in the event ofcommercialization, we are entitled to receive royalties on future net sales ofproducts containing a discovered flavor enhancer from the date of introductionof each product in each country until the earlier of 17 years thereafter oruntil the expiration of relevant patents in such country. We cannot assure youthat we will receive any further milestone payments or royalties under thiscollaboration.

***NestléSA***

InApril 2002, we entered into an initial collaboration agreement withNestlé, the world’s largest food company, to work for a three-year collaborativeperiod to discover specified flavors and flavor enhancers in the food andbeverage product fields of dehydrated and culinary food, frozen food and wetsoup.  In April 2005, we amended theagreement to provide for a three-year extension of the collaborative researchphase.  In March 2006, we further amendedthe agreement to include commercialization of novel flavors and flavorenhancers in the pet food category on a worldwide, co-exclusive basis.  In addition to the expansion, the Nestléagreement has been amended to allow us to reacquire rights to certain of ourflavor ingredients in certain geographic regions. As a result of thisamendment, Nestlé now has rights to flavor ingredients in Europe, Asia, Israel,Oceania, Africa, the Middle East and Latin America in specified productcategories within the dehydrated and culinary food, frozen food, and/or wetsoup product categories, as well as worldwide rights for the pet food category,while we have reacquired certain rights in North America and other geographicregions in specified product categories.

Under the terms ofthe collaboration agreement, Nestlé has agreed to pay to us certain researchand development funding over six years, subject to earlier termination underspecified circumstances. We are also eligible to receive milestone paymentsupon our achievement by certain dates of specific product discovery anddevelopment goals. Through December 31, 2006, we have received $10.0million in research and development funding, reimbursement of certain regulatoryexpenses of $339,000 and four milestone payments of $375,000 each. If allmilestones are achieved, and including all research and development fundingpaid or payable, we may be entitled to up to $15.8 million under the initialcollaboration. In addition, in the event of commercialization, we are entitledto receive royalties on future net sales of products containing a discoveredflavor or flavor enhancer from the date of introduction of each product in eachcountry until the expiration of relevant patents. We cannot assure you that wewill receive any further milestone payments or royalties under thiscollaboration.

InOctober 2004, we entered into a second product discovery and developmentcollaboration agreement with Nestlé to work for a five-year collaborativeperiod focusing on the discovery and commercialization of specified novelflavor ingredients in the coffee and coffee whiteners field.  Under the 

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termsof the agreement, Nestlé has agreed to pay us certain research and developmentfunding over five years, subject to extension or earlier termination underspecified circumstances.  Thiscollaborative period has been subsequently extended to a five-and-one-half yearcollaborative period, subject to further extension or earlier termination underspecified circumstances.  We are alsoeligible to receive milestone payments upon achievement of specific productdiscovery and development goals.  ThroughDecember 31, 2006, we have received $4.1 million in research anddevelopment funding.  If all milestonesare achieved, and including all research and development funding paid orpayable, we may be entitled to up to $14.0 million under the secondcollaboration.  In addition, in the eventof commercialization, we are entitled to receive royalties on future net salesof products containing a discovered flavor ingredient from the date ofintroduction of each product in each country until the expiration of relevantpatents. We cannot assure you that we will receive any milestone payments orroyalties under this collaboration.

**Our Technology**

We have discoveredor in-licensed many of the key receptors that mediate taste in mammals. Havingisolated human taste receptors, we have created proprietary tastereceptor-based assay systems that provide a biochemical or electronic readoutwhen a test compound affects the receptor. To enable faster compound discovery,we integrated our proprietary taste receptor-based screening assays into arobot-controlled automated system that uses plates containing an array ofindividual wells, each of which can screen a different compound. Ourreceptor-based discovery and development process has enabled us to improve ourability to find novel flavor ingredients over the traditional use of simpletaste tests.

***ReceptorDiscovery and Assay Development Technology***

There arecurrently five recognized primary senses of taste: umami (which is the savorytaste of glutamate), sweet, salt, bitter and sour. Scientists generally believethat each of these taste sensations is recognized by a distinct taste receptoror family of taste receptors in the mouth or on the tongue. A taste receptorfunctions either by physically binding to a flavor ingredient in a processanalogous to the way a key fits into a lock or by acting as a channel to allowions to flow directly into a taste cell. The brain recognizes tastes bydetermining which of the numerous receptors in the mouth have been contacted bya given flavor ingredient. Savory, sweet and bitter taste ingredients bind totaste receptors specific to each taste on the surface of taste bud cells. Incontrast, the taste of salt and the sour taste are thought to be recognized bytaste channels that allow the passage of particular ions into the taste budcells.

The current statusin the development of proprietary taste receptor-based assay systems for humantaste receptors is as follows:

·                  *Savory Receptor. *Glutamate is a natural component of foods, includingtomatoes, mushrooms, parmesan cheese, and meats. It is often added to foods inthe form of MSG to provide a savory flavor. The human savory receptor iscomposed of two proteins called hT1R1 and hT1R3. The T1R proteins are membersof the G protein-coupled receptor, or GPCR, family and are expressed on thesurface of certain taste bud cells. We created SavoryScreenHT, a proprietaryhigh-throughput savory taste receptor-based assay system and demonstrated thatit responded to MSG and inosine monophosphate, or IMP. We screened over 200,000compounds in SavoryScreenHT and identified a number of savory enhancers, includingS807, S336, S263 and S976, which were determined to be GRAS in March 2005.

·                  *Sweet Receptor. *The human sweet receptor is composed of two proteins calledhT1R2 and hT1R3. The hT1R3 protein is shared in common with the savoryreceptor. Like the savory receptor, the sweet receptor is also a member of theGPCR family and is expressed on the surface of certain taste bud cells. Wecreated SweetScreenHT, a proprietary high-throughput sweet taste receptor-basedassay system, and demonstrated that it responded to many differentsweet-tasting compounds including carbohydrate sweeteners and artificialsweeteners.  We have screened over300,000 compounds in SweetScreenHT and identified novel compounds that modulatesweet taste and could potentially function as sweet taste enhancers formid-calorie foods and beverages.  We arealso using SweetScreenHT to identify natural compounds that could potentiallyfunction as high potency sweeteners for no-calorie or low-calorie foods andbeverages.

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·                  *Bitter Receptors.* There are 25 bitterreceptors in humans.  These are alsomembers of the GPCR protein family.  Workfrom model systems showed that the 25 bitter receptors are likely presenttogether in the same taste cell.  Thebitter receptors are believed to have evolved as a defense mechanism to warn ofand prevent the ingestion of poisonous substances.  It is thought that each bitter receptorrecognizes a different set of bitter-tasting compounds.  We have characterized bitter ligands for mostof the 25 T2R receptors and we are using these receptors in cell-based assaysto discover bitter taste blockers.

·                  *Salt Receptor. *In contrast to the GPCRs that mediate savory, sweet andbitter tastes, sodium ions, and to a lesser extent, potassium ions, are thoughtto produce a salt taste via ion channels present on the surface of taste budcells. Ion channels are receptors that span the cell membrane and allow a flowof ions into or out of cells. Published work suggests that the EpithelialSodium Channel, or ENaC, is a mediator of salt taste. We have characterized twoforms of ENaC from human taste cells, termed Alpha ENaC and Delta ENaC.  For each form of ENaC, we have developed twoproprietary ENaC-based assay systems, SaltScreenHT, a high-throughput systemcapable of screening thousands of compounds per day, and SaltScreenEP, alower-throughput electrophysiology-based system. We demonstrated each of theSaltScreen systems are responsive to sodium and therefore could be used toidentify novel salt flavor enhancers. We are characterizing enhancers of DeltaENaC and have initiated a research effort to characterize alternative ionchannels and receptors that may play a role in salt taste perception. From thiswork, we are generating several potential targets for enhancement.

***ScreeningTechnologies and Compound Libraries***

We have developedor acquired access to expansive libraries of potential flavor ingredientscurrently comprised of over 300,000 natural and synthetic compounds. We intendto continue to acquire or develop additional compounds to add to ourlibraries.  Our recent focus has been onacquiring extracts and other natural compounds, which have a greater structuraldiversity than synthetic compounds and therefore provide numerous compounds forscreening. We have designed and selected our libraries to comprise compoundsthat we believe are likely to be safe and economical for use in packaged foodand beverage products. We are using our SavoryScreenHT, SweetScreenHT,SaltScreenHT, SaltScreenEP and BitterScreen assay systems to screen thecompounds in our libraries for their effects on specific taste receptors. Thesesystems use many of the same technologies that pharmaceutical companies use todiscover medicines. Our assay systems are much more sensitive than the humantongue, and can therefore be used to discover novel flavor ingredients thatcould not be identified using taste tests. We also use these systems to assist us in optimizing our lead compoundsby rapidly and iteratively testing the potency of the flavor ingredientsgenerated in the optimization process as the lead compound progresses to becomea product candidate.

**Regulatory Process**

Flavoringsubstances, including flavor ingredients, intended for use in foods andbeverages in the United States are regulated under provisions of the FD&CAct administered by the FDA. Flavor ingredients sold in countries and regionsoutside of the United States are also subject to regulations imposed bynational governments or regional regulatory authorities, as is the case in theEuropean Union.

***Regulationof Flavor Ingredients in the United States***

In the UnitedStates, flavor ingredients are regulated by the FDA as approved food additives,or as GRAS ingredients under the FD&C Act. The Food Additive Amendments of1958 prompted the flavor industry to establish in 1960 the FEMA ExpertPanel.  FEMA has administered the GRASprogram for flavors on behalf of the industry for over 40 years.  Other possible routes to approval of aflavor-modifying compound would be a GRAS self-determination (independent ofFEMA) with or without FDA notification, or a food additive petition to the FDA.Our goal is that the flavor ingredients, including flavor ingredients we maydiscover will be subject to one of the regulatory review processes describedbelow.

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***GRAS Review Process.***    Flavor ingredients that qualify for theGRAS review process are generally intended to be consumed in small quantitiesand have data supporting their safety under conditions of intended use. Anexpert panel, convened to undertake a GRAS review, determines whether aningredient is generally recognized as safe under the conditions of its intendeduse. These experts are qualified by scientific training and experience toevaluate the safety of chemicals used in food and may declare certain ingredientsas having been adequately shown through scientific procedures to be generallyrecognized as safe under the conditions of their intended use. Under the GRASprocess, manufacturers are required to obtain safety data from the scientificliterature or through the conduct of safety studies, determine the estimateddaily intake of the flavor ingredient per person and submit a report to theGRAS review panel describing the physical, chemical, safety, and metabolicproperties of the flavor ingredient. The entire GRAS determination process,including the safety and metabolic studies, application preparation and GRASpanel review, can take up to two years or longer. However, if there are priorsafety data on the ingredient or an ingredient with a related structure, thenfewer safety studies may be required for the GRAS review and the GRAS reviewprocess can be considerably shorter than two years.

The most common types of GRAS review are:

·                  *FEMA Expert Panel. *The FEMA Expert Panel is an independent panel of experts establishedby FEMA.  The FEMA Expert Panel, whichmay be used by FEMA members and certain other parties, meets up to three timesper year. The conclusions of the Expert Panel regarding a flavor or flavorenhancer are provided directly to the FDA and published in the journal FoodTechnology. To our knowledge, the FDA has not challenged the FEMA Expert Panel’sconclusion that the use of a flavoring substance is GRAS. In 2005, the FEMAExpert Panel published its findings on 185 new ingredients determined to beGRAS for specific flavor applications. We joined FEMA as an associate member in2003.  We became a full active member ofFEMA in 2006.  Four of our savoryingredients were determined to be GRAS by the FEMA Expert Panel in 2005.

·                  *Specifically Convened Independent Panel. *An independent, qualified panel ofexperts in pertinent scientific disciplines may be formed by the manufacturerto evaluate the safety of a specific compound for GRAS status. This process isknown as a “self determination of GRAS status.” The basis for the GRAS self determination is not required to besubmitted to the FDA.  However, the FDAmay request information on ingredients that have been self determined to beGRAS, or the information may be provided voluntarily.

***Benefitsof the FEMA GRAS Process***

There are threekey benefits of the FEMA GRAS review process:

·                  *Rapid Time for Commercialization. *Four ingredients developed as partof our savory program have received FEMA GRAS determination.  The processfrom selection for development until receipt of that determination tookapproximately 12 months.  We expect thatfuture flavor ingredients we develop will take a similar amount of time.  However, the length of time may varydepending on the properties of the flavor ingredient.  This is much shorter than the typical amountof time to obtain FDA approval under the food additive petition processapplicable to other food ingredients. Once the compound is determined to beFEMA GRAS, it can be immediately commercialized in the United States and severalother countries that recognize the FEMA GRAS status. As described above, theinitial phase of commercialization may include compound manufacturing,incorporation of the flavor ingredient into products, and the commercializationof products in consumer test markets.

·                  *Low Development Costs. *The total costs for the FEMA GRASprocess, including synthesis of material for regulatory studies, contractsafety studies and preparation of the FEMA GRAS application is generally under$1 million per compound.

·                  *Facilitated Approval in Other Countries. *Approval of flavors for useoutside of the United States varies widely by country. According to FEMA, sevencountries, including Brazil, New Zealand 

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and Australia, recognizeingredients on the FEMA GRAS list.  An additional set of countriesrecognize ingredients on the FEMA GRAS list “in principle”. These includeCanada, China, Philippines and Turkey. Approval in these countries may requirespecific applications to the food safety authority of the individual countriesbut usually not additional safety testing.

***Food Additive Petition Process.***    Food ingredients for which the GRAS processis not available may be evaluated as food additives. Food additives require FDAapproval prior to use in foods. An ingredient may be ineligible for GRASdetermination, and may be considered a food additive, because there isinsufficient general knowledge or for a variety of other reasons, includingconditions of intended use resulting in high dietary exposure or the ingredient’ssafety profile. If the ingredient is considered a food additive, a foodadditive petition must be filed and approved by the FDA. Food additivepetitions contain information on the chemical nature of the ingredient, themanufacturing process, information on use in food, estimates of human exposurefrom use of the compound in food and all known information related to thesafety of the ingredient.  The FDA reviews the petition content, requestsadditional information if necessary, publishes a proposed rule for use in food,reviews comments on the proposed rule and publishes a final rule, if the use isdetermined to be acceptable.  The safetydata requirements for food additives are the same as for GRAS substances.  We estimate that a food additive petitioncould cost up to $7 million and may take up to four years to complete.  Furthermore, additional studies adding costand time to approval may be required depending on the results of the initialsafety studies.  Examples of ingredientsthat have gone through a food additive petition process include the artificialsweeteners Aspartame, Acesulfame K and Sucralose. It may be necessary for anyhigh potency sweeteners that we discover or develop to follow this regulatoryroute.

**License Arrangements**

We have licensedrights from several companies and academic institutions, including thefollowing:

***University of California***

  In March 2000, we entered into a licenseagreement with the University of California under which we obtained exclusiverights to certain technologies held by the University of California that areinvolved in the biology of taste, including specified receptors in two tastereceptor families, T1Rs and T2Rs. The license may be converted to anon-exclusive license, or terminated, by the University of California if wefail to meet specified milestones relating to the discovery of specifiedproducts and the sale of specified products and services. Our exclusive rightsare also subject to rights granted by the University of California to theUnited States Government and a private medical foundation. In October 2006, weentered into an amended and restated agreement with the University ofCalifornia to include certain additional related technologies.  The agreement, as originally drafted and asamended and restated, required a license issue fee, payable in installmentsthrough 2005, and calls for annual maintenance fees commencing in 2006 androyalties or service revenues on sales of any products developed usingtechnologies licensed under the agreement. Royalties will accrue in eachcountry for as long as there exists a valid patent claim covering a productdeveloped under the agreement. No royalty payments have accrued under theagreement to date. The agreement will remain in effect until the later of theexpiration of the last to expire patent licensed under the agreement, or tenyears from the date that the last product to be developed under the agreementis introduced to market in the United States. We may terminate the agreement atany time, without cause, upon notice to the University of California. TheUniversity of California may terminate the agreement upon a breach of ourobligations under the agreement.

**Competition**

Our goal is to bethe leader in discovering novel flavor ingredients for use in a wide range ofpackaged food and beverage products. Other companies are possibly pursuingsimilar technologies and the commercialization of products and servicesrelevant to flavor ingredients. Although we are not aware of any othercompanies that have the scope of proprietary technologies and processes that wehave developed in our field, there are a number of competitors who possesscapabilities relevant to the flavor ingredient field.

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In particular, weface substantial competition from companies pursuing the commercialization ofproducts and services relevant to taste using more traditional methods for thediscovery of flavor ingredients. These competitors include leading flavorcompanies, such as International Flavors & Fragrances Inc., GivaudanSA, Symrise, Unilever and Firmenich. These companies provide flavors and otherproducts, such as oils, extracts and distillates, to consumer productscompanies for use in a wide variety of products including foods, beverages,confectionaries, dairy products and pharmaceuticals. Competitors currentlydeveloping or marketing high potency sweeteners include Tate & Lyle,NutraSweet, Ajinomoto and Cargill. We also face indirect competition from othercompanies such as Newly Weds Foods, Inc., a manufacturer of food coatingsand seasonings for restaurants, airlines and the food services industry. Wecurrently compete and will continue to compete in the future with thesecompanies in collaborating with and selling flavor products and technologies tomanufacturers of packaged food and beverage products. Many of these companieshave substantially greater capital resources, research and developmentresources and experience, manufacturing capabilities, regulatory expertise,sales and marketing resources, established relationships with consumer productscompanies and production facilities.

We may in thefuture face competition from life sciences and other technology companies andother commercial enterprises. These entities engage as we do in biotechnology,biology or chemistry and could apply this technology to the discovery anddevelopment of flavor ingredients. We are aware of a privately-held company,Redpoint Bio, formerly known as Linguagen Corp., that we believe is involved inresearch on sweetness potentiators, salt substitutes and bitter blockers,specifically adenosine 5’ monophosphate, or AMP, and has announced research anddevelopment collaborations with a number of companies. While we do not believethat any of these collaborations is competitive with our product discovery anddevelopment efforts, we cannot guarantee that products developed as a result ofour competitors’ existing or future collaborations will not compete with ourflavor ingredients.

Universities andpublic and private research institutions are also potential competitors. Whilethese organizations primarily have educational objectives, they may developproprietary technologies related to the sense of taste or secure patentprotection that we may need for the development of our technologies andproducts. We may attempt to license these proprietary technologies, but theselicenses may not be available to us on acceptable terms, if at all.

Methods forreducing sodium include the use of potassium chloride in combination withflavors and masking agents.  Althoughsavory flavor enhancers, such as IMP, are commercially available, they are notvery potent, are not patent protected and are sold as a commodity. The blockingof bitter taste is typically accomplished by attempting to mask the bittertaste with a sweetener or another flavor ingredient.  Although AMP has received GRAS determination,we do not believe this compound has been widely adopted into packaged food andbeverage products.  However, ourcompetitors, either alone or with their collaborative partners, may succeed indeveloping technologies or discovering flavor ingredients that are similar orpreferable in the areas of, among others, effectiveness, safety, cost and easeof commercialization, and our competitors may obtain intellectual propertyprotection or commercialize such products sooner than we do. Developments byothers may render our product candidates or our technologies obsolete. Inaddition, our current product discovery and development collaborators are notprohibited from entering into research and development agreements with thirdparties in any particular field.

**Patents and Proprietary Rights**

We will be able toprotect our proprietary rights from unauthorized use by third parties only tothe extent that our proprietary rights are described by valid and enforceablepatents or are effectively maintained as trade secrets. Accordingly, we arepursuing and will continue to pursue patent protection for our proprietarytechnologies. As of December 31, 2006 we are the owner or the exclusivelicensee of 49 issued United States patents, 104 pending United States patentapplications, 31 issued foreign patents and 209 pending foreign applicationscovering various aspects of our proprietary technology. Our issued patents haveterms that expire in 2018 through 2024.

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Our policy is tofile patent applications and to protect technologies, inventions andimprovements to inventions that are commercially important to the developmentof our business. For example, we may seek patent protection for receptors andnucleic acid sequences encoding receptors that are involved in taste and theuse of such receptors to identify ingredients that modulate taste. We also relyon trademarks to protect our proprietary technology. Generally, United Statespatents have a term of 17 years from the date of issue or 20 years from theearliest claimed priority date, whichever is later, for patents issued fromapplications filed with the United States Patent and Trademark Office prior toJune 8, 1995 or 20 years from the application filing date or earlierclaimed priority date in the case of patents issued from applications filed onor after June 8, 1995. Patents in most other countries have a term of 20years from the date of filing the patent application. Our success dependssignificantly upon our ability to develop ingredients and technologies that areprotected by our intellectual property and that do not infringe any competitorpatents. We intend to continue to file patent applications as we discover anddevelop new flavor ingredients and technologies.

Seeking andobtaining patents may provide some degree of protection for our intellectualproperty. However, our patent positions are highly uncertain and may involvecomplex legal and factual questions. No consistent standard regarding theallowability and enforceability of claims in many of the pending patentapplications has emerged to date. As a result, we cannot predict the breadth ofclaims that will ultimately be allowed in our patent applications, if any,including those we in-licensed or how we may be able to enforce our patentclaims against our competitors. In addition, we may not have been the first tofile patent applications for or to invent inventions relating to thetechnologies upon which we rely, which would preclude us from obtaining issuedpatents on the relevant inventions. We are aware of other companies andacademic institutions which have been performing research and have applied forpatents in the area of mammalian taste. In particular, other companies andacademic institutions have announced that they have identified taste receptors,published data on taste receptor sequence information or have filed patentapplications on receptors and their use, including the University ofCalifornia, Redpoint Bio, Monell Chemical Senses, Mount Sinai School ofMedicine, The Scripps Research Institute, Pfizer, Virginia CommonwealthUniversity, the California Institute of Technology, Duke University and theGerman Institute of Human Nutrition. If any of these companies or academicinstitutions are successful in obtaining broad patent claims, such patentscould potentially block our ability to use various aspects of our discovery anddevelopment process and might prevent us from developing or commercializingnewly discovered flavor ingredients or otherwise conducting our business.

We also rely inpart on trade secret protection for our confidential and proprietaryinformation and process. Our policy is to execute confidentiality agreementswith our employees and consultants upon the commencement of an employment orconsulting relationship. These agreements generally require that allconfidential information developed by the individual or made known to theindividual by us during the course of their employment shall be our exclusiveproperty. However, there can be no assurance that we will be able toeffectively enforce these agreements or that the subject proprietaryinformation will not be disclosed.

We are not a partyto any litigation, opposition, interference, or other potentially adverse exparte or inter-party governmental or non-governmental proceeding with regard toour patent and trademark positions. However, if we become involved inlitigation, interference proceedings, oppositions or other intellectualproperty proceedings, for example as a result of an alleged infringement, or athird-party alleging an earlier date of invention, we may have to spendsignificant amounts of money and time and, in the event of an adverse ruling,we could be subject to liability for damages, invalidation of our intellectualproperty and injunctive relief that could prevent us from using technologies ordeveloping products, any of which could have a significant adverse effect onour business financial condition and results of operation. In addition, anyclaims relating to the infringement of third-party proprietary rights, orearlier date of invention, even if not meritorious, could result in costlylitigation, lengthy governmental proceedings, divert management’s attention andresources and require us to enter royalty or license agreements which are notadvantageous if available at all.

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**Sales and Marketing**

While we do notcurrently intend to establish internal sales and marketing capabilities, we aredeveloping the capability to enable us to work closely with our collaboratorsand their suppliers in the incorporation of our flavor ingredients into theirproducts.  Under our currentcollaboration agreements, our collaborators are responsible for sales,marketing, and distribution of any packaged food or beverage productincorporating our flavor ingredients. As a result, we expect to commercializeour flavor ingredients without incurring significant sales, marketing anddistribution costs. Our six current collaborators, Ajinomoto, CadburySchweppes, Campbell, Coca-Cola, Kraft Foods and Nestlé, are recognized leadersin the sales, marketing and distribution of packaged food and beverageproducts.

**Manufacturing**

We intend toutilize third parties to manufacture our flavor ingredients. Under five of ourexisting product discovery and development collaborations, our collaboratormay, in its sole discretion, manufacture itself or through a third partymanufacturer the flavor ingredients it licenses from us. The remaining fourcollaborations require the collaborator to identify with us a mutually agreedupon third party to manufacture the flavor ingredients it licenses from us. Insome of these agreements, we maintain either the first right of negotiation oran option to manufacture based on provisions within the agreement.

There are a numberof reliable third party contract manufacturers available to produce our flavoringredients. Our current product candidates are relatively simple structuresmaking them easy and inexpensive to produce. We do not anticipate any capacityissues because of our low volume requirements and the number of reliable andavailable manufacturers.

**Employees**

As ofDecember 31, 2006, we had 112 full-time employees, including 27 with Ph.D.degrees. Of our full-time workforce, 83 employees are engaged in research anddevelopment and 29 are engaged in business development, finance andadministration. We also retain outside consultants. None of our employees arecovered by collective bargaining arrangements, and our management considers itsrelationships with our employees to be good. We have entered into employmentletter agreements with Kent Snyder, Mark Zoller, Ph.D., HarryLeonhardt, Esq., John Poyhonen and Sharon Wicker, the terms of which aredescribed in Item 11 of this Form 10-K.

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**Executive Officers**

The followingtable sets forth certain information concerning our executive officers andtheir ages as of December 31, 2006:

| Name                           | ** ** | **Age** | ** ** | **Position**                                                                          |
|--------------------------------|------------|---------|------------|---------------------------------------------------------------------------------------|
| Kent Snyder                    |       | 53      |       | President, Chief Executive Officer and Director                                       |
| Mark J. Zoller,  Ph.D.         |       | 53      |       | Executive Vice President of Discovery &  Development and Chief Scientific Officer |
| Harry J.  Leonhardt, Esq. |       | 50      |       | Senior Vice President, General Counsel and Corporate  Secretary                       |
| John Poyhonen                  |       | 46      |       | Senior Vice President, Chief Financial and Business  Officer                          |
| Sharon Wicker                  |       | 51      |       | Senior Vice President of Commercial Development and  Chief Strategy Officer           |

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**KentSnyder**, President and Chief Executive Officer, joined us inJune 2003 and has served as a member of our board of directors since thattime. Prior to joining us, from October 2001 to June 2003,Mr. Snyder was retired. From July 1991 to October 2001,Mr. Snyder held various marketing and sales management positions withAgouron Pharmaceuticals, Inc., a Pfizer company. Mr. Snyder wasPresident of Global Commercial Operations at Agouron. Prior to holding theposition of President of Global Commercial operations, Mr. Snyder servedas Senior Vice President of Commercial Affairs and Vice President of BusinessDevelopment. Mr. Snyder received his B.S. from the University of Kansasand his M.B.A. from Rockhurst College.

**MarkJ. Zoller, Ph.D**., joined us in March 2000 as VicePresident of Research and was promoted to Executive Vice President of Discoveryand Development and Chief Scientific Officer in January 2006, which position hestill holds. From May 1992 to December 1999, Dr. Zoller held anumber of scientific management positions at ARIAD Pharmaceuticals, mostrecently as Senior Vice President, Genomics and Scientific Director of theHoechst-ARIAD Genomics Center, which in December 1999 was acquired byAventis Pharmaceuticals. Dr. Zoller received his B.A. in Chemistry fromPomona College and his Ph.D. in Chemistry from the University of California,San Diego.

**HarryJ. Leonhardt, Esq.**, Senior Vice President, GeneralCounsel and Corporate Secretary, joined us in September 2003 as VicePresident, General Counsel and Corporate Secretary and was promoted in January2006 to Senior Vice President, General Counsel and Corporate Secretary. FromFebruary 2001 to February 2003, Mr. Leonhardt served asExecutive Vice President of Business Development, General Counsel and CorporateSecretary of Genoptix, Inc. From July 1996 to November 2000,Mr. Leonhardt held senior management positions with Nanogen, Inc. andserved most recently as Senior Vice President, General Counsel and Secretary.Mr. Leonhardt received his B.S. degree from the University of the Sciencesin Philadelphia and his Juris Doctorate from the University of SouthernCalifornia Law Center.

**JohnPoyhonen**, Senior Vice President and Chief Financial andBusiness Officer, joined us in October 2003 as Vice President and ChiefBusiness Officer and was promoted in April 2004 to Vice President, ChiefFinancial and Business Officer.  InJanuary 2006, he was promoted to Senior Vice President, Chief Financial andBusiness Officer.  From 1996 untilOctober 2003, Mr. Poyhonen served in various sales and marketingpositions for Agouron Pharmaceuticals, a Pfizer company, most recently as VicePresident of National Sales. Prior to holding this position, Mr. Poyhonenserved as Vice President of Marketing and Vice President of National Accounts.Mr. Poyhonen received his B.A. in Marketing from Michigan State Universityand his M.B.A. from the University of Kansas.

**SharonWicker,**Senior VicePresident of Commercial Development and Chief Strategy Officer, joined us inApril 2006.  From 2003 to 2006, Ms.Wicker held various strategic marketing positions, most recently as President,Flavor Business Unit at A.M. Todd Company. From 1999 to 2003, Ms. Wicker served as Vice President of Frozen Mealsfor Heinz North America.  From 1994 to1999 Ms. Wicker served as Vice President and General Manager of the MealsStrategic Business Unit of ConAgra.  From1984 to 1994 Ms. Wicker held a variety of marketing and general managementpositions for General Mills, including assignments as Brand Manager forCheerios and Betty Crocker desserts. Ms. Wicker received her BS in Food Scienceand Nutrition from Colorado State University and her M.B.A. from Michigan StateUniversity.

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**Item 1A. Risk Factors**

*Youshould consider carefully the following information about the risks describedbelow, together with the other information contained in this annual report onForm 10-K and in our other public filings, in evaluating our business. Ifany of the following risks actually occurs, our business, financial condition,results of operations and future growth prospects would likely be materiallyand adversely affected.  In these circumstances, the market price of ourcommon stock would likely decline.*

**Risks Related To Our Business**

***We are dependent on our product discovery and developmentcollaborators for all of our revenue and we are dependent on our current andany future product discovery and development collaborators to develop andcommercialize any flavor ingredients we may discover.***

A key element of ourstrategy is to commercialize our flavor ingredients through product discoveryand development collaborations. To date, all of our revenue has been derivedsolely from research and development payments and milestone payments receivedunder collaboration agreements with Ajinomoto, Cadbury Schweppes, Campbell,Coca-Cola, Kraft Foods and Nestlé. Substantially all of our revenue in theforeseeable future will result from these types of payments from thesecollaborations, unless we successfully commercialize a product candidatethrough these or other collaborators and earn royalties on future sales ofconsumer products incorporating our flavor ingredients.

Our agreement, as amended,with Campbell provides for research and development funding untilMarch 2009 and gives Campbell the right to terminate the agreement earlierwithout cause, provided that it pay a specified termination fee if itterminates the agreement prior to March 28, 2009. Our agreement withCoca-Cola provides for research and development funding until April 2008,and gives Coca-Cola the right to conclude the collaborative program earlier forany reason upon payment to us of an early conclusion fee.  Our agreement with Kraft Foods provides forresearch and development funding until December 2008, and gives Kraft Foods theright to conclude the agreement earlier for any reason upon payment to us ofadditional specified research funding, if it terminates the agreement prior toDecember 2008, provided that Kraft Foods may conclude the agreement on December9, 2007 without payment of additional research funding. Our initial agreementwith Nestlé (as amended in April 2005) provides for research and developmentfunding through April 2008 and gives Nestlé the right to terminate theagreement earlier without cause, provided that it pay additional specifiedresearch funding if it terminates the agreement prior to April 18, 2008.  Our most recent agreement with Nestléregarding the discovery and commercialization of novel flavor ingredients inthe coffee and coffee whitener fields provides for research and developmentfunding through April 2010 and gives Nestlé the right to terminate theagreement earlier without cause on or after April 26, 2007, provided that itpay additional specified research funding if it terminates the agreement afterApril 26, 2007 but prior to April 26, 2010.  Our agreement with CadburySchweppes provides for research and development funding through July 2007, andgives Cadbury Schweppes the right to terminate the agreement earlier withoutcause upon 90 days’ written notice.  Ourinitial agreement with Ajinomoto provides for research and development fundingthrough March 2009 and gives Ajinomoto the right to terminate the agreementwithout cause provided that it pay additional specified research funding if itterminates the agreement prior to March 23, 2009.  Our most recent agreement with Ajinomotoprovides for research and development funding through October 2009 and givesAjinomoto the right to terminate the agreement without cause provided that itpay additional specified research funding if it terminates the agreement priorto October 5, 2009.   If any or all of ourmaterial agreements with our collaborators expire or are terminated, ourrevenue would significantly decline and if all of our agreements expire or areterminated, our revenue would be substantially eliminated, which would have amaterial adverse effect on our business, financial condition and results ofoperations. Our collaborators may not renew their agreements with us or, ifthey do, they may not be on terms that are as favorable to us as our currentagreements.

Our current collaborationagreements provide that we will receive royalties of up to 4% on ourcollaborators’ sales of products containing our flavor ingredients.  The actual royalties payable vary byagreement and depend on a number of factors including, for example, the productfield, cost of goods 

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savings, degree of flavorenhancement and sales volume of collaborator products incorporating our flavoringredients.  It is possible that ourcollaborators will not incorporate our flavor ingredients into any or all oftheir products within their exclusive or co-exclusive product fields.

We do not currently havea commercialized product and cannot assure you we will have a commercializedproduct in the future, or at all. We will be dependent on our current and anyother possible future collaborators to commercialize any flavor ingredientsthat we successfully develop and to provide the sales, marketing anddistribution capabilities required for the success of our business. We havelimited or no control over the amount and timing of resources that our currentor any future collaborators may devote to our programs or potential products.Our collaborators may decide not to devote the necessary resources to thecommercialization of our flavor ingredients, or may pursue a competitor’sproduct if our flavor ingredients do not have the characteristics desired bythe collaborator. These characteristics include, among other things,enhancement properties, temperature stability, solubility, taste and cost. Ifthese collaborators fail to conduct their commercialization, sales andmarketing or distribution activities successfully and in a timely manner, wewill earn little or no royalty revenues from our flavor ingredients and we willnot be able to achieve our objectives or build a sustainable or profitablebusiness.

Our present and anyfuture product discovery and development collaboration opportunities could beharmed if:

·                  our existing or any futurecollaborators terminate their collaboration agreements with us prior to theexpiration of the agreements;

·                  we do not achieve our research anddevelopment objectives under our collaboration agreements prior to thetermination of the collaboration periods;

·                  we disagree with our collaborators asto the parties’ respective licensing rights to our flavor ingredients, methodsor other intellectual property we develop;

·                  we are unable to manage multiplesimultaneous collaborations;

·                  potential collaborators fail to spendtheir resources on research and development or commercialization of our flavoringredients due to general market conditions or for any other reason; or

·                  consolidationin our target markets limits the number of potential collaborators.

***We may not be able to negotiate additional collaborationagreements having terms satisfactory to us or at all.***

We may not be able toenter into additional product discovery and development collaborations due tothe exclusive nature of our current product discovery and developmentcollaborations. Each of our current collaboration agreements provides that wewill conduct research and development on flavor ingredients for use within oneor more defined packaged food and beverage product fields on an exclusive orco-exclusive basis for the respective collaborator during the collaborativeperiod specified in the agreement. Because each of these agreements is exclusiveor co-exclusive, we will not be able to enter into a collaboration agreementwith any other food and beverage company covering the same product field duringthe applicable collaborative period. In addition, our collaborators’competitors may not wish to do business with us at all due to our relationshipwith our collaborators. If we are unable to enter into additional productdiscovery and development collaborations, our ability to sustain or expand ourbusiness will be significantly diminished.

***We may not be successful in developing flavor ingredientsuseful for formulation into products.***

We may not succeed indeveloping flavor ingredients with the appropriate attributes required for usein successful commercial products. Successful flavor ingredients require, amongother things, appropriate biological activity, including the correct tasteproperty for the product application, an acceptable safety profile, includinglack of toxicity or allergenicity, and appropriate physical or chemicalproperties, including relative levels of stability, volatility and resistanceto heat. Successful flavor ingredients must 

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also be cost-efficientfor our collaborators. We may not be able to develop flavor ingredients thatmeet these criteria.

***If we or our collaborators are unable to obtain and maintainthe GRAS determination required before certain of our flavor ingredients can beincorporated into products that are sold, we would be unable to commercializeour flavor ingredients and our business would be adversely affected.***

In March 2005, weobtained a GRAS determination for four of our savory flavor ingredients.  Apart from these flavor ingredients, we donot have GRAS determination for any other flavor ingredient at this time. Inthe United States, the development, sale and incorporation of our flavoringredients into products are subject to regulation by the FDA and in someinstances other government bodies. Obtaining and maintaining a GRASdetermination can be costly and take many years.

Depending on the amountor intended use of a particular flavor ingredient added to a product and thenumber of product categories in which the flavor ingredient will beincorporated, specific safety assessment protocols and regulatory processesmust be satisfied before we or our collaborators can commercially market andsell products containing any flavor ingredients that we may discover. A keyelement of our strategy is to develop flavor ingredients that may be subject toreview under the FEMA GRAS process.  Inour experience with the savory program, safety studies, preparation and FEMAGRAS review took approximately 12 months and cost less than $1 million.  This experience may not be representative ofthe timing and cost for future programs. This approach is less expensive than the alternative of filing a foodadditive petition with the FDA, approval of which can take up to four years.The FEMA GRAS process may take longer than 12 months and cost more than$1 million depending on the properties of the flavor ingredient, and ifadditional safety studies are requested by the FEMA Expert Panel or arenecessary to explain unexpected safety study findings. There is a risk that oneor more of our product candidates may not qualify for a FEMA GRASdetermination. This may occur for a variety of reasons, including the flavoringredient’s intended use, the amount of the flavor ingredient intended to beadded to packaged foods and beverages, the number of product categories inwhich the flavor ingredient will be incorporated, whether the flavor ingredientimparts sweetness, the safety profile of the flavor ingredient and the FEMAExpert Panel’s interpretation of the safety data. Even if we obtain a GRASdetermination with respect to a flavor ingredient, the FDA has the ability tochallenge such determination, which could materially adversely affect ourability to market products on schedule or at all. In the event that aparticular flavor ingredient does not qualify for FEMA GRAS determination, wecould be required to pursue a lengthy FDA approval process or dedicate ourdevelopment efforts to alternative ingredients, which would further delaycommercialization. In addition, laws, regulations or FDA practice governing theregulatory approval process, the availability of the GRAS determination processor the manufacture or labeling of such products, may change in a manner thatcould adversely affect our ability to commercialize products on schedule or atall.

Sales of our flavoringredients outside of the United States will be subject to foreign regulatoryrequirements. In most cases, whether or not a GRAS determination has beenobtained, approval of a product by the comparable regulatory authorities offoreign countries must still be obtained prior to manufacturing or marketingthe product in those countries. A GRAS determination in the United States or inany other jurisdiction does not ensure approval in other jurisdictions becausethe requirements from jurisdiction to jurisdiction may vary widely. Obtainingforeign approvals could result in significant delays, difficulties and costsfor us and require additional safety studies and additional expenses. If wefail to comply with these regulatory requirements or to obtain and maintainrequired approvals, our ability to generate revenue will be diminished.

We and our collaboratorsmay not be successful in overcoming these regulatory hurdles, which couldresult in product launch delays, unanticipated expenses, termination ofcollaborations, and flavor ingredients not being approved for incorporationinto consumer products. These consequences would have a material adverse effecton our business financial condition and results of operations.

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***If we or our collaborators are unable to obtain and maintainthe regulatory approval required before any high potency sweeteners can beincorporated into products that are sold, we would be unable to commercializeour high potency sweeteners and our business would be adversely affected.***

In the United States, thedevelopment, sale and incorporation of our high potency sweeteners intoproducts are subject to regulation by the Food and Drug Administration, or FDA,and in some instances other government bodies. Obtaining and maintainingregulatory approval can be costly and take many years.

Depending on the amountor intended use of a particular high potency sweetener added to a product andthe number of product categories in which the high potency sweetener will beincorporated, specific safety assessment protocols and regulatory processesmust be satisfied before we or our collaborators can commercially market andsell products containing any high potency sweeteners that we may discover. Anelement of our strategy is to develop high potency sweeteners that may besubject to review under the Food Additive Petition process, which encompassesfiling a food additive petition with the FDA, approval of which can take up tofour years or more and may cost up to $7 million or more.  Government resource constraints may also slowthe review and approval process.  Inaddition, laws, regulations or FDA practice governing the regulatory approvalprocess, the availability of the Food Additive Petition process or themanufacture or labeling of such products, may change in a manner that couldadversely affect our ability to commercialize products on schedule or at all.

Sales of our high potencysweeteners outside of the United States will be subject to foreign regulatoryrequirements. In most cases, whether or not FDA approval has been obtained,approval of a product by the comparable regulatory authorities of foreigncountries must still be obtained prior to manufacturing or marketing theproduct in those countries. A FDA approval in the United States or in any otherjurisdiction does not ensure approval in other jurisdictions because therequirements from jurisdiction to jurisdiction may vary widely. Obtainingforeign approvals could result in significant delays, difficulties and costsfor us and require additional safety studies and additional expenses. If wefail to comply with these regulatory requirements or to obtain and maintainrequired approvals, our ability to generate revenue will be diminished.

We and our collaboratorsmay not be successful in overcoming these regulatory hurdles, which couldresult in product launch delays, unanticipated expenses, termination ofcollaborations, and high potency sweeteners not being approved forincorporation into consumer products. These consequences would have a materialadverse effect on our business financial condition and results of operations.

***Even if we or our collaborators receive regulatory approvaland incorporate our flavor ingredients into products, those products may neverbe commercially successful.***

Even if we discover anddevelop flavor ingredients that obtain the necessary GRAS determination or otherregulatory approval, our success depends to a significant degree upon thecommercial success of packaged food and beverage products incorporating thoseflavor ingredients. If these products fail to achieve or subsequently maintainmarket acceptance or commercial viability, our business would be significantlyharmed because our royalty revenue is dependent upon consumer sales of theseproducts. In addition, we could be unable to maintain our existingcollaborations or attract new product discovery and development collaborators.Many factors may affect the market acceptance and commercial success of anypotential products incorporating flavor ingredients that we may discover,including:

·                  health concerns, whether actual orperceived, or unfavorable publicity regarding our flavor ingredients or thoseof our competitors;

·                  the timing of market entry ascompared to competitive products;

·                  the rate of adoption of products byour collaborators and other companies in the flavor industry; and

·                  anyproduct labeling that may be required by the FDA or other United States orforeign regulatory agencies for products incorporating our flavor ingredients.

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***We have a history of operating losses and we may not achieveor maintain profitability.***

We have not beenprofitable and have generated substantial operating losses since we wereincorporated in September 1998. We incurred net losses of approximately$23.1 million for the year ended December 31, 2006. As of December 31,2006, we had an accumulated deficit of approximately $127.3 million. We expectto incur additional losses for at least the next two years. The extent of ourfuture losses will depend, in part, on the rate of increase in our operatingexpenses and the rate of growth, if any, in our revenue from our existing andany future product discovery and development collaborations as well as fromother sources that may become available to us in the future and on the level ofour expenses. To date, our revenue has come solely from research anddevelopment funding, upfront fees, cost reimbursement and milestone paymentsunder our product discovery and development collaboration agreements withAjinomoto, Cadbury Schweppes, Campbell, Coca-Cola, Kraft Foods and Nestlé. Inorder for us to generate royalty revenue and become profitable, we must retainour existing product discovery and development collaborations and ourcollaborators must commercialize products incorporating one or more of ourflavor ingredients, from which we can derive royalty revenues. Our ability togenerate royalty revenue is uncertain and will depend upon our ability to meetparticular research, development and commercialization objectives.

***We expect that our results of operations will fluctuate fromperiod to period, and this fluctuation could cause our stock price to decline.***

Our operating resultshave fluctuated in the past and are likely to vary significantly in the futurebased upon a number of factors, many of which we have little or no controlover. We operate in a highly dynamic industry and future results could besubject to significant fluctuations. These fluctuations could cause us to failto meet or exceed financial expectations of securities analysts or investors,which could cause our stock price to decline rapidly and significantly. Revenueand expenses in future periods may be greater or less than revenue and expensesin the immediately preceding period or in the comparable period of the prioryear. Therefore, period-to-period comparisons of our operating results are notnecessarily a good indication of our future performance. Some of the factorsthat could cause our operating results to fluctuate include:

·                  termination of any of our productdiscovery and development collaboration agreements;

·                  our ability to discover and developflavor ingredients or the ability of our product discovery and developmentcollaborators to incorporate them into packaged food and beverage products;

·                  our receipt of milestone payments inany particular period;

·                  the ability and willingness ofcollaborators to commercialize products incorporating our flavor ingredients onexpected timelines, or at all;

·                  our ability to enter into new productdiscovery and development collaborations and technology collaborations or toextend the terms of our existing collaboration agreements and our paymentobligations, expected revenue and other terms of any other agreements of thistype;

·                  our ability, or our collaborators’ability, to successfully satisfy all pertinent regulatory requirements;

·                  the demand for our collaborators’products containing our flavor ingredients; and

·                  generaland industry specific economic conditions, which may affect our collaborators’research and development expenditures.

***Changes infinancial accounting standards related to stock-based compensation expenseshave had and are expected to have a significant effect on our reported results.***

On January 1, 2006 weadopted Statement of Financial Accounting Standards, or SFAS, No. 123R, *Share-Based Payment*, which requires that we recordcompensation expense in the statement of operations for stock-based payments,such as employee stock options, using the fair value method. The adoption ofthe standard is expected to continue to have a significant effect on ourreported earnings, although it will not affect our cash flows, and couldadversely impact our ability to provide accurate guidance on our projected

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future financial results due to the variability of thefactors used to establish the value of stock options.  If factors change and we employ differentassumptions or different valuation methods in the application of SFAS 123R infuture periods, the compensation expense that we record under SFAS 123R maydiffer significantly from what we have recorded in the current period, whichcould negatively affect our stock price and our stock price volatility.

***Compliance with regulation of corporategovernance and public disclosure may result in additional expenses.***

Laws, regulations andstandards relating to corporate governance and public disclosure, including theSarbanes-Oxley Act of 2002, SEC regulations and NASDAQ Stock Market rules, arecostly to comply with.  Our efforts tocomply with these laws, regulations and standards have resulted in, and arelikely to continue to result in, general and administrative expense andmanagement time related to compliance activities.  In particular, our efforts to comply with Section 404of the Sarbanes-Oxley Act of 2002 and the related regulations regarding ourrequired assessment of our internal controls over financial reporting and ourexternal auditors’ audit of that assessment requires the commitment ofsignificant financial and managerial resources. If our efforts to comply withlaws, regulations and standards differ from the activities intended byregulatory or governing bodies, our reputation may be harmed and we might besubject to sanctions or investigation by regulatory authorities, such as theSEC. Any such action could adversely affect our financial results and themarket price of our common stock.

***We may need to obtain additional capital to fund ouroperations.***

If we are unable tosuccessfully commercialize our flavor ingredients, we may need to obtainadditional capital or change our strategy to continue our operations. Inaddition, our business and operations may change in a manner that would consumeavailable resources at a greater rate than anticipated. In such event, we mayneed to raise substantial additional capital to, among other things:

·                  fundnew research, discovery or development programs;

·                  advanceadditional product candidates into and through the regulatory approval process;and

·                  acquire rightsto products or product candidates, technologies or businesses.

If we require additionalcapital to continue our operations, we cannot assure you that additionalfinancing will be available on terms acceptable to us, or at all. If adequatefunds are not available or are not available on acceptable terms, our abilityto fund our operations, take advantage of opportunities, identify and developflavor ingredients, develop technologies or otherwise respond to competitivepressures could be significantly limited. In addition, if financing is notavailable, we may need to alter our strategy or cease operations. In addition,issuances of debt or additional equity could impact the rights of the holdersof our common stock, may dilute our stockholders’ ownership and may imposerestrictions on our operations. These restrictions could include limitations onadditional borrowing, specific restrictions on the use of our assets as well asprohibitions on our ability to create liens, pay dividends, redeem our stock ormake investments.

***If we lose our key personnel or are unable to attract andretain qualified personnel, it could adversely affect our business.***

Our success depends to asignificant degree upon the continued contributions of our executive officers,management and scientific staff. If we lose the services of one or more ofthese people and, in particular, Kent Snyder, our President and Chief ExecutiveOfficer, or Mark Zoller, Ph.D., our Executive Vice President of Discovery &Development and Chief Scientific Officer, the relationships we have with ourcollaborators would likely be negatively impacted and we may be delayed orunable to develop new product candidates, commercialize our existing productcandidates or achieve our other business objectives, any of which could causeour stock price to decline. We have entered into employment letter agreementswith the following executive officers: Kent Snyder, Mark Zoller, Ph.D., HarryLeonhardt, Esq., our Senior Vice President, General Counsel and CorporateSecretary, John Poyhonen, our Senior Vice President, Chief Financial andBusiness Officer and Sharon Wicker, our Senior Vice President and ChiefStrategy Officer.  

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All of our employees areat-will employees, which means that either we or the employee may terminatetheir employment at any time. We currently have no key person insurance.

In addition, ourdiscovery and development programs depend on our ability to attract and retainhighly skilled scientists, including molecular biologists, biochemists,chemists and engineers. We may not be able to attract or retain qualifiedemployees in the future due to the intense competition for qualified personnelamong technology-based businesses, particularly in the San Diego area. We alsoface competition from universities and public and private research institutionsin recruiting and retaining highly qualified scientific and managementpersonnel. If we are not able to attract and retain the necessary personnel toaccomplish our business objectives, we may experience constraints that willadversely affect our ability to meet the demands of our current or any futureproduct discovery and development collaborators in a timely fashion or tosupport our independent discovery and development programs.

***We may encounter difficulties managing our growth, whichcould adversely affect our business.***

Our strategy includesentering into and working on simultaneous flavor ingredient discovery anddevelopment programs across multiple markets. We increased the number of ourfull-time employees from seven on December 31, 1999 to 112 onDecember 31, 2006 and we expect to continue to grow to meet our strategicobjectives. If our growth continues, it will continue to place a strain on us,our management and our resources. Our ability to effectively manage our operations,growth and various projects requires us to continue to improve our operational,financial and management controls, reporting systems and procedures and toattract and retain sufficient numbers of talented employees. We may not be ableto successfully implement these tasks on a larger scale and, accordingly, wemay not achieve our research, development and commercialization goals.  If we fail to improve our operational,financial and management information systems, or fail to effectively monitor ormanage our new and future employees or our growth, our business would suffersignificantly. In addition, no assurance can be made that we will be able tomaintain adequate facilities to house our staff, conduct our research orachieve our business objectives.

***We will rely on third parties to manufacture our flavoringredients on a commercial scale.***

We do not have experiencein manufacturing, nor do we have the resources or facilities to manufacture,flavor ingredients on a commercial scale. Therefore, the commercialization ofour flavor ingredients will depend in part on our or our collaborators’ abilityto contract with third-party manufacturers of our flavor ingredients on a largescale, at a competitive cost, with the specified quality and in accordance withrelevant food and beverage regulatory requirements. Any such third-partymanufacturers may encounter manufacturing difficulties at any time that couldresult in delays in the commercialization of potential flavor ingredients. Ourinability to find capable third-party manufacturers or to enter into agreementson acceptable terms with third-party manufacturers could delaycommercialization of any products we may develop and may harm our relationshipswith our existing and any future product discovery and developmentcollaborators and our customers. Moreover, if we are required to change fromone third-party manufacturer to another for any reason, the commercializationof our products may be delayed further. In addition, if third-partymanufacturers fail to comply with the FDA’s good manufacturing practiceregulations or similar regulations in other countries, then we may be subjectto adverse regulatory action including product recalls, warning letters andwithdrawal of our products, or our collaborators’ or customers’ products, fromthe market.

Further, because ourflavor ingredients are regulated as food products under the FD&C Act, weand the third parties with which we collaborate or contract to manufacture,process, pack, import or otherwise handle our products or our productingredients, may be required to comply with certain registration, prior noticesubmission, recordkeeping and other regulatory requirements. Failure of anyparty in the chain of distribution to comply with any applicable requirementsunder the FD&C Act or the FDA’s implementing regulations, or similarregulations in other countries, may adversely affect the manufacture and/ordistribution of our products in commerce.

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***If we acquire products, technologies or other businesses, wewill incur a variety of costs, may have integration difficulties and mayexperience numerous other risks that could adversely affect our business.***

If appropriate opportunities become available, we mayconsider acquiring businesses, technologies or products that we believe are astrategic fit with our business. We currently have no commitments or agreementswith respect to, and are not actively seeking, any material acquisitions. Wehave limited experience in identifying acquisition targets, successfully acquiringthem and integrating them into our current infrastructure. We may not be ableto successfully integrate any businesses, products, technologies or personnelthat we might acquire in the future without a significant expenditure ofoperating, financial and management resources, if at all. In addition, futureacquisitions might be funded by issuances of additional debt or equity, whichcould impact your rights as a holder of our common stock and may dilute yourownership percentage. Any of the foregoing could have a significant adverseeffect on our business, financial condition and results of operations.

**RisksRelated To Our Industry**

***Our ability to compete in the flavor ingredient market maydecline if we do not adequately protect our proprietary technologies.***

Our success depends inpart on our ability to obtain and maintain intellectual property that protectsour technologies and flavor ingredients. Patent positions may be highlyuncertain and may involve complex legal and factual questions, including the abilityto establish patentability of sequences relating to taste receptors, proteins,chemical synthesis techniques, compounds and methods for using them to modulatetaste for which we seek patent protection. No consistent standard regarding theallowability or enforceability of claims in many of our pending patentapplications has emerged to date. As a result, we cannot predict the breadth ofclaims that will ultimately be allowed in our patent applications, if any,including those we have in-licensed or the extent to which we may enforce theseclaims against our competitors. The degree of future protection for ourproprietary rights is therefore highly uncertain and we cannot assure you that:

·                  we were the first to file patentapplications or to invent the subject matter claimed in patent applicationsrelating to the technologies upon which we rely;

·                  others will not independently developsimilar or alternative technologies or duplicate any of our technologies;

·                  others did not publicly disclose ourclaimed technology before we conceived the subject matter included in any ofour patent applications;

·                  any of our patent applications willresult in issued patents;

·                  any of our patent applications willnot result in interferences or disputes with third parties regarding priorityof invention;

·                  any patents that have issued or maybe issued to us, our collaborators or our licensors will provide a basis forcommercially viable products or will provide us with any competitive advantagesor will not be challenged by third parties;

·                  we will develop additionalproprietary technologies that are patentable;

·                  the patents of others will not havean adverse effect on our ability to do business; or

·                  newproprietary technologies from third parties, including existing licensors, willbe available for licensing to us on reasonable commercial terms, if at all.

In addition, patent lawoutside the United States is uncertain and in many countries intellectualproperty laws are undergoing review and revision. The laws of some countries donot protect intellectual property rights to the same extent as domestic laws.It may be necessary or useful for us to participate in opposition proceedingsto determine the validity of our competitors’ patents or to defend the validityof any of our or our licensors’ future patents, which could result insubstantial costs and would divert our efforts and attention from other aspectsof our business.

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Technologies licensed tous by others, or in-licensed technologies, are important to our business. Inparticular, we depend on high-throughput screening technologies that welicensed from Aurora Biosciences, technology related to certain taste receptorsequences that we license from the University of California and others andtechnology related to compound libraries that we license from third parties. Inaddition, we may in the future acquire rights to additional technologies bylicensing such rights from existing licensors or from third parties. Suchin-licenses may be costly. Also, we generally do not control the patentprosecution, maintenance or enforcement of in-licensed technologies.Accordingly, we are unable to exercise the same degree of control over thisintellectual property as we do over our internally developed technologies.Moreover, some of our academic institution licensors, collaborators andscientific advisors have rights to publish data and information to which wehave rights. If we cannot maintain the confidentiality of our technologies andother confidential information in connection with our collaborations, ourability to protect our proprietary information or obtain patent protection inthe future may be impaired, which could have a significant adverse effect onour business, financial condition and results of operations.

***Many of the patent applications we and our licensors havefiled have not yet been substantively examined and may not result in patentsbeing issued.***

Many of the patentapplications filed by us and our licensors were filed recently with the UnitedStates Patent and Trademark Office and most have not been substantivelyexamined and may not result in patents being issued. Some of these patentapplications claim sequences that were identified from different publiclyavailable sequence information sources such as the High-Throughput GenomicSequences division of GenBank. It is difficult to predict whether any of our orour licensors’ applications will ultimately be found to be patentable or, ifso, to predict the scope of any allowed claims. In addition, the disclosure inour or our licensors’ patent applications, particularly in respect of theutility of our claimed inventions, may not be sufficient to meet the statutoryrequirements for patentability in all cases. As a result, it is difficult topredict whether any of our or our licensors’ applications will be allowed, or,if so, to predict the scope of any allowed claims or the enforceability of thepatents. Even if enforceable, others may be able to design around any patentsor develop similar technologies that are not within the scope of such patents.Our and our licensors’ patent applications may not issue as patents that willprovide us with any protection or competitive advantage.

***Disputes concerning the infringement or misappropriation ofour proprietary rights or the proprietary rights of others could be timeconsuming and extremely costly and could delay our research and developmentefforts.***

Our commercial success,if any, will be significantly harmed if we infringe the patent rights of thirdparties or if we breach any license or other agreements that we have enteredinto with regard to our technology or business.

We are aware of othercompanies and academic institutions that have been performing research in theareas of taste modulation and flavor ingredients. In particular, othercompanies and academic institutions have announced that they have conductedtaste-receptor research and have published data on taste receptor sequenceinformation and taste receptors or filed patent applications or obtained patentprotection on taste modulation or taste receptors and their uses, includingRedpoint Bio, Mount Sinai School of Medicine, The Scripps Research Institute,the University of California, Monell Chemical Senses Corp., Pfizer, Inc.,  International Flavors & FragrancesInc., Givaudan SA, Symrise, Unilever, Firmenich, Tate & Lyle, NutraSweet,Ajinomoto, Cargill, Virginia Commonwealth University and the German Instituteof Human Nutrition. To the extent any of these companies or academicinstitutions currently have, or obtain in the future, broad patent claims, suchpatents could block our ability to use various aspects of our discovery anddevelopment process and might prevent us from developing or commercializingnewly discovered flavor ingredients or otherwise conducting our business. TheUniversity of California, for example, claims certain patent rights relating tothe coexpression of T1R receptors that may not have been licensed to us. Whileour technology is focused on the use of human T1R receptors, we cannot assure youthat it does not infringe such patent rights.  In such event, if we arenot able to amend our license with the University of California to include suchpatent rights and our technology is found to interfere with or infringe suchpatent rights, our business, financial condition and results of operationscould suffer a significant adverse effect. In addition, 

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it is possible that someof the flavor ingredients that are discovered using our technology may not bepatentable or may be covered by intellectual property of third parties.

We are not currently aparty to any litigation, interference, opposition, protest, reexamination,reissue or any other potentially adverse governmental, ex parte or inter-partyproceeding with regard to our patent or trademark positions.  However, thelife sciences and other technology industries are characterized by extensivelitigation regarding patents and other intellectual property rights. Many lifesciences and other technology companies have employed intellectual property litigationas a way to gain a competitive advantage. If we become involved in litigation,interference proceedings, oppositions, reexamination, protest or otherpotentially adverse intellectual property proceedings as a result of allegedinfringement by us of the rights of others or as a result of priority ofinvention disputes with third parties, we might have to spend significantamounts of money, time and effort defending our position and we may not besuccessful. In addition, any claims relating to the infringement of third-partyproprietary rights or proprietary determinations, even if not meritorious,could result in costly litigation, lengthy governmental proceedings, divertmanagement’s attention and resources, or require us to enter into royalty or licenseagreements that are not advantageous to us.

Should any person havefiled patent applications or obtained patents that claim inventions alsoclaimed by us, we may have to participate in an interference proceedingdeclared by the relevant patent regulatory agency to determine priority ofinvention and, thus, the right to a patent for these inventions in the UnitedStates. Such a proceeding could result in substantial cost to us even if theoutcome is favorable. Even if successful on priority grounds, an interferenceaction may result in loss of claims based on patentability grounds raised inthe interference action. Litigation, interference proceedings or otherproceedings could divert management’s time and efforts. Even unsuccessfulclaims could result in significant legal fees and other expenses, diversion ofmanagement’s time and disruption in our business. Uncertainties resulting frominitiation and continuation of any patent proceeding or related litigationcould harm our ability to compete and could have a significant adverse effecton our business, financial condition and results of operations.

An adverse ruling arisingout of any intellectual property dispute, including an adverse decision as tothe priority of our inventions, could undercut or invalidate our intellectualproperty position. An adverse ruling could also subject us to significantliability for damages, including possible treble damages, prevent us from usingtechnologies or developing products, or require us to negotiate licenses todisputed rights from third parties. Although patent and intellectual propertydisputes in the technology area are often settled through licensing or similararrangements, costs associated with these arrangements may be substantial andcould include license fees and ongoing royalties. Furthermore, necessarylicenses may not be available to us on satisfactory terms, if at all. Failureto obtain a license in such a case could have a significant adverse effect onour business, financial condition and results of operations.

***If we are unable to protect our trade secrets and otherproprietary information, we could lose any competitive advantage we may have,which could adversely affect our business.***

We rely in part on tradesecret protection for our confidential and proprietary information, know howand processes. Our policy is to execute proprietary information and inventionagreements with our employees and consultants upon the commencement of anemployment or consulting relationship. These agreements generally require thatall confidential information developed by the individual or made known to theindividual by us during the course of the individual’s relationship with us bekept confidential and not be disclosed to third parties. These agreements alsogenerally provide that inventions conceived by the individual in the course oftheir employment shall be our exclusive property. There can be no assurancethat we will be able to effectively enforce these agreements or thatproprietary information is our exclusive property. There can be no assurancethat the subject proprietary information will not be disclosed, that otherswill not independently develop substantially equivalent proprietary informationand techniques or otherwise gain access to our trade secrets or that we canmeaningfully protect our trade secrets. Costly and time-consuming litigationcould be necessary to enforce and determine the scope of our proprietaryrights, and failure to obtain or maintain trade secret protection couldadversely affect our competitive business position.

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***Many potential competitors, including those who have greaterresources and experience than we do, may develop products or technologies thatmake ours obsolete or noncompetitive.***

The life sciences andother technology industries are characterized by rapid technological change,and the area of sensory or taste receptor research is a rapidly evolving field.Our future success will depend on our ability to maintain a competitiveposition with respect to technological advances. Technological developments byothers may result in our flavor ingredients and technologies becoming obsolete.

In particular, we facesubstantial competition from companies pursuing the commercialization ofproducts and services relevant to taste using more traditional methods for thediscovery of flavor ingredients, or for the reduction of salt, sugar, MSG orbitter taste. These competitors include leading flavor companies, such asInternational Flavors & Fragrances Inc., Givaudan SA, Symrise,Quest International and Firmenich. We currently compete and will continue tocompete in the future with these companies in collaborating with and sellingflavor products and technologies to manufacturers of packaged food and beverageproducts. Many of these companies have substantially greater capital resources,research and development resources and experience, manufacturing capabilities,regulatory expertise, sales and marketing resources, established relationshipswith consumer products companies and production facilities.

Savory flavor enhancers,particularly IMP, are commercially available, and we will compete with thecompanies that produce these flavors. IMP is widely available and is agenerally accepted food additive by the packaged food and beverage industry. Asa result, our existing and future collaborators may choose to incorporate IMPor similar savory flavor enhancers into their packaged food and beverageproducts instead of our savory flavor ingredients.  In addition, we maycompete with bitter masking or bitter blocking compounds, such as AMP.

We may in the future facecompetition from life sciences and other technology companies and othercommercial enterprises. These entities engage as we do in biotechnology,biology or chemistry and could apply this technology to the discovery anddevelopment of flavor ingredients. We are aware of one other company, RedpointBio, a privately-held company that we believe is involved in research onsweetness potentiators, salt substitutes and bitter blockers, specifically AMP,and has announced research and development collaborations with severalcompanies. We cannot guarantee that products developed as a result of ourcompetitors’ existing or future collaborations will not compete with our flavoringredients.

Universities and publicand private research institutions are also potential competitors. While theseorganizations primarily have educational objectives, they may developproprietary technologies related to the sense of taste or secure patentprotection that we may need for the development of our technologies andproducts. We may attempt to license these proprietary technologies, but theselicenses may not be available to us on acceptable terms, if at all.

Our competitors, eitheralone or with their collaborative partners, may succeed in developingtechnologies or discovering flavor ingredients that are more effective, safer,more affordable or more easily commercialized than ours, and our competitorsmay obtain intellectual property protection or commercialize products soonerthan we do. Developments by others may render our product candidates or ourtechnologies obsolete. In addition, our current product discovery anddevelopment collaborators are not prohibited from entering into research anddevelopment collaboration agreements with third parties in any product field.Our failure to compete effectively would have a significant adverse effect onour business, financial condition and results of operations.

***We may be sued for product liability, which could adverselyaffect our business.***

Because our businessstrategy involves the development and sale by our collaborators of commercialproducts incorporating our flavor ingredients, we may be sued for productliability. We may be held liable if any product we develop and commercialize,or any product our collaborators commercialize that incorporates any of ourflavor ingredients, causes injury or is found otherwise unsuitable duringproduct testing, manufacturing, marketing, sale or consumer use. In addition,the safety studies we must perform and the regulatory approvals we must obtainprior to incorporating our flavor ingredients into a commercial product willnot protect us from any such liability.

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If we and ourcollaborators commence sale of commercial products we will need to obtainproduct liability insurance, and this insurance may be prohibitively expensive,or may not fully cover our potential liabilities. Inability to obtainsufficient insurance coverage at an acceptable cost or otherwise to protectagainst potential product liability claims could prevent or inhibit thecommercialization of products developed by us or our product discovery anddevelopment collaborators. We may be obligated to indemnify our productdiscovery and development collaborators for product liability or other lossesthey incur as a result of our flavor ingredients. Any indemnification wereceive from such collaborators for product liability that does not arise fromour flavor ingredients may not be sufficient to satisfy our liability toinjured parties. If we are sued for any injury caused by our flavor ingredientsor products incorporating our flavor ingredients, our liability could exceedour total assets.

***We use hazardous materials. Any claims relating to improperhandling, storage or disposal of these materials could be time consuming andcostly.***

Our discovery anddevelopment process requires our employees to routinely handle hazardouschemical, radioactive and biological materials. Our operations also producehazardous waste products. Federal, state and local laws and regulations governthe use, manufacture, storage, handling and disposal of these materials. As aresult of the increase in size of our operations, we are now classified as alarge quantity generator of hazardous waste. This classification may result inincreased scrutiny of our operations by the Environmental Protection Agency.Compliance with applicable environmental laws and regulations may be expensive,and current or future environmental regulations may impair our discovery anddevelopment efforts.

In addition, we cannot entirely eliminate the risk ofaccidental contamination or discharge and any resultant injury from thesematerials. Our insurance policies have limited coverage for damages or cleanupcosts related to hazardous waste disposal or contamination. We may be forced tocurtail operations or be sued for any injury or contamination that results fromour use or the use by others of these materials, and our liability may exceedour total assets.

**Risks Related To Our Common Stock**

***The price of our common stock is volatile.***

The market pricesfor securities of biotechnology companies historically have been highlyvolatile, and the market has from time to time experienced significant priceand volume fluctuations that are unrelated to the operating performance ofparticular companies. Since our initial public offering in June 2004, theprice of our common stock has ranged from approximately $5 per share toapproximately $23 per share. The market price of our common stock may fluctuatein response to many factors, including:

·                  developmentsconcerning our collaborative agreements;

·                  delays incommercialization of our flavor ingredients;

·                  results ofsafety evaluation of our flavor ingredients;

·                  developmentsrelated to the United States and international regulatory approval of ourproducts;

·                  results ofconsumer acceptance testing of our flavor ingredients by our collaborators;

·                  announcements oftechnological innovations by us or others;

·                  developments inpatent or other proprietary rights;

·                  future sales ofour common stock by existing stockholders;

·                  comments bysecurities analysts;

·                  general marketconditions;

·                  fluctuations inour operating results;

·                  governmentregulation;

·                  failure of anyof our flavor ingredients, if approved, to achieve commercial success; and

·                  publicconcern as to the safety of our flavor ingredients.

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***Anti-takeover provisions in our charter documents and underDelaware law may make an acquisition of us more complicated and the removal andreplacement of our directors and management more difficult.***

Provisions of our amendedand restated certificate of incorporation and bylaws, as well as provisions ofDelaware law, could make it more difficult for a third party to acquire us,even if doing so would benefit our stockholders. These provisions may also makeit difficult for stockholders to remove and replace our board of directors andmanagement. These provisions:

·                  authorize the issuance of “blankcheck” preferred stock by our board of directors, without stockholder approval,which could increase the number of outstanding shares and prevent or delay atakeover attempt;

·                  limit who may call a special meetingof stockholders;

·                  prohibit stockholder action bywritten consent, thereby requiring all stockholder actions to be taken at ameeting of our stockholders; and

·                  establishadvance notice requirements for nominations for election to the board ofdirectors or for proposing matters that can be acted upon at stockholdermeetings.

In addition, therequirements of Section 203 of the Delaware General Corporation Law maydiscourage, delay or prevent a third party from acquiring us.

***Our shareholder rights plan may hinder or prevent change ofcontrol transactions.***

Our shareholder rightsplans may discourage transactions involving an actual or potential change inour ownership.  In addition, our board ofdirectors may issue shares of preferred stock without any further action byyou.  Such issuances may have the effectof delaying or preventing a change in our ownership.  If changes in our ownership are discouraged,delayed or prevented, it would be more difficult for our current board ofdirectors to be removed and replaced, even if you and other stockholdersbelieve such actions are in the best interests of us and our stockholders.

***We have never paid cash dividends on our capital stock andwe do not anticipate paying dividends in the foreseeable future.***

We have paid no cashdividends on any of our classes of capital stock to date, and we currentlyintend to retain our future earnings, if any, to fund the development andgrowth of our business. In addition, the terms of any future debt or creditfacility may preclude us from paying any dividends. As a result, capitalappreciation, if any, of our common stock will be your sole source of potentialgain for the foreseeable future.

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** **

**Item 1B.   *Unresolved Staff Comments***

None.

**Item 2.    *Properties***

We currently leaseapproximately 64,000 square feet of laboratory and office space at 4767 NexusCenter Drive, San Diego, California, 92121. Our lease for this facility expires on February 28, 2017.Commencing April 1, 2007, our current monthly lease obligations for rent willbe approximately $192,000. Until April 1, 2007, we are not required to payrent.  We are responsible for expenses associatedwith the use and maintenance of the building, such as utilities and common areamaintenance. These costs will vary each month, and we expect that these costswill be approximately $101,000 per month.

We believe thatour facilities are adequate to meet our business requirements for the near-termand that additional space will be available on commercially reasonable terms,if required.

**Item 3.    *Legal Proceedings***

We are not a partyto any material legal proceedings at this time.

**Item 4.    *Submission of Matters to a Vote of Security Holders***

No matters weresubmitted to a vote of our security holders during the quarter endedDecember 31, 2006.

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**PART II**

**Item 5.    *Market for Registrant’s Common Equity, RelatedStockholder Matters and Issuer Purchases of Equity Securities***

**Common Stock Market Price**

Our common stockcommenced trading on the NASDAQ Stock Market on June 22, 2004 under thesymbol “SNMX.” The following table sets forth the high and low sales prices pershare of our common stock as traded on the NASDAQ Stock Market for the periodsindicated.
| Fiscal 2006 Quarter ended | ** ** | **March 31,  2006** | ** ** | **June 30,  2006** | ** ** | **September  30, 2006** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------|------------|--------------------------|------------|-------------------------|------------|------------------------------|------------|-----------------------------|------------|
| High                                     |       | $                        | 17.08      |                    | $          | 16.59                        |       | $                           | 15.75      |   | $ | 19.00 |   |
| Low                                      |       | $                        | 11.87      |                    | $          | 11.36                        |       | $                           | 12.01      |   | $ | 12.35 |   |

 
| Fiscal 2005 Quarter ended | ** ** | **March 31,  2005** | ** ** | **June 30,  2005** | ** ** | **September  30, 2005** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------|------------|--------------------------|------------|-------------------------|------------|------------------------------|------------|-----------------------------|------------|
| High                                     |       | $                        | 13.73      |                    | $          | 16.84                        |       | $                           | 22.80      |   | $ | 17.05 |   |
| Low                                      |       | $                        | 7.91       |                    | $          | 9.99                         |       | $                           | 16.01      |   | $ | 11.50 |   |

 

The last saleprice for our common stock as reported by the NASDAQ Stock Market onJanuary 31, 2007 was $14.62 per share. As of January 31, 2007, there were approximately 73 shareholders ofrecord of our common stock.

We have neverdeclared or paid any cash dividends to our shareholders. We do not presentlyplan to pay cash dividends in the foreseeable future and intend to retain anyfuture earnings for reinvestment in our business.

Information aboutour equity compensation plans is included in Item 12 of Part III of thisannual report.

**Repurchases of Equity Securities**

There were no repurchases of equity securities in thefourth quarter of 2006.

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** **

**Item 6.    *Selected Financial Data***

The Statement ofOperations Data and Balance Sheet Data presented below should be read inconjunction with Item 7, Management’s Discussion and Analysis of FinancialCondition and Results of Operations, and Item 8, Financial Statement includedin this annual report on Form 10-K. Amounts are in thousands, except share and per share amounts.
| ** **                                                       | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Statements of Operations Data:**                               |       |                                        |       |   |   |   |   |   |   |   |   |
| Revenue under  collaborative agreements                          |       | $                                           | 12,230     |   | $ | 9,385 |   | $ | 8,347 |   | $ | 9,537 |   | $ | 7,327 |   |
| Operating expenses:                                              |       |                                        |       |   |   |   |   |   |   |   |   |
| Research and  development                                        |       | 25,393                                      |       | 20,330 |   | 18,318 |   | 18,095 |   | 18,175 |   |
| General and  administrative                                      |       | 13,735                                      |       | 10,229 |   | 10,178 |   | 9,093 |   | 4,312 |   |
| Total operating  expenses                                        |       | 39,128                                      |       | 30,559 |   | 28,496 |   | 27,188 |   | 22,487 |   |
| Loss from operations                                             |       | (26,898                                     | )          | (21,174 | ) | (20,149 | ) | (17,651 | ) | (15,160 | ) |
| Interest income, net                                             |       | 3,841                                       |       | 1,344 |   | 435 |   | 198 |   | 339 |   |
| Net loss                                                         |       | $                                           | (23,057    | ) | $ | (19,830 | ) | $ | (19,714 | ) | $ | (17,453 | ) | $ | (14,821 | ) |
| Basic and diluted net  loss per share(1):                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Historical                                                       |       | $                                           | (0.77      | ) | $ | (0.77 | ) | $ | (1.40 | ) | $ | (10.03 | ) | $ | (9.60 | ) |
| Pro Forma                                                        |       |                                        |       |   |   | $ | (0.89 | ) | $ | (0.97 | ) |   |   |
| Shares used to compute  basic and diluted net loss per share(1): |       |                                        |       |   |   |   |   |   |   |   |   |
| Historical                                                       |       | 29,809,854                                  |       | 25,916,229 |   | 14,040,727 |   | 1,739,380 |   | 1,544,268 |   |
| Pro Forma                                                        |       |                                        |       |   |   | 22,143,380 |   | 17,944,686 |   |   |   |

 

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(1)          Please see Note 1to our financial statements for an explanation of the method used to calculatethe historical and pro forma net loss per share and the number of shares usedin the computation of the per share amounts. The pro forma basic and diluted net loss per share gives effect to theconversion of our convertible preferred stock into shares of common stock as ifconverted at the date of original issuance.

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| ** **                                                 | ** ** | **As of December 31,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                 | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Balance Sheet Data:**                                    |       |                                  |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and investments available-for-sale |       | $                                     | 74,104     |   | $ | 83,813 |   | $ | 40,847 |   | $ | 17,058 |   | $ | 27,586 |   |
| Working capital                                            |       | 65,455                                |       | 80,178 |   | 36,841 |   | 15,160 |   | 22,667 |   |
| Total assets                                               |       | 90,182                                |       | 88,531 |   | 43,802 |   | 20,440 |   | 34,720 |   |
| Long-term  obligations                                     |       | —                                |       | — |   | — |   | — |   | 906 |   |
| Accumulated  deficit                                       |       | (127,283                              | )          | (104,226 | ) | (84,396 | ) | (64,682 | ) | (47,229 | ) |
| Total stockholders’  equity                           |       | 69,477                                |       | 82,445 |   | 38,373 |   | 17,104 |   | 28,219 |   |
|                                                            |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Item 7.    *Management’s Discussion and Analysis of FinancialCondition and Results of Operations***

*Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with our Financial Statements and the relatedNotes to Financial Statements in Item 8, “Financial Statements andSupplementary Data” in this annual report on Form 10-K.*

*Certain statements contained in this annual reporton Form 10-K, including statements regarding the development, growth andexpansion of our business, our intent, belief or current expectations,primarily with respect to our future operating performance, and the products weexpect to offer and other statements regarding matters that are not historicalfacts, are “forward-looking statements” within the meaning of Section 27Aof the Securities Act and Section 21E of the Securities Exchange Act of1934, as amended, and are subject to the “safe harbor” created by thesesections. Future filings with the SEC, future press releases and future oral orwritten statements made by us or with our approval, which are not statements ofhistorical fact, may also contain forward-looking statements. Because suchstatements include risks and uncertainties, many of which are beyond ourcontrol, actual results may differ materially from those expressed or impliedby such forward-looking statements. Some of the factors that could cause actualresults to differ materially from those expressed or implied by suchforward-looking statements can be found under the caption “Risk Factors” andelsewhere in this annual report on Form 10-K.  Readers are cautioned not to place unduereliance on forward-looking statements. The forward-looking statements speakonly as of the date on which they are made, and we undertake no obligation toupdate such statements to reflect events that occur or circumstances that existafter the date on which they are made.*

**Overviewand Recent Developments**

We are a leadingcompany focused on using proprietary taste receptor-based assays, screeningtechnologies and optimization chemistry to discover and develop novel flavoringredients for the packaged food and beverage industry.  We believe our flavor ingredients will enablepackaged food and beverage companies to improve the nutritional profile oftheir products while maintaining or enhancing taste and may generate cost ofgoods savings.  We license our flavoringredients to our collaborators on an exclusive or co-exclusive basis, whichwe believe will provide these companies with the ability to differentiate theirproducts.  We have entered into productdiscovery and development collaborations with six of the world’s leadingpackaged food and beverage companies: Ajinomoto, Cadbury, Campbell, Coca-Cola,Kraft and Nestlé.  We currentlyanticipate that we will derive all of our revenues from existing and futurecollaborations.  Depending upon thecollaboration, our existing collaboration agreements provide for upfront fees,research and development funding, reimbursement of certain regulatory costs,milestone payments based upon our achievement of research or development goalsand, in the event of commercialization, royalties on future sales of consumerproducts incorporating our flavor ingredients. Our current programs focus on the development of savory, sweet and saltflavor enhancers, high potency sweeteners and bitter taste modulators.

We have incurredsignificant losses since our inception in 1998 and, as of December 31,2006 our accumulated deficit was $127.3 million.  We expect to incur additional losses over atleast the next two years as we continue to develop flavor ingredients.  Our results of operations have fluctuatedfrom period to 

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periodand likely will continue to fluctuate substantially in the future based upon:

·                  termination of any of our productdiscovery and development collaboration agreements;

·                  our ability to discover and developnew flavor ingredients or the ability of our product discovery and developmentcollaborators to incorporate them into their products;

·                  our ability to enter into new, orextend existing, product discovery and development collaborations and technologycollaborations;

·                  the demand for our collaborators’products containing our flavor ingredients; and

·                  variabilityof our stock-based compensation expense in conjunction with fluctuations of ourstock price.

In January 2006 we entered into a Lease Agreement withARE-NEXUS CENTRE II, LLC, or the Nexus Lease.  Under the terms of theNexus Lease, we are now leasing approximately 64,000 square feet of office,research and development space at 4767 Nexus Centre Drive, San Diego,California for a term commencing in late November 2006 with rent commencingApril 1, 2007 and ending on February 28, 2017.  We have theright to extend the term of the Nexus Lease for an additional five years, andwe have the right to terminate the Nexus Lease early effective March 31, 2014upon payment of an early termination fee. In connection with the execution ofthe Nexus Lease, in January 2006 we amended our existing lease with ARE-11099North Torrey Pines, LLC for the property located at 11099 North Torrey PinesRoad, La Jolla, California to provide for the extension of the lease term,subject to certain limitations, until we move all of our operations to the newlocation.  The majority of our operationswere moved to the new facility in November 2006.  We expect to move the remainder of ouroperations to the new facility in the first quarter of 2007.

In February 2006, weamended our existing agreement with Campbell to extend the collaborativeresearch phase for an additional research phase of up to three years, throughMarch 2009. During the extension period, we will continue to work withCampbell on the discovery and commercialization of new ingredients that improvethe taste of wet soups and savory beverages. Under the terms of the extension,Campbell has agreed to pay us incremental research funding of up to $3.0million, assuming we meet specified research goals, over the extension period.The other payment terms of the existing agreement, including milestones androyalties based on net sales of products using the new ingredients, remainunchanged.

In March 2006, we enteredinto a Collaborative Research, Development, Commercialization and LicenseAgreement with Ajinomoto. for the discovery and commercialization of novelflavor ingredients on an exclusive basis in the soup, sauce and culinary aids,and noodle product categories, and on a co-exclusive basis in the bouillonproduct category within Japan and other Asian markets.  Under the terms of the new collaboration,Ajinomoto has agreed to pay us an upfront license fee and discovery anddevelopment funding for up to three years.  In addition, we are eligibleto receive milestone payments upon achievement of specific product discoveryand development goals. The combined total of upfront license fees, researchfunding and milestone payments could exceed $8.3 million if all milestones aremet. Upon commercialization, we will receive royalty payments based on sales ofproducts containing flavor ingredients developed under the agreement.

In March 2006, weamended our existing discovery and development collaboration with Nestlé,originally entered into in 2002, to include commercialization of novel flavorsand flavor enhancers in the pet food category on a worldwide, co-exclusivebasis.  In addition to the expansion, theagreement with Nestlé has been amended to allow us to reacquire rights tocertain of our flavor ingredients in certain geographic regions. As a result ofthis amendment, Nestlé now has rights to flavor ingredients in Europe, Asia,Israel, Oceania, Africa, the Middle East and Latin America in specified productcategories within the dehydrated and culinary food, frozen food and/or wet soupproduct categories, as well as worldwide rights for the pet food category,while we have reacquired certain rights in North America and other geographicregions in specified product categories.

In October 2006,we entered into a second Collaborative Research, Commercialization and LicenseAgreement with Ajinomoto for the discovery and commercialization of specifiednatural flavor 

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ingredients.  Underthe terms of the agreement, Ajinomoto has agreed to pay us research funding forup to three years based on research progress during the collaborativeperiod.  In addition, we are eligible to receive payments upon achievementof specific milestones. The combined total of research funding and milestonepayments could exceed $2.8 million if all milestones are met. Uponcommercialization, we will receive payments based on sales of productscontaining new flavor ingredients developed under the agreement.

In March 2000, weentered into a license agreement with The Regents of the University ofCalifornia under which we obtained exclusive rights to certain technologiesheld by the University of California that are involved in the biology of taste,including specified receptors in two taste receptor families, T1Rs, andT2Rs.  In October 2006, we entered intoan amended and restated license agreement to include certain additional relatedtechnologies.  As with the originallicense agreement, the amended and restated license agreement calls for annualmaintenance fees and royalties on sales of any products developed using thetechnologies licensed under the agreement. Royalties will accrue in each country for as long as there exists avalid patent claim covering a product developed under the agreement.  The agreement will remain in effect until theexpiration of the last to expire patent licensed under the agreement.

**Revenue**

We derive revenuefrom our product discovery and development collaborations. To date, our revenuehas come solely from upfront fees, research and development funding,reimbursement of certain regulatory costs and milestone payments under ourproduct discovery and development collaboration agreements with Ajinomoto,Cadbury Schweppes, Campbell, Coca-Cola, Kraft Foods and Nestlé. As ofDecember 31, 2006, we have recognized cumulative revenue under ourcollaborations of $49.2 million. If any of these collaborative agreements wereto be terminated, this could have a significant effect on future revenues.

From our inceptiondate to the present, research and development payments represented the primarysource of our revenue. Based on current collaborations, we anticipate thatsubstantially all of our revenues in the near future will be derived from researchand development payments, and we may receive additional milestone payments inthe future upon the achievement of certain goals set forth in our collaborationagreements.

In addition, inthe event our collaborators launch products incorporating our flavoringredients, we will receive royalty payments based upon the future sales ofthose products, which, if received, could be significantly larger than researchand development funding or milestone payments. In order for us to generateroyalty revenue and become profitable, we must retain our existing or establishnew product discovery and development collaborations and our collaborators mustcommercialize products incorporating one or more of our flavor ingredients. Ourability to generate royalty revenue is uncertain and will depend upon ourability to meet particular research, development and commercializationobjectives.

**Researchand Development**

Our research anddevelopment expenses consist primarily of costs associated with our discoveryand development efforts in connection with our primary programs focused on thedevelopment of savory, sweet and salt flavor enhancers, high potency sweetenersand bitter taste modulators. We track research and development costs by thetype of cost incurred rather than by project. Research and development costsare comprised of salaries and other personnel-related expenses, facilities anddepreciation, research and development supplies, patent and licensing, outsideservices and non-cash stock-based compensation expenses. We charge research anddevelopment expenses to operations as incurred.

The research anddevelopment payments we have received from our collaboration agreements withAjinomoto, Cadbury Schweppes, Campbell, Coca-Cola, Kraft Foods and Nestléhistorically have not covered all of our research and development expenses. Weexpect that our research and development expenses are likely to increase in thefuture as a result of our existing product discovery and developmentcollaborations, internal product discovery and development activities andtechnology development and any expansion of these activities.

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At this time, dueto the risks inherent in the discovery of flavor ingredients, we are unable toestimate with any certainty the costs we will incur in the continueddevelopment of our flavor ingredients for commercialization.  We anticipate that we will makedeterminations regarding the research and development projects to pursue andthe funding of each project on an ongoing basis in response to the progress of eachdiscovery and development program, as well as an ongoing assessment of itsmarket potential. We cannot be certain when any net cash inflow from thecommercialization of our flavor ingredients will commence.

Our ability tocomplete the development of our current product candidates is subject to manyrisks and uncertainties. These risks include the risks, among others, that:

·                  we are substantially dependent uponour collaborators for research and development funding;

·                  our collaborators may terminate theirrespective collaboration programs early;

·                  we may not be able to discover flavoringredients with the desired taste attributes;

·                  we may not be successful indeveloping flavor ingredients with attributes required for use in commercialproducts;

·                  we may be unable to maintain FEMAGRAS determination for our savory product candidates; and

·                  wemay be unable to obtain FEMA GRAS determination or regulatory approval forcandidates in our other programs.

If we do notcomplete the development of our flavor ingredients on a timely basis, ourcollaborators may terminate or not renew our collaboration agreements, we maybegin receiving revenue from the commercialization of products incorporatingour flavor ingredients later than anticipated, or not at all, and it may bemore difficult to enter into new collaboration agreements. In any of thesecases, we may require substantial additional funding in order to continuedevelopment of our flavor ingredients.

**Generaland Administrative**

General andadministrative expenses consist primarily of salaries and otherpersonnel-related expenses related to business development, legal, financialand other administrative functions and Sarbanes-Oxley compliance.  General and administrative expenses alsoinclude non-cash stock-based compensation expenses.   We expect that our general andadministrative expenses are likely to increase in the future as a result ofsupporting additional commercialization activities, business development andresearch and development.

**Results of Operations**

**Years Ended December 31, 2006, 2005 and 2004**

***Revenue Under Collaboration Agreements***

We recordedrevenue of $12.2 million, $9.4 million and $8.3 million during the years endedDecember 31, 2006, 2005 and 2004, respectively.  Research anddevelopment payments, upfront fees and milestone payments under collaborationswith Ajinomoto, Cadbury Schweppes, Campbell, Coca-Cola, Kraft Foods and Nestléaccounted for approximately 100% of total revenue for the year endedDecember 31, 2006.  Research anddevelopment payments, reimbursement of certain regulatory expenses, upfrontfees and milestone payments under collaborations with Cadbury Schweppes,Campbell, Coca-Cola, Kraft Foods and Nestlé accounted for approximately 100% oftotal revenue for the year ended December 31, 2005.  Research and development payments andmilestone payments under collaborations with Campbell, Coca-Cola, Kraft Foodsand Nestlé accounted for 100% of total revenue for the year endedDecember 31, 2004.

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***Research and Development Expenses***

Our research anddevelopment expenses (including stock-based compensation expenses charged toresearch and development) were $25.4 million, $20.3 million and $18.3 millionfor the years ended December 31, 2006, 2005 and 2004, respectively. A comparison of research and development expenses by category is as follows (inthousands):
|                                                                                        | ** ** | **Year Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Salaries and  personnel                                                                |       | $                                      | 9,133      |   | $ | 7,685 |   | $ | 7,211 |   |
| Facilities and  depreciation                                                           |       | 5,133                                  |       | 4,568 |   | 4,449 |   |
| Research and  development supplies                                                     |       | 3,328                                  |       | 2,742 |   | 1,989 |   |
| Outside services                                                                       |       | 2,202                                  |       | 806 |   | 1,357 |   |
| Patent and  licensing                                                                  |       | 1,854                                  |       | 1,406 |   | 1,588 |   |
| Miscellaneous                                                                          |       | 695                                    |       | 476 |   | 313 |   |
| Total research  and development expenses (excluding non-cash stock-based compensation) |       | 22,345                                 |       | 17,683 |   | 16,907 |   |
| Non-cash  stock-based compensation                                                     |       | 3,048                                  |       | 2,647 |   | 1,411 |   |
| Total research  and development expenses                                               |       | $                                      | 25,393     |   | $ | 20,330 |   | $ | 18,318 |   |

 

***Salaries and Personnel.***  Ourexpenses for research and development personnel, including consultants, were$9.1 million, $7.7 million and $7.2 million for the years endedDecember 31, 2006, 2005 and 2004, respectively. Our research anddevelopment staff increased from an average of 61 for the year ended December31, 2005 to an average of 79 for the year ended December 31, 2006.  The increase in staff was primarily to support the identification and optimization ofproduct candidates from our discovery and development programs and to supportincreasing activities in product development and research management.  The increase of $474,000 from 2004 to2005 was primarily due to increases in payroll expenses of approximately$575,000, partially offset by a decrease in consulting expense of approximately$103,000.  Our research and developmentstaff increased from an average of 56 for the year ended December 31, 2004 toan average of 61 for the year ended December 31, 2005.  The increase in staff was primarily tosupport continuing optimization of product candidates from our discovery anddevelopment programs.

***Facilities and Depreciation.***    Ourfacilities and depreciation expenses were $5.1 million, $4.6 million and$4.4 million for the years ended December 31, 2006, 2005 and 2004,respectively. The increase of $565,000 from 2005 to 2006 was primarily attributableto increased depreciation expense due to the addition of new scientificequipment and costs associated with the move to the new facility in the fourthquarter of 2006.  The increase of$119,000 from 2004 to 2005 was primarily attributable to an increase in rentexpense and related costs of approximately $349,000, incurred as a result ofreduced sublease rental income and increased rent expense due to inflationadjustments.  This increase was partiallyoffset by a reduction in our depreciation expense of approximately $230,000.

***Research and Development Supplies.*** Our expenses for supplies used in research and development were $3.3 million,$2.7 million and $2.0 million for the years ended December 31, 2006, 2005and 2004, respectively.  The increase of $586,000 from 2005 to 2006 wasprimarily attributable to increased purchases of scientific supplies andcompound acquisition expenses associated with increased screening activity in2006. The increase of $753,000 from 2004 to 2005 was primarily attributable toincreased purchases of scientific supplies and compound acquisition expensesassociated with increased screening activity in 2005.

***Outside Services.***  Our outsideservices expenses were $2.2 million, $806,000 and $1.4 million for the yearsended December 31, 2006, 2005 and 2004, respectively.  The increaseof $1.4 million from 2005 to 2006 was primarily attributable to an increase incosts incurred for chemistry and product development 

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outsourcing.  The decrease of $551,000 from 2004 to 2005was primarily attributable to a reduction of costs incurred for outsourceddevelopment activities related to the development of our savory ingredients,which were determined to be FEMA GRAS in March 2005.

***Patent and Licensing.***  Our patentand licensing expenses were $1.9 million, $1.4 million and $1.6 million for theyears ended December 31, 2006, 2005 and 2004, respectively.  Theincrease of $448,000 from 2005 to 2006 was primarily attributable to certainforeign patent activities commencing in the fourth quarter of 2005 and completedin the second quarter of 2006.  Thedecrease of $182,000 from 2004 to 2005 was primarily attributable to reducedlicensing fees in 2005 compared to 2004.

***Non-cashStock-based Compensation.*** Our non-cash stock-based compensation expenses were $3.0 million, $2.6million and $1.4 million for the years ended December 31, 2006, 2005 and2004, respectively.  The increase of$401,000 from 2005 to 2006 was primarily due to an increase in compensationexpense in 2006 compared to 2005 for stock options granted to employees,partially offset by a decrease in compensation expense for stock optionsgranted to non-employees.  The increasein employee-related stock-based compensation expense is due to our adoption ofSFAS 123R in the first quarter of 2006. The increase of $1.2 million from 2004 to 2005 was primarily due to anincrease in compensation expense in 2005 compared to 2004 for stock optionsgranted to non-employees, as the fair value of these options atDecember 31, 2005 was revalued in accordance with Emerging Issues TaskForce, or EITF, Issue No. 96-18, *Accounting for EquityInstruments That Are Issued to Other Than Employees for Acquiring or inConjunction with Selling Goods or Services*.  This increase was partially offset by adecrease in stock-based compensation expense in 2005 compared to 2004 for stockoptions granted to employees, as the amortization of deferred compensationrelated to these stock options is recognized on an accelerated basis.

***General and Administrative Expenses***

Our general andadministrative expenses (including stock-based compensation expenses charged togeneral and administrative) were $13.7 million, $10.2 million and $10.2 millionfor the years ended December 31, 2006, 2005 and 2004, respectively. The $3.5 million increase in expenses from 2005 to 2006 was primarilyattributable to an increase in non-cash stock-based compensation expense ofapproximately $1.8 million, an increase in payroll expense of approximately$1.2 million, and an increase in consulting expenses of approximately $488,000.  Theincrease in non-cash stock-based compensation expense is due to the adoption ofSFAS 123R in the first quarter of 2006, offset by a decrease in amortization ofdeferred compensation and compensation expense for stock options granted tonon-employees.  The increases in expensesfor payroll and in expenses for recruiting and relocation were due to theimpact of annual merit, cost of living and promotion salary increases and toincreased headcount.  The increase inconsulting expenses was due to one-time consulting expenses.

  The $51,000 increase inexpenses from 2004 to 2005 was attributable to increases in personnel andrelated expenses, audit, legal and consulting fees and facilities-relatedexpenses of approximately $2.0 million, partially offset by a decrease innon-cash stock-based compensation expense of approximately $1.9 million.  The increase in expenses for personnel andrelated expenses of approximately $1.0 million was due to increased headcountreflecting our increased business development activities, reporting activitiesand Sarbanes-Oxley compliance activities. Additionally, the increase in expense was due to increases in audit,legal and consulting fees of approximately $358,000, $178,000 and $53,000,respectively, due to Sarbanes-Oxley compliance requirements and increasedreporting obligations as a result of being a public company for a full year, asopposed to part of the year in 2004. Also, facilities-related expenses increased approximately $208,000,primarily attributable to an increase in rent expense and related costs ofapproximately $188,000, incurred as a result of reduced sublease rental incomeand increased rent expense due to inflation adjustments.  These increases were offset by a decrease innon-cash stock-based compensation expense of approximately $1.9 million.  The decrease in overall stock-basedcompensation expense is primarily due to a decrease in stock-based compensationexpense in 2005 compared to 2004 for stock options granted to employees, as theamortization of deferred compensation related to these stock options isrecognized on an accelerated basis.

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***Interest Income***

Interest incomewas $3.8 million, $1.3 million and $435,000 for the years endedDecember 31, 2006, 2005 and 2004, respectively.  The increase of $2.5million from 2005 to 2006 was primarily attributable to our higher average cashbalances for the year ended December 31, 2006 as a result of our November 2005public offering of common stock, and to higher rates of return on thosebalances.  The increase of $909,000 from2004 to 2005 was primarily attributable to our higher average cash balances forthe year ended December 31, 2005 as a result of our initial publicoffering in June 2004 and our November 2005 public offering of common stock,which generated higher interest earnings on those balances.

***Liquidity and CapitalResources***

Since ourinception, we have financed our business primarily through private and publicplacements of stock, research and development payments under our productdiscovery and development collaborations with Ajinomoto, Cadbury Schweppes,Campbell, Coca-Cola, Kraft Foods and Nestlé, and interest income.  As ofDecember 31, 2006 we had received in excess of $167.5 million in proceedsfrom the sales of common and preferred stock.  In addition, we hadreceived $54.4 million in non-refundable license fees, research and developmentpayments, cost reimbursements and milestone payments from our collaborationagreements, and $7.5 million in interest income.  As of December 31, 2006,over the remaining life of our current collaboration agreements, we expect toreceive an additional $21.6 million in non-refundable research and developmentpayments from our collaborators.  We may not receive these payments if thecollaborations are terminated.  Inaddition, we may receive payments in the event we achieve research ordevelopment milestones and royalty payments in the event our collaboratorscommercialize products incorporating our flavor ingredients.

AtDecember 31, 2006, we had $74.1 million in cash, cash equivalents andinvestments available-for-sale as compared to $83.8 million atDecember 31, 2005, a decrease of $9.7 million.  This overall decreaseresulted primarily from the use of cash to fund our operations.

***Operating Activities***

Operatingactivities used cash of $8.1 million for the year ended December 31, 2006compared to $13.9 million for the year ended December 31, 2005.  Operating cash flow in 2006 compared to theprior year period reflects an increase in our net loss of $3.2 million.  Non-cash expenses increased $1.2 million to$7.6 million for the year ended December 31, 2006 from $6.3 million for theyear ended December 31, 2005.  Theincrease in non-cash operating expenses was primarily due to the implementationof SFAS 123R in the first quarter of 2006. Net decreases in other current assets provided cash of $1.1 million forthe year ended December 31, 2006, while net increases in other current assetsused cash of $978,000 for the year ended December 31, 2005.  Net increases in operating liabilitiesprovided cash of $6.4 million and $522,000 for the years ended December 31,2006 and 2005, respectively.

Operatingactivities used cash of $13.9 million for the year ended December 31, 2005compared to $10.1 million for the year ended December 31, 2004. Operating cash flow in 2005 compared to the prior year period reflects anincrease in our net loss of $116,000.  Non-cash expenses for the yearended December 31, 2005 decreased $1.2 million to $6.3 million for theyear ended December 31, 2005 from $7.5 million for the year endedDecember 31, 2004.  This decrease was primarily due to a relativedecrease in the amortization of employee deferred stock-based compensation ofapproximately $2.6 million for the year ended December 31, 2005, partiallyoffset by an increase in stock-based compensation expense for non-employees of$1.9 million for the year ended December 31, 2005.  Additionally, netincreases in operating assets and liabilities over the year endedDecember 31, 2005 used cash of $456,000, while net increases in operatingassets and liabilities over the year ended December 31, 2004 provided cashof $2.1 million.

***Investing Activities***

Investingactivities used cash of $47.2 million for the year ended December 31,2006.  Cash used in 2006 reflects thepurchases of available for sale securities of $110.2 million and purchases ofproperty and equipment of $5.7 million. These purchases were partially offset by the maturities ofavailable-for-sale securities of $68.7 million.

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Investingactivities provided cash of $12.1 million for the year ended December 31,2005.  Cash provided in 2005 reflects the maturities of available-for-salesecurities of $45.8 million, offset by purchases of available-for-salesecurities of $31.8 million with the proceeds from our public offering inNovember 2005 to obtain higher rates of interest income.

Investingactivities used cash of $21.3 million for the year ended December 31,2004.  Cash used in 2004 reflects thepurchases of available-for-sale securities with the proceeds from our initialpublic offering in June 2004 to obtain higher rates of interest income.

***Financing Activities***

Financingactivities provided cash of $2.6 million, $58.7 million and $35.0 million forthe years ended December 31, 2006, 2005 and 2004, respectively.  Cash provided by financing activities in 2006reflects the net proceeds from the sale of common stock of $2.6 million,primarily from the exercise of stock options. Cash provided by financing activities in 2005 reflects the net proceedsfrom the sale of common stock of $58.7 million, primarily from the sale ofcommon stock during our November 2005 public offering of common stock. Cash provided by financing activities in 2004 reflects the net proceeds fromthe sale of common stock of $35.0 million, primarily from the sale of commonstock during our initial public offering.

As ofDecember 31, 2006 future minimum payments due under our contractualobligations are as follows (in thousands):
| ** **       | ** ** | **Payments Due by Period** | ** ** |
|------------------|------------|-------------------------------------------|------------|
| ** **       | ** ** | **Total**                                 | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **After 5 years** | ** ** |
| Operating leases |       | $                                         | 26,748     |   | $ | 1,804 |   | $ | 4,923 |   | $ | 5,180 |   | $ | 14,841 |   |
| License payments |       | 194                                       |       | 56 |   | 66 |   | 36 |   | 36 |   |
| Total            |       | $                                         | 26,942     |   | $ | 1,860 |   | $ | 4,989 |   | $ | 5,216 |   | $ | 14,877 |   |

 

As ofDecember 31, 2006, we had no long-term debt obligations.

As ofDecember 31, 2006, we have net open purchase orders (defined as total openpurchase orders at year end less any accruals or invoices charged to or amountspaid against such purchase orders) totaling approximately $752,000.  In the next twelve months, we also plan tospend approximately $3.0 to $3.5 million on capital expenditures.

Our future capitaluses and requirements depend on numerous forward-looking factors.  Thesefactors may include, but are not limited to, the following:

·                  the rate of progress and cost ofresearch and development activities;

·                  the number and scope of our researchactivities;

·                  the costs of filing, prosecuting,defending and enforcing any patent claims and other intellectual propertyrights;

·                  our ability to establish and maintainproduct discovery and development collaborations;

·                  the effect of competing technologicaland market developments;

·                  the terms and timing of anycollaborative, licensing and other arrangements that we may establish; and

·                  theextent to which we acquire or in-license new products, technologies orbusinesses.

We believe ouravailable cash, cash equivalents, investments and existing sources of fundingwill be sufficient to satisfy our anticipated operating and capitalrequirements through at least the next 12 months.

Until we cangenerate significant cash from our operations, we expect to continue to fundour operations with existing cash resources that were primarily generated fromthe proceeds of offerings of our equity securities and research and developmentpayments and milestone payments under our product 

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discoveryand development collaborations.  As of December 31, 2006, under ourexisting collaboration agreements, assuming all milestones are achieved and wereceive all research and development funding, we may be entitled to up to $33.9million.  In 2007, we anticipate receiving $10.9 million in non-refundableresearch and development funding.  Thisdoes not include any additional payments we may receive related to the achievementof additional milestones, or to new collaborations or extensions of existingcollaborations.  We may not receive thepayments if the collaborations are terminated or not renewed, or if we do notachieve the milestones set forth in the collaboration agreements.  Inaddition, the timing of the receipt of milestone payments in particular isuncertain, as we may achieve milestones significantly earlier or later than wecurrently expect.

We continue topursue additional collaborations, which could result in additionalrevenue.  We may not recognize revenues for research and developmentfunding or milestones if the collaborations are terminated, or if we do notachieve the milestones set forth in the collaboration agreements.  Ourexpenses will vary based upon (but not limited to) the forward-looking factorslisted above.

***Off-Balance Sheet Arrangements***

As ofDecember 31, 2006 and 2005, we did not have any relationships withunconsolidated entities or financial partnerships, such as entities oftenreferred to as special purpose or structured finance entities, which would havebeen established for the purposes of facilitating off-balance sheetarrangements or other contractually narrow or limited purposes.  As such,we are not materially exposed to any financing, liquidity, market or creditrisk that could arise if we had engaged in these relationships.

**Critical Accounting Policies**

Our discussion andanalysis of our financial condition and results of operations are based on ourfinancial statements, which have been prepared in accordance with United Statesgenerally accepted accounting principles, or GAAP.  The preparation ofthese financial statements requires management to make estimates and judgmentsthat affect the reported amounts of assets, liabilities and expenses andrelated disclosure of contingent assets and liabilities.  On an ongoingbasis, we evaluate these estimates, including those related to revenuerecognition, long-lived assets, accrued liabilities, and income taxes. These estimates are based on historical experience and various otherassumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for judgments about the carrying values ofassets and liabilities.  Actual results may differ from these estimatesunder different assumptions or conditions.  While our significantaccounting policies are described in more detail in Note 1 to our financialstatements, we believe the following accounting policies to be critical to thejudgments and estimates used in the preparation of our financial statements:

***Revenue Recognition***

Our revenue recognition policies are in compliance with the StaffAccounting Bulletin, or SAB, No. 104, *Revenue Recognition*and EITF Issue No. 00-21, *Revenue Arrangements withMultiple Deliverables*.  Someof our agreements contain multiple elements, including upfront fees, researchfunding, milestones, and royalties.

Revenue is deferred for fees received before earned.Non-refundable upfront fees associated with our future performance are deferredand recognized over the remaining minimum period of our performance obligationsunder the agreement.  Non-refundablelicense fees associated with future performance involving a specific program orcollaboration are recognized over the period of service for that specificprogram or collaboration.  Non-refundableupfront fees, if not associated with our future performance, will be recognizedwhen received.  Amounts received forresearch funding are recognized as revenues as the services are performed.  Revenue from milestones is recognized whenearned, as evidenced by written acknowledgement from the collaborator or otherpersuasive evidence that the milestone has been achieved, provided that (i) themilestone event is substantive and its achievability was not reasonably assuredat the inception of the agreement, and (ii) our performance obligations afterthe milestone achievement will continue to be funded by the collaborator at alevel comparable to before the milestone achievement.  If both of these criteria are not met, themilestone payment is recognized over the remaining minimum period 

48

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of our performanceobligations under the agreement.  Revenuefrom cost reimbursements is recognized when earned, as evidenced by writtenacknowledgement from the collaborator or other persuasive evidence.  Royalties to be received based on productsales made by our collaborators incorporating our product, if any, will berecognized as earned.  To date, we havenot earned any royalties.

***Stock-based Compensation***

We grant optionsto purchase our common stock to our employees and directors under our equityincentive plan. Eligible employees can also purchase shares of our common stockunder our employee stock purchase plan at the lower of: (i) 85% of the fairmarket value on the first day of a two-year offering period; or (ii) 85% of thefair market value on the last date of each six-month purchase period within thetwo-year offering period.  In addition,we grant options to purchase our common stock to non-employees under our equityincentive plan.

For the yearsended December 31, 2005 and 2004, prior to the adoption of SFAS 123R, werecorded deferred compensation for stock options and stock awards granted equalto the difference between the exercise price and the fair value of our commonstock on the date of grant as determined for the purpose of recording ourinitial public offering, or IPO, cheap stock calculation. We recorded optionsor awards issued to non-employees at their fair value in accordance with theSFAS 123, *Accounting for Stock-Based Compensation*,and periodically remeasure them in accordance with EITF 96-18 and recognizethem over the service period. In connection with the grant of stock options toemployees, we recorded deferred stock-based compensation of $442,000 for theyear ended December 31, 2004. We recorded this amount as a component ofstockholders’ equity and amortized it, on an accelerated basis, as a non-cashcharge to operations over the vesting period of the options. We recordedemployee and non-employee stock-based compensation expense of $5.3 million and$6.0 million for the years ended December 31, 2005 and 2004, respectively.

InDecember 2004, the FASB issued SFAS 123R, which requires companies toexpense the estimated fair value of employee stock options and similar awards.This statement is a revision to SFAS 123 and supersedes Accounting PrinciplesBoard, or APB, Opinion No. 25, *Accounting for StockIssued to Employees*, and amends FASB Statement No. 95, *Statement of Cash Flows*. The accounting provisions of SFAS 123R were effective for the firstquarter of fiscal 2006.   In conjunctionwith the adoption of SFAS 123R, the unamortized balance of deferredcompensation recorded for our IPO cheap stock calculation was reclassified toadditional paid-in capital.  As of ouradoption date of SFAS 123R, the unamortized balance of deferred compensationwas $1.1 million.

Effective January1, 2006, we use the fair value method to apply the provisions of SFAS 123R witha modified prospective application which provides for certain changes to themethod for valuing stock-based compensation. The valuation provisions of SFAS123R apply to new awards and to awards that are outstanding on the effectivedate and subsequently modified or cancelled. Under the modified prospectiveapplication, prior periods are not revised for comparative purposes.Stock-based compensation expense recognized under SFAS 123R for the year endedDecember 31, 2006 was $6.3 million. At December 31, 2006, total unrecognizedestimated compensation expense related to non-vested stock options grantedprior to that date was $10.3 million, which is expected to be recognized over aweighted average period of 1.9 years. Total stock options granted to employeesand non-employee directors during the years ended December 31, 2006 and 2005represented 4.1% and 2.5%, respectively, of outstanding shares as of the end ofeach fiscal year.

Both prior andsubsequent to the adoption of SFAS 123R, we estimated the value of stock-basedawards on the date of grant using the Black-Scholes option pricing model. Priorto the adoption of SFAS 123R, the value of each stock-based award was estimatedon the date of grant using the Black-Scholes model for the pro formainformation required to be disclosed under SFAS 123 in the footnotes to ourfinancial statements. The determination of the fair value of stock-basedpayment awards on the date of grant using an option-pricing model is affectedby our stock price as well as assumptions regarding a number of complex and subjectivevariables. These variables include, but are not limited to, our expected stockprice volatility over the term of the awards, risk-free interest rate and theexpected term of the awards.

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If factors changeand we employ different assumptions in the application of SFAS 123R in futureperiods, the compensation expense that we record in future periods under SFAS123R may differ significantly from what we have recorded in the current period.Therefore, we believe it is important for investors to be aware of the highdegree of subjectivity involved when using option pricing models to estimatestock-based compensation under SFAS 123R. Option-pricing models were developedfor use in estimating the value of traded options that have no vesting orhedging restrictions, are fully transferable and do not cause dilution. Becauseour stock-based payments have characteristics significantly different fromthose of freely traded options, and because changes in the subjective inputassumptions can materially affect our estimates of fair values, in our opinion,existing valuation models, including the Black-Scholes model, may not providereliable measures of the fair values of our stock-based compensation.Consequently, there is a risk that our estimates of the fair values of ourstock-based compensation awards on the grant dates may bear little resemblanceto the actual values realized upon the exercise, expiration, early terminationor forfeiture of those stock-based payments in the future. Certain stock-basedpayments, such as employee stock options, may expire worthless or otherwiseresult in zero intrinsic value as compared to the fair values originallyestimated on the grant date and reported in our financial statements.Alternatively, value may be realized from these instruments that issignificantly in excess of the fair values originally estimated on the grantdate and reported in our financial statements. There is currently nomarket-based mechanism or other practical application to verify the reliabilityand accuracy of the estimates stemming from these valuation models, nor isthere a means to compare and adjust the estimates to actual values. Althoughthe fair value of employee stock-based awards is determined in accordance withSFAS 123R and SAB 107 using an option-pricing model, that value may not beindicative of the fair value observed in a willing buyer/willing seller markettransaction.

Estimates ofstock-based compensation expenses are significant to our financial statements,but these expenses are based on the aforementioned option valuation model andwill never result in the payment of cash by us. For this reason, we do not viewstock-based compensation as related to our operational performance.

For purposes ofestimating the fair value of stock options granted to employees andnon-employee directors during the year ended December 31, 2006 using theBlack-Scholes model, we have made a subjective estimate regarding our stockprice volatility (weighted average of 60.43% for the year ended December 31,2006). We used an average of the historical volatility of our stock for theperiod our stock has been publicly traded and the historical volatilities ofthe common stock of several publicly traded companies management feels arecomparable to us, consistent with the guidance in SFAS 123R and SAB 107.  If our stock price volatility assumption wereincreased to 70%, the weighted average estimated fair value of stock optionsgranted during the year ended December 31, 2006 would increase by $0.93 pershare, or 9.8%.

The risk-freeinterest rate for the expected term of the option is based on the averageUnited States Treasury yield curve at the balance sheet date for the expectedterm (weighted average of 4.88% for the year ended December 31, 2006) which, ifincreased to 6.00%, would increase the weighted average estimated fair value ofstock options granted during the year ended December 31, 2006 by $0.26 pershare, or 2.7%.

***Leasehold Incentive Obligation***

In conjunction with the Nexus Lease, we received atenant improvement allowance of up to $155 per square foot, or $9.9million.  As the tenant improvements wereconstructed, we recorded both the covered tenant improvements (as fixed assets)and an offsetting leasehold incentive obligation on our balance sheet.  As construction on the facility has beencompleted and we have taken occupancy of the new facility, we are recordingdepreciation expense to depreciate the covered tenant improvements andrecording an offsetting reduction to rent expense to amortize the leasehold incentiveobligation over the initial term of the Nexus Lease, in accordance with FASBTechnical Bulletin 88-1, *Issues Relating toAccounting for Leases*.

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**New Accounting Pronouncements**

In June 2006, theFASB ratified EITF Issue No. 06-2, *Accounting for SabbaticalLeave and Other Similar Benefits Pursuant to FASB Statement No. 43,Accounting for Compensated Absences*. EITF Issue No. 06-2 provides guidelines under which sabbatical leave orother similar benefits provided to an employee are considered to accumulate, asdefined in SFAS 43. If such benefits are deemed to accumulate, then thecompensation cost associated with a sabbatical or other similar benefitarrangement should be accrued over the requisite service period. The provisionsof this Issue are effective for fiscal years beginning after December 15,2006 and allow for either retrospective application or a cumulative effectadjustment to accumulated deficit approach upon adoption. We do not expect theadoption of EITF Issue No. 06-02 to have a material impact on our financialstatements.

In June 2006,the FASB issued FASB Interpretation No., or FIN, 48, *Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109*. FIN 48prescribes a recognition threshold and measurement attribute for recognitionand measurement of a tax position taken or expected to be taken in a taxreturn. FIN 48 also provides guidance on de-recognition, classification,interest and penalties, accounting in interim periods, disclosure andtransition. The interpretation is effective for fiscal years beginning afterDecember 15, 2006. The cumulative effect upon adoption of applying theprovision shall be reported as an adjustment to the opening balance of retainedearnings for that fiscal year, presented separately. We do not expect theadoption of FIN 48 to have a material impact on our financial statements.

In September 2006,the FASB issued SFAS 157, *Fair Value Measurements*.SFAS 157 establishes a framework for measuring fair value in accordance withGAAP, clarifies the definition of fair value within that framework, and expandsdisclosures about the use of fair value measurements.  It also responds to investors’ requests forexpanded information about the extent to which companies measure assets andliabilities at fair value, the information used to measure fair value and theeffect of fair value measurements on earnings. SFAS 157 applies whenever otherstandards require (or permit) assets or liabilities to be measured at fairvalue, and does not expand the use of fair value in any new circumstances. SFAS157 is effective for financial statements issued for fiscal years beginningafter November 15, 2007. We do not expect the adoption of SFAS 157 to havea material impact on its financial statements.

**Item7A.    *Quantitative andQualitative Disclosures About Market Risk***

Our primaryexposure to market risk is interest income sensitivity, which is affected bychanges in the general level of United States interest rates. Due to the natureof our short-term investments, we believe that we are not subject to anymaterial market risk exposure. We do not have any foreign currency or otherderivative financial instruments.

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**Item 8.    *Financial Statements and Supplementary Data***

**Index to Financial Statements**
| Description                                              | ** ** | ** ** |
|----------------------------------------------------------|------------|------------|
|                                                     |       |       |
| Report of Independent  Registered Public Accounting Firm |       |       |
|                                                     |       |       |
| Balance Sheets                                           |       |       |
|                                                     |       |       |
| Statements of Operations                                 |       |       |
|                                                     |       |       |
| Statements of Stockholders’  Equity                 |       |       |
|                                                     |       |       |
| Statements of Cash Flows                                 |       |       |
|                                                     |       |       |
| Notes to Financial  Statements                           |       |       |

** **

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** **

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

The Board of Directors andStockholdersSenomyx, Inc.

We have auditedthe accompanying balance sheets of Senomyx, Inc. as of December 31, 2006and 2005, and the related statements of operations, stockholders’ equity, andcash flows for each of the three years in the period ended December 31,2006. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted ouraudits in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

In our opinion,the financial statements referred to above present fairly, in all materialrespects, the financial position of Senomyx, Inc. at December 31, 2006 and2005, and the results of its operations and its cash flows for each of thethree years in the period ended December 31, 2006, in conformity with U.S.generally accepted accounting principles.

As discussed in Note 1 to the financial statements,effective January 1, 2006, Senomyx, Inc. adopted Statement of FinancialAccounting Standards No. 123 (revised 2004), *“Accountingfor Stock-Based Compensation”*.

We have alsoaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the effectiveness of Senomyx, Inc.’s internalcontrol over financial reporting as of December 31, 2006, based on thecriteria established in Internal Control-Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our reportdated February 20, 2007, expressed an unqualified opinion thereon.

 
|                   | /s/ Ernst & Young LLP |   |
|------------------------|---------------------------|--------|
|                   |                      |
|                   |                      |
| San Diego,  California |                      |
| February 20,  2007     |                      |

 

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**Senomyx, Inc.**

**Balance Sheets**

**(Inthousands, except share and per share data)**
| ** **                                                                                                                                                               | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                               | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **Assets:**                                                                                                                                                              |       |                  |       |   |   |
| Current assets:                                                                                                                                                          |       |                  |       |   |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                                |       | $                     | 21,225     |   | $ | 73,908 |   |
| Investments available-for-sale                                                                                                                                           |       | 52,879                |       | 9,905 |   |
| Other current assets                                                                                                                                                     |       | 1,239                 |       | 2,300 |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| Total current  assets                                                                                                                                                    |       | 75,343                |       | 86,113 |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| Property and  equipment, net                                                                                                                                             |       | 14,839                |       | 2,418 |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| Total assets                                                                                                                                                             |       | $                     | 90,182     |   | $ | 88,531 |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| **Liabilities  and stockholders’ equity**                                                                                                                           |       |                  |       |   |   |
| Current  liabilities:                                                                                                                                                    |       |                  |       |   |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| Accounts payable and accrued expenses                                                                                                                                    |       | $                     | 5,410      |   | $ | 4,096 |   |
| Other current liabilities                                                                                                                                                |       | 39                    |       | 111 |   |
| Leasehold incentive obligation                                                                                                                                           |       | 966                   |       | — |   |
| Deferred revenue                                                                                                                                                         |       | 3,473                 |       | 1,728 |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| Total current  liabilities                                                                                                                                               |       | 9,888                 |       | 5,935 |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| Deferred rent                                                                                                                                                            |       | 213                   |       | 151 |   |
| Leasehold  incentive obligation                                                                                                                                          |       | 8,854                 |       | — |   |
| Deferred revenue                                                                                                                                                         |       | 1,750                 |       | — |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| Commitments                                                                                                                                                              |       |                  |       |   |   |
| Stockholders’  equity:                                                                                                                                              |       |                  |       |   |   |
| Preferred stock, $.001 par value, 7,500,000 shares  authorized; no shares issued or outstanding at December 31, 2006 and  2005                                      |       | —                |       | — |   |
| Common stock, $.001 par value, 120,000,000 shares  authorized; 30,166,399 and 29,678,697 shares issued and outstanding at  December 31, 2006 and 2005, respectively |       | 30                    |       | 30 |   |
| Additional paid-in-capital                                                                                                                                               |       | 196,748               |       | 187,792 |   |
| Deferred compensation                                                                                                                                                    |       | —                |       | (1,143 | ) |
| Accumulated other comprehensive loss                                                                                                                                     |       | (18                   | )          | (8 | ) |
| Accumulated deficit                                                                                                                                                      |       | (127,283              | )          | (104,226 | ) |
|                                                                                                                                                                     |       |                  |       |   |   |
| Total  stockholders’ equity                                                                                                                                         |       | 69,477                |       | 82,445 |   |
|                                                                                                                                                                     |       |                  |       |   |   |
| Total liability and  stockholders’ equity                                                                                                                           |       | $                     | 90,182     |   | $ | 88,531 |   |

 

See accompanying notes tofinancial statements.

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**Senomyx, Inc**.

**Statements of Operations**

**(Inthousands, except share and per share data)**

|                                                                                                                         | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                    |       |                                        |       |   |   |   |   |
| Revenue under  collaborative agreements                                                                                 |       | $                                           | 12,230     |   | $ | 9,385 |   | $ | 8,347 |   |
| Operating expenses:                                                                                                     |       |                                        |       |   |   |   |   |
| Research and  development (including $3,048, $2,647 and $1,411 of non-cash stock-based  compensation, respectively)     |       | 25,393                                      |       | 20,330 |   | 18,318 |   |
| General and  administrative (including $4,457, $2,701 and $4,625 of non-cash stock-based  compensation, respectively)   |       | 13,735                                      |       | 10,229 |   | 10,178 |   |
|                                                                                                                    |       |                                        |       |   |   |   |   |
| Total operating  expenses                                                                                               |       | 39,128                                      |       | 30,559 |   | 28,496 |   |
|                                                                                                                    |       |                                        |       |   |   |   |   |
| Loss from operations                                                                                                    |       | (26,898                                     | )          | (21,174 | ) | (20,149 | ) |
|                                                                                                                    |       |                                        |       |   |   |   |   |
| Interest income                                                                                                         |       | 3,841                                       |       | 1,344 |   | 435 |   |
|                                                                                                                    |       |                                        |       |   |   |   |   |
| Net loss                                                                                                                |       | $                                           | (23,057    | ) | $ | (19,830 | ) | $ | (19,714 | ) |
|                                                                                                                    |       |                                        |       |   |   |   |   |
| Basic and diluted net  loss per share                                                                                   |       | $                                           | (0.77      | ) | $ | (0.77 | ) | $ | (1.40 | ) |
|                                                                                                                    |       |                                        |       |   |   |   |   |
| Shares used to compute  basic and diluted net loss per share                                                            |       | 29,809,854                                  |       | 25,916,229 |   | 14,040,727 |   |
|                                                                                                                    |       |                                        |       |   |   |   |   |
| Pro forma net loss per  common share assuming conversion of preferred stock, basic and diluted                          |       |                                        |       |   |   | $ | (0.89 | ) |
|                                                                                                                    |       |                                        |       |   |   |   |   |
| Shares used in computing pro forma net loss per common share assuming  conversion of preferred stock, basic and diluted |       |                                        |       |   |   | 22,143,380 |   |

 

Seeaccompanying notes to financial statements.

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**Senomyx, Inc.**

**Statementsof Stockholders’ Equity**

**(Inthousands, except for share data)**
| ** **                                                                              | ** ** | ** **               | ** ** | ** **            | ** ** | ** **  | ** ** | ** **   | ** ** | ** **        | ** ** | ** **       | ** ** | **Accumulated**        | ** ** | ** **  | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------|------------|-------------|------------|--------------|------------|-------------------|------------|------------------|------------|------------------------|------------|-------------|------------|------------|------------|
| ** **                                                                              | ** ** | ** **               | ** ** | ** **            | ** ** | ** **  | ** ** | ** **   | ** ** | **Additional**    | ** ** | ** **       | ** ** | **other**              | ** ** | ** **  | ** ** | **Total**  | ** ** |
| ** **                                                                              | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **paid-in** | ** ** | **Deferred** | ** ** | **comprehensive** | ** ** | **Accumulated**  | ** ** | **stockholders’** | ** ** |
| ** **                                                                              | ** ** | **Shares**               | ** ** | **Amount**            | ** ** | **Shares**  | ** ** | **Amount**   | ** ** | **capital**       | ** ** | **compensation** | ** ** | **loss**               | ** ** | **deficit** | ** ** | **equity** | ** ** |
| ** **                                                                              | ** ** | ** **               | ** ** | ** **            | ** ** | ** **  | ** ** | ** **   | ** ** | ** **        | ** ** | ** **       | ** ** | ** **             | ** ** | ** **  | ** ** | ** ** | ** ** |
| Balance at  December 31, 2003                                                      |       | 25,825,826               |       | $                     | 70,150     |        | 2,020,736  |         | $          | 2                 |       | $                | 20,173     |                   | $          | (8,540      | )          | $          | 1          |   | $ | (64,682 | ) | $ | 17,104 |   |
|                                                                                    |       |                     |       |                  |       |        |       |         |       |              |       |             |       |                   |       |        |       |       |       |
| Issuance  of common stock to employees related to the exercise of options               |       | —                   |       | —                |       | 667,509     |       | 1            |       | 688               |       | —           |       | —                 |       | —      |       | 689        |       |
| Repurchase  of unvested common stock from employees                                     |       | —                   |       | —                |       | (41,661     | )          | —       |       | (31               | )          | —           |       | —                 |       | —      |       | (31        | )          |
| Compensation  related to stock options to employees                                     |       | —                   |       | —                |       | —      |       | —       |       | 442               |       | (442             | )          | —                 |       | —      |       | —     |       |
| Compensation related to  restricted stock issued to consultants                         |       | —                   |       | —                |       | —      |       | —       |       | 1,119             |       | —           |       | —                 |       | —      |       | 1,119      |       |
| Amortization of deferred  compensation                                                  |       | —                   |       | —                |       | —      |       | —       |       | —            |       | 4,917            |       | —                 |       | —      |       | 4,917      |       |
| Reduction of deferred  compensation for cancellation of unvested employee stock options |       | —                   |       | —                |       | —      |       | —       |       | (573              | )          | 573              |       | —                 |       | —      |       | —     |       |
| Issuance of common stock  related to exercise of warrant                                |       | —                   |       | —                |       | 7,675       |       | —       |       | —            |       | —           |       | —                 |       | —      |       | —     |       |
| Conversion of preferred  stock to common stock                                          |       | (25,825,826              | )          | (70,150               | )          | 16,205,306  |       | 16           |       | 70,134            |       | —           |       | —                 |       | —      |       | —     |       |
| Issuance of common stock  in initial public offering, net of issuance costs             |       | —                   |       | —                |       | 6,450,000   |       | 6            |       | 34,291            |       | —           |       | —                 |       | —      |       | 34,297     |       |
| Comprehensive loss:                                                                     |       |                     |       |                  |       |        |       |         |       |              |       |             |       |                   |       |        |       |       |       |
| Unrealized loss on  investments                                                         |       | —                   |       | —                |       | —      |       | —       |       | —            |       | —           |       | (8                     | )          | —      |       | (8         | )          |
| Net loss                                                                                |       | —                   |       | —                |       | —      |       | —       |       | —            |       | —           |       | —                 |       | (19,714     | )          | (19,714    | )          |
| Comprehensive loss                                                                      |       | —                   |       | —                |       | —      |       | —       |       | —            |       | —           |       | —                 |       | —      |       | (19,722    | )          |
| Balance at  December 31, 2004                                                      |       | —                   |       | —                |       | 25,309,565  |       | 25           |       | 126,243           |       | (3,492           | )          | (7                     | )          | (84,396     | )          | 38,373     |       |
|                                                                                    |       |                     |       |                  |       |        |       |         |       |              |       |             |       |                   |       |        |       |       |       |
| Issuance of common stock  related to the exercise of options                            |       | —                   |       | —                |       | 196,270     |       | 1            |       | 617               |       | —           |       | —                 |       | —      |       | 618        |       |
| Issuance  of common stock related to employee stock plan purchases                      |       | —                   |       | —                |       | 123,567     |       | —       |       | 640               |       | —           |       | —                 |       | —      |       | 640        |       |
| Issuance  of common stock in a public offering, net of issuance costs                   |       | —                   |       | —                |       | 4,049,295   |       | 4            |       | 57,294            |       | —           |       | —                 |       | —      |       | 57,298     |       |
| Compensation  related to stock options issued to consultants                            |       | —                   |       | —                |       | —      |       | —       |       | 2,870             |       | —           |       | —                 |       | —      |       | 2,870      |       |
| Compensation  related to acceleration of vesting of stock option issued to director     |       | —                   |       | —                |       | —      |       | —       |       | 128               |       | —           |       | —                 |       | —      |       | 128        |       |
| Amortization  of deferred compensation                                                  |       | —                   |       | —                |       | —      |       | —       |       | —            |       | 2,349            |       | —                 |       | —      |       | 2,349      |       |
| Comprehensive loss:                                                                     |       |                     |       |                  |       |        |       |         |       |              |       |             |       |                   |       |        |       |       |       |
| Unrealized loss  on investments                                                         |       | —                   |       | —                |       | —      |       | —       |       | —            |       | —           |       | (1                     | )          | —      |       | (1         | )          |
| Net loss                                                                                |       | —                   |       | —                |       | —      |       | —       |       | —            |       | —           |       | —                 |       | (19,830     | )          | (19,830    | )          |
| Comprehensive  loss                                                                     |       | —                   |       | —                |       | —      |       | —       |       | —            |       | —           |       | —                 |       | —      |       | (19,831    | )          |
| Balance at December 31, 2005                                                       |       | —                   |       | —                |       | 29,678,697  |       | 30           |       | 187,792           |       | (1,143           | )          | (8                     | )          | (104,226    | )          | 82,445     |       |
|                                                                                         |            |                          |            |                       |            |             |            |              |            |                   |            |                  |            |                        |            |             |            |            |            |  |  |  |  |  |  |  |

 

Seeaccompanying notes to financial statements.

** **

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**Senomyx, Inc.**

**Statementsof Stockholders’ Equity**

**(Inthousands, except for share data)**
| ** **                                                                             | ** ** | ** **               | ** ** | ** **            | ** ** | ** **  | ** ** | ** **   | ** ** | ** **        | ** ** | ** **       | ** ** | **Accumulated**        | ** ** | ** **  | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------|------------|-------------|------------|--------------|------------|-------------------|------------|------------------|------------|------------------------|------------|-------------|------------|------------|------------|
| ** **                                                                             | ** ** | ** **               | ** ** | ** **            | ** ** | ** **  | ** ** | ** **   | ** ** | **Additional**    | ** ** | ** **       | ** ** | **other**              | ** ** | ** **  | ** ** | **Total**  | ** ** |
| ** **                                                                             | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **paid-in** | ** ** | **Deferred** | ** ** | **comprehensive** | ** ** | **Accumulated**  | ** ** | **stockholders’** | ** ** |
| ** **                                                                             | ** ** | **Shares**               | ** ** | **Amount**            | ** ** | **Shares**  | ** ** | **Amount**   | ** ** | **capital**       | ** ** | **compensation** | ** ** | **loss**               | ** ** | **deficit** | ** ** | **equity** | ** ** |
| ** **                                                                             | ** ** | ** **               | ** ** | ** **            | ** ** | ** **  | ** ** | ** **   | ** ** | ** **        | ** ** | ** **       | ** ** | ** **             | ** ** | ** **  | ** ** | ** ** | ** ** |
| Balance at  December 31, 2005                                                     |       | —                   |       | $                     | —     |        | 29,678,697 |         | $          | 30                |       | $                | 187,792    |                   | $          | (1,143      | )          | $          | (8         | ) | $ | (104,226 | ) | $ | 82,445 |   |
|                                                                                   |       |                     |       |                  |       |        |       |         |       |              |       |             |       |                   |       |        |       |       |       |
| Issuance of common stock  related to the exercise of options                           |       | —                   |       | —                |       | 337,514     |       | —       |       | 1,733             |       | —           |       | —                 |       | —      |       | 1,733      |       |
| Issuance of common stock  related to employee stock plan purchases                     |       | —                   |       | —                |       | 150,188     |       | —       |       | 861               |       | —           |       | —                 |       | —      |       | 861        |       |
| Compensation related to  stock options granted to consultants                          |       | —                   |       | —                |       | —      |       | —       |       | 1,193             |       | —           |       | —                 |       | —      |       | 1,193      |       |
| Compensation related to  stock options granted to employees and non-employee directors |       | —                   |       | —                |       | —      |       | —       |       | 6,312             |       | —           |       | —                 |       | —      |       | 6,312      |       |
| Reduction of deferred  compensation due to adoption of SFAS 123(R)                     |       | —                   |       | —                |       | —      |       | —       |       | (1,143            | )          | 1,143            |       | —                 |       | —      |       | —     |       |
| Comprehensive loss:                                                                    |       |                     |       |                  |       |        |       |         |       |              |       |             |       |                   |       |        |       |       |       |
| Unrealized  loss on investments                                                        |       | —                   |       | —                |       | —      |       | —       |       | —            |       | —           |       | (10                    | )          | —      |       | (10        | )          |
| Net loss                                                                               |       | —                   |       | —                |       | —      |       | —       |       | —            |       | —           |       | —                 |       | (23,057     | )          | (23,057    | )          |
| Comprehensive  loss                                                                    |       | —                   |       | —                |       | —      |       | —       |       | —            |       | —           |       | —                 |       | —      |       | (23,067    | )          |
|                                                                                   |       |                     |       |                  |       |        |       |         |       |              |       |             |       |                   |       |        |       |       |       |
| Balance at December 31, 2006                                                      |       | —                   |       | $                     | —     |        | 30,166,399 |         | $          | 30                |       | $                | 196,748    |                   | $          | —      |       | $          | (18        | ) | $ | (127,283 | ) | $ | 69,477 |   |

 

See accompanying notes tofinancial statements.

57

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**Senomyx, Inc.**

**Statements of Cash Flows**

**(Inthousands)**
| ** **                                                                                                                  | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Operating Activities**                                                                                                    |       |                                        |       |   |   |   |   |
| Net loss                                                                                                                    |       | $                                           | (23,057    | ) | $ | (19,830 | ) | $ | (19,714 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:                                                |       |                                        |       |   |   |   |   |
| Depreciation and  amortization                                                                                              |       | 1,584                                       |       | 1,215 |   | 1,462 |   |
| Accretion of  discount on available-for-sale securities                                                                     |       | (1,427                                      | )          | (215 | ) | — |   |
| Amortization of  leasehold incentive obligation                                                                             |       | (80                                         | )          | — |   | — |   |
| Stock-based  compensation for employees and non-employee directors                                                          |       | 6,312                                       |       | — |   | — |   |
| Amortization of  deferred stock-based compensation                                                                          |       | —                                      |       | 2,349 |   | 4,917 |   |
| Stock-based  compensation for non-employees                                                                                 |       | 1,193                                       |       | 2,998 |   | 1,119 |   |
| Change in  operating assets and liabilities:                                                                                |       |                                        |       |   |   |   |   |
| Other current  assets                                                                                                       |       | 1,061                                       |       | (978 | ) | 44 |   |
| Accounts payable  and accrued expenses                                                                                      |       | 702                                         |       | 711 |   | 1,621 |   |
| Deferred revenue                                                                                                            |       | 3,495                                       |       | (130 | ) | 443 |   |
| Deferred rent                                                                                                               |       | 62                                          |       | (59 | ) | 29 |   |
| Leasehold  incentive obligation                                                                                             |       | 2,092                                       |       | — |   | — |   |
| Net cash used in  operating activities                                                                                      |       | (8,063                                      | )          | (13,939 | ) | (10,079 | ) |
|                                                                                                                        |       |                                        |       |   |   |   |   |
| **Investing activities**                                                                                                    |       |                                        |       |   |   |   |   |
| Purchases of property  and equipment                                                                                        |       | (5,657                                      | )          | (1,941 | ) | (1,079 | ) |
| Proceeds from sale of  property and equipment                                                                               |       | —                                      |       | 84 |   | — |   |
| Purchases of  available-for-sale securities                                                                                 |       | (110,207                                    | )          | (31,813 | ) | (27,505 | ) |
| Maturities of  available-for-sale securities                                                                                |       | 68,650                                      |       | 45,775 |   | 7,300 |   |
| Net cash (used in)  provided by investing activities                                                                        |       | (47,214                                     | )          | 12,105 |   | (21,284 | ) |
|                                                                                                                        |       |                                        |       |   |   |   |   |
| **Financing activities**                                                                                                    |       |                                        |       |   |   |   |   |
| Proceeds from issuance  of common stock                                                                                     |       | 2,594                                       |       | 58,657 |   | 34,986 |   |
| Repurchase of common  stock                                                                                                 |       | —                                      |       | — |   | (31 | ) |
| Net cash provided by  financing activities                                                                                  |       | 2,594                                       |       | 58,657 |   | 34,955 |   |
|                                                                                                                        |       |                                        |       |   |   |   |   |
| Net (decrease) increase  in cash and cash equivalents                                                                       |       | (52,683                                     | )          | 56,823 |   | 3,592 |   |
| Cash and cash  equivalents at beginning of year                                                                             |       | 73,908                                      |       | 17,085 |   | 13,493 |   |
| Cash and cash  equivalents at end of year                                                                                   |       | $                                           | 21,225     |   | $ | 73,908 |   | $ | 17,085 |   |
|                                                                                                                        |       |                                        |       |   |   |   |   |
| **Supplemental schedule of  non-cash investing and financing activities:**                                             |       |                                        |       |   |   |   |   |
| Purchases of  property and equipment and leasehold incentive obligation directly reimbursed  by lessor of new facility      |       | $                                           | 7,808      |   | — |   | — |   |
| Purchases of  property and equipment included in accounts payable, accrued expenses and  other current liabilities          |       | $                                           | 540        |   | $ | 34 |   | — |   |
| Proceeds from  issuance of common stock (net) included in accounts payable, accrued expenses  and other current liabilities |       | —                                      |       | $ | 101 |   | — |   |
| Conversion of preferred  stock into common stock                                                                            |       | —                                      |       | — |   | $ | 70,150 |   |

 

See accompanying notes tofinancial statements.

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**Senomyx, Inc.**

**Notesto Financial Statements**

**1.Organization and Summary of Significant Accounting Policies**

***Organization andBusiness***

Senomyx, Inc. (the “Company”) was incorporated onSeptember 16, 1998 in Delaware and commenced operations inJanuary 1999. The Company is a biotechnology company using proprietarytaste receptor-based assays, screening technologies and optimization chemistryto discover and develop novel flavor ingredients for the packaged food andbeverage industry. The Company has entered into product discovery anddevelopment collaborations with six of the world’s leading packaged food andbeverage companies: Ajinomoto Co., Inc. (“Ajinomoto”), Cadbury Schweppes,Campbell Soup Company (“Campbell”), The Coca-Cola Company (“Coca-Cola”), KraftFoods Global, Inc. (“Kraft Foods”) and Nestlé SA (“Nestlé”). The Company’scollaboration agreements provide for upfront license fees, research funding,reimbursement of certain regulatory costs, milestone payments if the Companyachieves development goals and royalties on future sales of consumer productsincorporating the Company’s flavor ingredients. The Company’s current programsfocus on the development of savory, sweet and salt flavor enhancers, highpotency sweeteners and bitter taste modulators.

***Use of Estimates***

The preparation of financial statements in conformitywith United States generally accepted accounting principles (“GAAP”) requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates.

***Cash and CashEquivalents***

The Company considers all highly liquid investmentswith a remaining maturity of three months or less when purchased to be cashequivalents. Cash equivalents are recorded at cost, which approximates marketvalue.

***InvestmentsAvailable-for-Sale***

The Company’s surplus cash is invested in commercialpaper and United States government agency bonds with maturity dates of one yearor less from the settlement date. The amortized cost of debt securities isadjusted for amortization of premiums and accretion of discounts to maturitywith all amortization and accretion included in interest income. The Company’sshort-term investments are classified as available-for-sale and carried atestimated fair value, as determined by quoted market prices, with unrealizedgains and losses reported in a separate component of accumulated othercomprehensive income. Realized gains and losses and declines in value judged tobe other-than-temporary, if any, on available-for-sale securities are includedin interest income. The cost of securities sold is based on the specificidentification method. Interest on securities classified as available-for-saleis included in interest income.

***Fair Value ofFinancial Instruments***

The carrying amount of cash and cash equivalents,investments available-for-sale, accounts payable and accrued expenses areconsidered to be representative of their respective fair value because of the short-termnature of those items.

***Concentration ofCredit Risk and Major Collaborations***

Financial instruments, which potentially subject theCompany to concentrations of credit risk, consist of cash, cash equivalents andinvestments available-for-sale. The Company limits its exposure to credit lossby placing its cash, cash equivalents, and investments with high credit qualityfinancial institutions in instruments with short maturities.

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The Company derives its revenues from a relativelysmall number of collaborators. For the year ended December 31, 2006, revenuesfrom its six collaborators accounted for 19%, 7%, 17%, 28%, 6% and 23%,respectively, of total revenues.  For theyear ended December 31, 2005, revenues from its five collaboratorsaccounted for 16%, 16%, 21%, 43% and 4%, respectively, of total revenues. Forthe year ended December 31, 2004, revenues from its four collaboratorsaccounted for 17%, 23%, 24% and 36%, respectively, of total revenues.

***Property andEquipment***

Property and equipment are stated at cost lessaccumulated depreciation and are depreciated over the estimated useful lives ofthe assets (ranging from three to five years) using the straight-line method.Leasehold improvements are amortized over the estimated useful life of theasset or the lease term, whichever is shorter.

***Patent Costs***

Costs related to filing and pursuing patentapplications are expensed as incurred, as recoverability of such expendituresis uncertain.

***Impairment ofLong-Lived Assets***

In accordance with Financial Accounting StandardsBoard (“FASB”) Statement of Financial Accounting Standards (“SFAS”)No. 144, *Accounting for the Impairmentor Disposal of Long-Lived Assets*, if indicators of impairment exist,the Company assesses the recoverability of the affected long-lived assets bydetermining whether the carrying value of such assets can be recovered throughundiscounted future operating cash flows. If impairment is indicated, theCompany measures the amount of such impairment by comparing the fair value tothe carrying value. There have been no indicators of impairment throughDecember 31, 2006.

***LeaseholdIncentive Obligation***

In conjunction with the lease agreement covering thefacility occupied by the Company (the “Nexus Lease”), the Company received atenant improvement allowance of $155 per square foot leased, or $9.9million.  As the tenant improvements wereconstructed, the Company recorded both the covered tenant improvements (asfixed assets) and an offsetting leasehold incentive obligation on the Company’sbalance sheet.  Through the initial termof the Nexus Lease, the Company records depreciation expense to depreciate thetenant improvements and records an offsetting reduction to rent expense (toamortize the leasehold incentive obligation), in accordance with FASB TechnicalBulletin 88-1, *Issues Relating to Accounting for Leases*.

***Revenue Recognition***

The Company’srevenue recognition policies are in compliance with the Staff AccountingBulletin (“SAB”) No. 104, *Revenue Recognition*and Emerging Issues Task Force (“EITF”) Issue No. 00-21, *RevenueArrangements with Multiple Deliverables*.  Some of the Company’s agreements containmultiple elements, including upfront fees, research funding, costreimbursements, milestones, and royalties.

Non-refundablelicense fees, if not associated with future Company performance, are recognizedwhen received. Non-refundable license fees, if associated with future Companyperformance, are associated with a specific program or collaboration andrecognized over the period of service for that specific program orcollaboration.

Amounts receivedfor research funding are recognized as revenues as the services are performed.Revenue is deferred for fees received before earned.

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Revenue frommilestones is recognized when earned, as evidenced by written acknowledgmentfrom the collaborator or other persuasive evidence that the milestone has beenachieved, provided that (i) the milestone event is substantive and itsachievability was not reasonably assured at the inception of the agreement, and(ii) the Company’s performance obligations after the milestone achievementwill continue to be funded by the collaborator at a level comparable to beforethe milestone achievement. If both of these criteria are not met, the milestonepayment is recognized over the remaining minimum period of the Company’sperformance obligations under the agreement.

Revenue from costreimbursements is recognized when earned, as evidenced by writtenacknowledgment from the collaborator or other persuasive evidence.

Royalties to bereceived based on product sales made by the Company’s collaboratorsincorporating the Company’s product, if any, will be recognized as earned. Todate, the Company has not earned any royalties.

***Research and Development***

Research and development costs, including thoseincurred in relation to the Company’s collaborative agreements, are expensed inthe period incurred. Research and development costs primarily consist ofsalaries and related expenses for personnel, facilities and depreciation,research and development supplies, patents and licenses and outside services.

***ComprehensiveIncome (Loss)***

SFAS No. 130, *ReportingComprehensive Income*, requires that all components of comprehensiveincome, including net income, be reported in the financial statements in theperiod in which they are recognized. Comprehensive income (loss) is defined asthe change in equity during a period from transactions and other events andcircumstances from non-owner sources. The Company’s accumulated othercomprehensive loss, as of December 31, 2006 and 2005, consisted ofunrealized gains and losses on investments available-for-sale and is reportedin stockholders’ equity.

***Deferred Rent***

Rent expense is recorded on a straight-line basis overthe initial term of any lease. The difference between rent expense accrued andamounts paid under any lease agreement is recorded as deferred rent in theaccompanying balance sheets.

***Stock-BasedCompensation***

For the yearsended December 31, 2005 and 2004, prior to the adoption of SFAS 123R,*Share-Based Payment,* the Company recorded deferredcompensation for stock options and stock awards granted to employees andnon-employee directors equal to the difference between the exercise price andthe fair value of the Company’s common stock on the date of grant as determinedfor the purpose of recording the Company’s initial public offering (“IPO”)cheap stock calculation. The Company records options or awards issued tonon-employees at their fair value in accordance with the SFAS 123, *Accounting for Stock-Based Compensation*, and periodicallyremeasures them in accordance with EITF 96-18, *Accountingfor Equity Instruments That Are Issued to Other Than Employees for Acquiring orin Conjunction with Selling Goods or Services*, and recognize themover the service period. In connection with the grant of stock options toemployees and non-employee directors, the Company recorded deferred stock-basedcompensation of $442,000 for the year ended December 31, 2004. The Companyrecorded this amount as a component of stockholders’ equity and amortized it,on an accelerated basis, as a non-cash charge to operations over the vestingperiod of the options. The Company recorded employee and non-employeestock-based compensation expense of $5.3 million and $6.0 million for the yearsended December 31, 2005 and 2004, respectively.

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InDecember 2004, the FASB issued SFAS 123R, which requires companies toexpense the estimated fair value of employee stock options and similar awards.This statement is a revision to SFAS 123, and supersedes Accounting PrinciplesBoard (“APB”) Opinion No. 25, *Accounting for StockIssued to Employees*, and amends FASB Statement No. 95, *Statement of Cash Flows*. The accounting provisions of SFAS 123R were effective for the firstquarter of fiscal 2006.   In conjunctionwith the adoption of SFAS 123R, the unamortized balance of deferred stock-basedcompensation recorded for the IPO cheap stock calculation was written offagainst stockholders’ equity.  As of theadoption date of SFAS 123R, the unamortized balance of deferred stock-basedcompensation was $1.1 million.

Effective January1, 2006, the Company uses the fair value method to apply the provisions of SFAS123R with a modified prospective application which provides for certain changesto the method for valuing stock-based compensation. The valuation provisions ofSFAS 123R apply to new awards and to awards that are outstanding on theeffective date and subsequently modified or cancelled. Under the modifiedprospective application, prior periods are not revised for comparativepurposes.  Upon adoption of SFAS 123R,the Company has continued to use the Black-Scholes model which was previouslyused for the Company’s pro forma information required under SFAS 123. TheCompany’s employee stock options have various restrictions that reduce optionvalue, including vesting provisions and restrictions on transfer and hedging,among others, and are often exercised prior to their contractual maturity.  Because the Company’s employee stock optionshave characteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect thefair value estimate, in management’s opinion, the existing models do notnecessarily provide a reliable single measure of the fair value of the Company’semployee stock options.

Theweighted-average estimated fair value of employee stock options granted duringthe year ended December 31, 2006 was $9.54 per share using the Black-Scholesmodel with the following weighted average assumptions (annualized percentages):

|                         | ** ** | **Year ended  December 31, 2006** | ** ** |
|-------------------------|------------|--------------------------------------------------|------------|
| Expected volatility     |       | 60.43                                            | %          |
| Risk-free interest rate |       | 4.88                                             | %          |
| Dividend yield          |       | 0.0                                              | %          |
| Expected term           |       | 6.08 years                                       |       |

 

Theweighted-average estimated fair value of employee stock purchase rights grantedduring the year ended December 31, 2006 was $6.94 per share using theBlack-Scholes model with the following weighted average assumptions (annualizedpercentages):

|                         | ** ** | **Year ended  December 31, 2006** | ** ** |
|-------------------------|------------|--------------------------------------------------|------------|
| Expected volatility     |       | 67.33                                            | %          |
| Risk-free interest rate |       | 4.90                                             | %          |
| Dividend yield          |       | 0.0                                              | %          |
| Expected term           |       | 1.25 years                                       |       |

 

Expectedvolatility is based on the Company’s historical volatility and the historicalvolatilities of the common stock of comparable publicly traded companies. Therisk-free interest rate for the expected term of the option is based on theaverage United States Treasury yield curve at balance sheet date for theexpected term.  The expected term ofoptions granted is derived from the average midpoint between vesting and thecontractual term, as described in SAB No. 107, *Share-Based Payment. *The assumptions related to expected volatility and risk-freeinterest rate used for the valuation of stock options under the Company’s stockplan differ from those used for the valuation of stock purchase rights underthe Company’s employee stock purchase plan primarily due to the difference intheir respective expected terms.

As stock-basedcompensation expense recognized in the Statement of Operations for 2006 isbased on awards ultimately expected to vest, it should be reduced for estimatedforfeitures.  SFAS 123R requires 

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forfeitures to beestimated at the time of grant and revised, if necessary, in subsequent periodsif actual forfeitures differ from those estimates.  Pre-vesting forfeitures were estimated to beapproximately 7.2% for the year ended December 31, 2006 based on historicalexperience.  In the Company’s pro formainformation required under SFAS 123 for the periods prior to fiscal 2006, theCompany accounted for forfeitures as they occurred.

Compensationexpense related to stock-based compensation for options and awards grantedsubsequent to the adoption of SFAS 123R is recognized on a straight-linebasis.  Compensation expense related tostock-based compensation is allocated to research and development or generaland administrative based upon the department to which the associated employeeor non-employee reports.

Total estimatedstock-based compensation expense, related to all of the Company’s stock-basedawards granted to employees and non-employee directors, recognized for the yearended December 31, 2006 was comprised as follows (in thousands, except pershare data):

|                                                                                                             | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2006**                               | ** ** |
| Research and  development                                                                                   |       | $                                      | (1,939     | ) |
| General and  administrative                                                                                 |       | (4,373                                 | )          |
| Employee and non-employee director stock-based  compensation expense                                        |       | $                                      | (6,312     | ) |
|                                                                                                        |       |                                   |       |
| Employee and  non-employee director stock-based compensation expense, per common share,  basic and diluted: |       | $                                      | (0.21      | ) |

 

At December 31,2006, total unrecognized estimated compensation expense related to non-vestedstock options granted prior to that date was $10.3 million, which is expectedto be recognized over a weighted average period of 1.9 years.

As a result ofadopting SFAS 123R, the Company’s net loss for the year ended December 31, 2006is approximately $4.9 million higher than if the Company had continued toaccount for share-based compensation under APB Opinion No. 25.  Basic and diluted net loss per share for theyear ended December 31, 2006 are $0.16 higher than if the Company continued toaccount for share-based compensation under APB Opinion No. 25.

***ProForma Information under SFAS 123 for Periods Prior to Fiscal 2006***

Prior to adoptingthe provisions of SFAS 123R, the Company recorded estimated compensationexpense for employee stock options based upon their intrinsic value on the dateof grant pursuant to APB Opinion No. 25, and provided the required pro formadisclosures of SFAS 123.  Under APBOpinion No. 25, when the purchase price of restricted stock or the exerciseprice of the Company’s employee stock options equals or exceeds the fair valueof the underlying stock on the date of issuance or grant, no compensationexpense is recognized. In the event that stock options are granted with anexercise price below the fair value of the Company’s common stock per share onthe grant date, the difference between the fair value of the Company’s commonstock and the exercise price of the stock option was recorded as deferredcompensation.  Deferred compensation wasamortized to compensation expense on an accelerated basis in accordance withFinancial Accounting Standards Board Interpretation (“FIN”) No. 28, *Accounting for Stock Appreciation Rights and OtherVariable Stock Option or Award Plans*, over the vesting period of therelated options, generally four years.

Options or stockawards issued to non-employees who are not directors of the Company arerecorded at their fair value in accordance with SFAS No. 123 andEITF Issue No. 96-18, *Accounting forEquity Instruments That Are Issued to Other Than Employees for Acquiring or inConjunction with Selling Goods or Services*, and are periodicallyrevalued as the options vest and are recognized as expense over the relatedservice period.

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For the yearsended December 31, 2005 and 2004, the fair value of options issued to employeeswas estimated at the date of grant using the Black-Scholes option valuationmodel with the following weighted average assumptions: (a) risk-freeinterest rates of 4.1% and 3.0%; (b) expected dividend yield of 0% for allperiods; (c) volatility factor of 70% for all periods; and(d) five-year estimated life of the options for all periods. The estimatedweighted average fair value of stock options granted during 2005 and 2004 was$6.03 and $6.55, respectively.

As required underSFAS No. 123, for purposes of pro forma disclosures, the estimated fair valueof the options is amortized to expense over the vesting period of the relatedoptions. The Company’s pro forma information follows (in thousands, except pershare data):

|                                                                                       | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                                    | ** ** | **2004** | ** ** |
| Net loss as reported                                                                  |       | $                                           | (19,830    | ) | $ | (19,714 | ) |
| Add: Stock-based  employee compensation expense included in net loss                  |       | 2,477                                       |       | 4,917 |   |
| Deduct: Stock-based  employee compensation expense determined under fair value method |       | (6,538                                      | )          | (6,452 | ) |
|                                                                                  |       |                                        |       |   |   |
| Pro forma net loss                                                                    |       | $                                           | (23,891    | ) | $ | (21,249 | ) |
|                                                                                  |       |                                        |       |   |   |
| Basic and diluted net  loss per share as reported                                     |       | $                                           | (0.77      | ) | $ | (1.40 | ) |
|                                                                                  |       |                                        |       |   |   |
| Pro forma basic and diluted net loss per share                                        |       | $                                           | (0.92      | ) | $ | (1.51 | ) |

 

***Net Loss Per Share***

The Company calculated net loss per share inaccordance with SFAS No. 128, *EarningsPer Share*, and SAB No. 98. Basic earnings per share (“EPS”) iscalculated by dividing the net loss by the weighted average number of commonshares outstanding for the period, without consideration for common stockequivalents. Diluted EPS is computed by dividing the net income or loss by theweighted average number of common share equivalents outstanding for the perioddetermined using the treasury-stock method. Dilutive common share equivalents include the dilutive effect ofin-the-money shares, which is calculated based on the average share price foreach period using the treasury stock method. Under the treasury stock method,the exercise price of a share, the amount of compensation cost, if any, forfuture service that the Company has not yet recognized, and the amount ofestimated tax benefits that would be recorded in paid-in capital, if any, whenthe share is exercised are assumed to be used to repurchase shares in thecurrent period.  For purposes of thiscalculation, common stock subject to repurchase by the Company, convertiblepreferred stock, options, and warrants are considered to be common stockequivalents and are only included in the calculation of diluted earnings pershare when their effect is dilutive.

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The following table sets forth the computation ofbasic and diluted, and unaudited pro forma basic and diluted, net loss pershare for the respective periods. The unaudited pro forma basic and diluted netloss per share represent the weighted average common shares outstanding reducedby the weighted average unvested common shares subject to repurchase, and givesthe effect to the conversion of the convertible preferred stock into shares ofcommon stock as if converted at the date of original issuance. 

|                                                                                                   | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Historical:**                                                                                   |       |                                       |       |   |   |   |   |
| Net loss (in thousands)                                                                           |       | $                                          | (23,057    | ) | $ | (19,830 | ) | $ | (19,714 | ) |
|                                                                                              |       |                                       |       |   |   |   |   |
| Weighted average common  shares                                                                   |       | 29,910,453                                 |       | 26,090,294 |   | 14,354,942 |   |
| Weighted average  unvested common shares subject to repurchase                                    |       | (100,599                                   | )          | (174,065 | ) | (314,215 | ) |
|                                                                                              |       |                                       |       |   |   |   |   |
| Denominator for basic  and diluted earnings per share                                             |       | 29,809,854                                 |       | 25,916,229 |   | 14,040,727 |   |
|                                                                                              |       |                                       |       |   |   |   |   |
| Basic and diluted net  loss per share                                                             |       | $                                          | (0.77      | ) | $ | (0.77 | ) | $ | (1.40 | ) |
|                                                                                              |       |                                       |       |   |   |   |   |
| **Pro forma:**                                                                                    |       |                                       |       |   |   |   |   |
| Net loss (in thousands)                                                                           |       |                                       |       |   |   | $ | (19,714 | ) |
|                                                                                              |       |                                       |       |   |   |   |   |
| Pro forma basic and  diluted net loss per share                                                   |       |                                       |       |   |   | $ | (0.89 | ) |
|                                                                                              |       |                                       |       |   |   |   |   |
| Shares used above                                                                                 |       |                                       |       |   |   | 14,040,727 |   |
| Pro forma adjustment to  reflect assumed weighted average effect of conversion of preferred stock |       |                                       |       |   |   | 8,102,653 |   |
|                                                                                              |       |                                       |       |   |   |   |   |
| Pro forma shares used to compute basic and diluted net loss per share                             |       |                                       |       |   |   | 22,143,380 |   |

 

|                                                                                                              | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                   | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                         |       |                                       |       |   |   |   |   |
| **Historical  outstanding antidilutive securities not included in diluted net loss per  share calculation:** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Preferred stock*                                                                                             |       | —                                     |       | — |   | 8,102,653 |   |
| Common stock subject to  repurchase                                                                          |       | 59,426                                     |       | 148,779 |   | 228,092 |   |
| Options to purchase  common stock                                                                            |       | 3,489,874                                  |       | 2,483,417 |   | 1,992,710 |   |
|                                                                                                         |       |                                       |       |   |   |   |   |
|                                                                                                         |       | 3,549,300                                  |       | 2,632,196 |   | 10,323,455 |   |

 

----

* Represents the number of shares of common stock intowhich preferred stock was convertible.

***Segment Reporting***

The Company currently operates in a single operatingsegment.  The Company generates revenuesfrom collaborations that result primarily from its underlying research anddevelopment activities.  In addition,financial results are prepared and reviewed by management as a single operatingsegment.  The Company periodicallyevaluates the benefits of operating in distinct segments and will reportaccordingly when such distinction is made.

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***Recent AccountingPronouncements***

In June 2006, theFASB ratified EITF Issue No. 06-2, *Accounting for SabbaticalLeave and Other Similar Benefits Pursuant to FASB Statement No. 43,Accounting for Compensated Absences*. EITF Issue No. 06-2 provides guidelines under which sabbatical leave orother similar benefits provided to an employee are considered to accumulate, asdefined in FASB Statement 43, *Accounting for CompensatedAbsences*. If such benefits are deemed to accumulate, then thecompensation cost associated with a sabbatical or other similar benefitarrangement should be accrued over the requisite service period. The provisionsof this Issue are effective for fiscal years beginning after December 15,2006 and allow for either retrospective application or a cumulative effectadjustment to accumulated deficit approach upon adoption. The Company does notexpect the adoption of EITF Issue No. 06-02 to have a material impact on itsfinancial statements.

In June 2006,the FASB issued FASB Interpretation No. 48, *Accounting for Uncertainty in Income Taxes, an interpretation of FASBStatement No. 109* (“FIN 48”). FIN 48 prescribes arecognition threshold and measurement attribute for recognition and measurementof a tax position taken or expected to be taken in a tax return. FIN 48also provides guidance on de-recognition, classification, interest andpenalties, accounting in interim periods, disclosure and transition. Theinterpretation is effective for fiscal years beginning after December 15,2006. The cumulative effect upon adoption of applying the provision shall be reportedas an adjustment to the opening balance of retained earnings for that fiscalyear, presented separately. The Company does not expect the adoption ofFIN 48 to have a material impact on its financial statements.

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurement*.SFAS 157 establishes a framework for measuring fair value in accordance withGAAP, clarifies the definition of fair value within that framework, and expandsdisclosures about the use of fair value measurements.  It also responds to investors’ requests forexpanded information about the extent to which companies measure assets andliabilities at fair value, the information used to measure fair value and theeffect of fair value measurements on earnings. SFAS 157 applies whenever otherstandards require (or permit) assets or liabilities to be measured at fairvalue, and does not expand the use of fair value in any new circumstances. SFAS157 is effective for financial statements issued for fiscal years beginningafter November 15, 2007. The Company does not expect the adoption of SFAS157 to have a material impact on its financial statements.

**2. Balance Sheet Details**

***InvestmentsAvailable-for-Sale***

The following is a summary of investments available-for-salesecurities at December 31, 2006 (in thousands): 

|                         | ** ** | ** **              | ** ** | ** **               | ** ** | ** **               | ** ** | **Estimated**       | ** ** |
|-------------------------|------------|-------------------------|------------|--------------------------|------------|--------------------------|------------|---------------------|------------|
| ** **              | ** ** | **Amortized Cost** | ** ** | **Unrealized Gain** | ** ** | **Unrealized Loss** | ** ** | **Fair Value** | ** ** |
| Commercial Paper        |       | $                       | 30,171     |                     | $          | —                   |       | $                   | (20        | ) | $ | 30,151 |   |
| Government Agency Bonds |       | 22,726                  |       | 2                        |       | —                   |       | 22,728              |       |
|                    |       |                    |       |                     |       |                     |       |                |       |
|                    |       | $                       | 52,897     |                     | $          | 2                        |       | $                   | (20        | ) | $ | 52,879 |   |

 

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The following is asummary of investments available-for-sale securities at December 31, 2005(in thousands): 

|                         | ** ** | ** **              | ** ** | ** **               | ** ** | ** **               | ** ** | **Estimated**       | ** ** |
|-------------------------|------------|-------------------------|------------|--------------------------|------------|--------------------------|------------|---------------------|------------|
| ** **              | ** ** | **Amortized Cost** | ** ** | **Unrealized Gain** | ** ** | **Unrealized Loss** | ** ** | **Fair Value** | ** ** |
| Commercial Paper        |       | $                       | 2,186      |                     | $          | —                   |       | $                   | (1         | ) | $ | 2,185 |   |
| Government Agency Bonds |       | 7,727                   |       | —                   |       | (7                       | )          | 7,720               |       |
|                    |       |                    |       |                     |       |                     |       |                |       |
|                    |       | $                       | 9,913      |                     | $          | —                   |       | $                   | (8         | ) | $ | 9,905 |   |

 

Gross realized gains and losses on available-for-salesecurities were immaterial during the years ended December 31, 2006 and2005. All of the available-for-sale securities have a contractual maturity atDecember 31, 2006 of one year or less.

***Property andEquipment***

Property and equipment consists of the following (inthousands): 

|                                                 | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Scientific equipment                            |       | $                     | 7,285      |   | $ | 7,019 |   |
| Computer equipment                              |       | 2,376                 |       | 2,237 |   |
| Furniture and fixtures                          |       | 1,004                 |       | 362 |   |
| Leasehold improvements                          |       | 12,399                |       | 892 |   |
|                                            |       |                  |       |   |   |
|                                            |       | 23,064                |       | 10,510 |   |
| Less accumulated  depreciation and amortization |       | (8,225                | )          | (8,092 | ) |
|                                            |       |                  |       |   |   |
|                                            |       | $                     | 14,839     |   | $ | 2,418 |   |

 

Depreciation and amortization expense was $1.5million, $1.2 million and $1.5 million for the years endedDecember 31, 2006, 2005 and 2004, respectively.

***Accounts Payableand Accrued Expenses***

Accounts payableand accrued expenses consist of the following (in thousands): 

|                            | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Accounts payable           |       | $                     | 1,107      |   | $ | 1,018 |   |
| Accrued employee  benefits |       | 2,719                 |       | 2,214 |   |
| Other accrued expenses     |       | 1,584                 |       | 864 |   |
|                       |       |                  |       |   |   |
|                       |       | $                     | 5,410      |   | $ | 4,096 |   |

 

**3. Product Discovery and DevelopmentCollaborations**

*Ajinomoto.*    In March 2006,the Company entered into a collaboration agreement with Ajinomoto for thediscovery and commercialization of novel flavor ingredients on an exclusivebasis in the soup, sauce and culinary aids, and noodle product categories, andon a co-exclusive basis in the bouillon product category within Japan and otherAsian markets.  The agreement requiresAjinomoto to pay an upfront license fee and make discovery and developmentfunding payments for up to three years. The Company is also eligible to receivemilestone payments upon the achievement of specific product discovery anddevelopment goals and, in the event of commercialization, receive royalties onsales of products containing new flavor ingredients developed under theagreement until the expiration of relevant patents.

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In October 2006, the Company entered into a secondcollaboration agreement with Ajinomoto for the discovery and commercialization ofspecified natural flavor ingredients.  The agreement requires Ajinomoto tomake discovery and development funding payments for up to three years. TheCompany is also eligible to receive milestone payments upon the achievement ofspecific product discovery and development goals and, in the event ofcommercialization, receive royalties on sales of products containing new flavoringredients developed under the agreement. 

Through December 31, 2006, the Company hasreceived $6.1 million in non-refundable upfront license fees and discovery anddevelopment funding. The upfront fees were recorded as deferred revenue and arebeing amortized over the period of obligation by the Company.  If all milestones are achieved, and includingall research and development funding paid or payable, the Company may beentitled to up to $10.2 million. There is no guarantee that the Companywill receive any milestone payments or royalties under these collaborations.

*CadburySchweppes.*    InJuly 2005, the Company entered into a collaboration agreement with CadburySchweppes for the discovery and commercialization of new flavor ingredients inthe gum confectionary area. The agreement requires Cadbury Schweppes to makeresearch funding payments for up to two years. The Company is also eligible toreceive milestone payments upon the achievement of specific product discoveryand development goals and, in the event of commercialization, receive royaltieson sales of products containing new flavor ingredients developed under theagreement.

Through December 31, 2006, the Company hasreceived $1.3 million in non-refundable upfront license fees and researchfunding. The upfront fee was recorded as deferred revenue and is beingamortized over the period of obligation by the Company.  If all milestones are achieved, and includingall research funding paid or payable, the Company may be entitled to up to$3.1 million. There is no guarantee that the Company will receive anymilestone payments or royalties under this collaboration.

*CampbellSoup Company.*    InMarch 2001, the Company entered into a collaboration agreement withCampbell to work for a three-year collaborative period for the discovery anddevelopment of specified flavors and flavor enhancers. The agreement requiresCampbell to make research funding payments over three years totaling$3.6 million. The Company is also eligible to receive milestone paymentsupon the achievement of a specific product development goal and, in the eventof commercialization, receive royalties on future net sales of collaboratorproducts containing a discovered ingredient.

The agreement was amended in July 2002 to providefor an option to negotiate the right to expand the field to include additionalspecified products. The Company received $1.8 million from Campbell forthe option, which was recorded as deferred revenue and recognized as revenueratably over the remaining term of the agreement (20 months). Theagreement was further amended in November 2002 to redefine earnedroyalties during the royalty term.

In July 2003, the Company received $650,000 inadditional research support funding and expense reimbursement. The payment wasrecorded as deferred revenue and was recognized as revenue ratably over theremaining term of the agreement (eight months).

The agreement was further amended in March 2004to extend the collaborative period until the earlier of March 2006 or whena flavor or flavor enhancer selected by Campbell receives Generally Recognizedas Safe (“GRAS”) determination, subject to earlier termination under specifiedcircumstances. Under the terms of the extension, the Company will provideadditional research and receive additional research funding totaling$3.0 million for two additional years.

The agreement was further amended in February 2006 toextend the collaborative period until the earlier of March 2009 or when aflavor or flavor enhancer selected by Campbell receives a GRAS determination,subject to earlier termination under specified circumstances. Under the termsof the extension, the Company will provide additional research and receiveadditional research funding totaling up to $3.0 million for threeadditional years.

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Through December 31, 2006, the Company hasreceived $9.7 million in research and development funding. If all milestonesare achieved, and including all research and development funding paid orpayable, the Company may be entitled to up to $13.1 million. There is noguarantee that the Company will receive any milestone payments or royaltiesunder this collaboration.

*TheCoca-Cola Company.*    InApril 2002, the Company entered into a collaboration agreement withCoca-Cola for the discovery and development of specified flavors and flavorenhancers. The agreement required Coca-Cola to make research funding paymentsover three years totaling $6.0 million. The Company is also eligible toreceive milestone payments upon the achievement of specific product developmentgoals and, in the event of commercialization, receive royalties on future salesof collaborator products containing a discovered ingredient.  The agreement was amended in April 2004 to extendthe collaborative period until April 2008, subject to earlier terminationunder specified circumstances. Under terms of the extension, the Company will provideadditional research and receive additional research funding totaling $6.0million for three additional years.

Through December 31, 2006, the Company hasreceived $9.5 million in research and development funding. If allmilestones are achieved, and including all research and development fundingpaid or payable, the Company may be entitled to up to $14.8 million. Thereis no guarantee that the Company will receive any milestone payments orroyalties under this collaboration.

*KraftFoods Global, Inc.*    In December 2000, the Company entered intoa collaboration agreement with Kraft Foods for the discovery and development offlavor enhancers. Under the terms of the collaboration, Kraft Foods agreed topay research funding of approximately $1.4 million per year for threeyears. In May 2002, the agreement was amended to provide for an additionalcollaborative program. The level of research support under the original programwas reduced from $1.4 million to $1.1 million per year for the remainderof the research term. In May 2005 and July 2005, the agreement was furtheramended to extend the collaborative period until June 2005 and July 2007,respectively, and to provide for an additional specified product field. TheCompany is eligible to receive milestone payments upon the achievement ofspecific product development goals and, in the event of commercialization,receive royalties on future net sales of collaborator products containing adiscovered ingredient.

Kraft Foods agreed to make research funding paymentsrelated to the May 2002 program of $1.8 million over the period fromMay 2002 through December 2003, $1.8 million over the periodfrom January 2004 through May 2005, $339,000 over the period May 2005through July 2005, and $1.7 million from July 2005 though November 2006.  The Company is also eligible to receivemilestone payments upon the achievement of specific product development goalsand receive royalties on net sales of collaborator products containing a discoveredingredient related to this additional program. The Company earned a milestonepayment of $375,000 in 2002 and a milestone payment of $250,000 in 2006 fromthe May 2002 research program.

Through December 31, 2006, the Company hasreceived $9.4 million in research and development funding, one milestonepayment of $375,000 and one milestone payment of $250,000. If all milestonesare achieved, and including all research and development funding paid orpayable, the Company may be entitled to up to $10.7 million. There is noguarantee that the Company will receive any further milestone payments orroyalties under this collaboration.

In December 2005,the Company further amended the agreement to provide for a new three-yeardiscovery and development collaboration. In November 2006, this agreement wasfurther amended to revise the structure of the research and developmentfunding.   Under the terms of the newcollaboration, Kraft Foods has agreed to pay the Company an initial license feeand incremental discovery and development funding over the three-yearperiod.  The Company is eligible toreceive milestone payments upon achievement of specific product discovery anddevelopment goals, and, in the event of commercialization, receive royaltiesbased on sales of Kraft Foods products containing any flavor modifiersdeveloped under the agreement. 

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Through December31, 2006, the Company has received $1.6 million in non-refundable license feesand research and development funding related to the new collaboration.  The license fee was recorded as deferred revenueand is being amortized over the period of the obligation by the Company.  If all milestones are achieved, and includingall license fees and research and development funding payable, the Company maybe entitled to up to $5.4 million for the new collaboration.  There is no guarantee that the Company willreceive any milestone payments or royalties under this collaboration.

*NestléSA.*    InApril 2002, as amended in April 2005, the Company entered into acollaboration agreement with Nestlé for the discovery and development ofspecified flavors and flavor enhancers. The agreement requires Nestlé to makeresearch funding payments through 2008 totaling $13.6 million, subject toearlier termination under specified circumstances.  The Company is also eligible to receivemilestone payments upon the achievement of specific product development goalsand, in the event of commercialization, receive royalties on future net salesof collaborator products containing a discovered ingredient. The Companyreceived payments for the achievement of four milestones in 2002, 2003, 2004and 2005.  The Company also receivedpayment for the reimbursement of certain regulatory expenses in 2005.  Through December 31, 2006, the Companyhas received $10.0 million in research and development funding, fourmilestone payments of $375,000 each and $339,000 in reimbursement of certainregulatory costs. If all milestones are achieved, and including all researchand development funding paid or payable, the Company may be entitled to up to $15.8 million.There is no guarantee that the Company will receive any further milestonepayments or royalties under this collaboration.

In October 2004, the Company entered into asecond product discovery and development collaboration agreement with Nestlé towork for a five-year collaborative period focusing on the discovery andcommercialization of specified novel flavor ingredients, subject to extensionor earlier termination under specified circumstances.  This agreement has subsequently been extendedfor two three-month increments.  Underthe terms of the agreement, Nestlé has agreed to pay to the Company certainresearch and development funding totaling $11.7 million over five and one-halfyears, subject to earlier termination under specified circumstances. TheCompany is also eligible to receive milestone payments upon achievement ofspecific product discovery and development goals, and in the event ofcommercialization, is entitled to receive royalties on future net sales ofproducts containing a discovered novel flavor ingredient.  There is no guarantee that the Company willreceive any milestone payments or royalties under this collaboration.

Under this second agreement, through December 31,2006, the Company has received $4.1million in research and development funding.If all milestones are achieved, and including all research and developmentfunding paid or payable, the Company may be entitled to up to$14.0 million. There is no guarantee that the Company will receive anymilestone payments or royalties under this collaboration.

In connection with the above listed collaborationagreements, the Company has recognized revenue of $12.2 million, $9.4 millionand $8.3 million for the years ended December 31, 2006, 2005 and2004, respectively. As of December 31, 2006 and 2005, the Company hasdeferred revenue of $5.2 million and $1.7 million, respectively.

**4. Commitments**

***Leases and Loans***

The Company leases its primary office facility underthe Nexus Lease that expires on February 28, 2017. The Company moved themajority of its operations to the new facility in November 2006.  Rent payments on the facility commence April1, 2007. The Nexus Lease provides for an annual minimum 3% rent increase. TheCompany began recognizing rent expense upon the facility being ready tooccupy.  Gross rent expense for the yearsended December 31, 2006, 2005 and 2004 was $3.8 million, $4.1 million and$4.0 million, respectively. Prior to moving to the new facility, theCompany sublet part of the facility it occupied, and the sublease rental incomefor the years ended December 31, 2006, 2005 and 2004 was $619,000,$742,000 and $899,000, respectively. Sublease income is recorded as an offsetto the Company’s allocated facilities costs. The Company has also entered intovarious operating lease agreements for office equipment.

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The estimated annual future minimum rental paymentsunder the Company’s operating leases in effect at December 31, 2006, whichexpire through 2017, for the years ending December 31 are as follows (inthousands): 

|                              | ** ** | **Operating  Leases** | ** ** |
|------------------------------|------------|-----------------------|------------|
| 2007                         |       | $                     | 1,804      |   |
| 2008                         |       | 2,432                 |       |
| 2009                         |       | 2,491                 |       |
| 2010                         |       | 2,552                 |       |
| 2011                         |       | 2,628                 |       |
| Thereafter                   |       | 14,841                |       |
|                         |       |                  |       |
| Total minimum lease payments |       | $                     | 26,748     |   |

 

In connection with certain license and collaborationagreements, the Company’s annual future minimum obligation payments are asfollows, $56,000, $33,000, $33,000, $18,000, $18,000 and $36,000 for the yearsending December 31, 2007, 2008, 2009, 2010, 2011 and thereafter,respectively.

**5. Stockholders’ Equity**

***Initial PublicOffering***

On June 25, 2004, the Company completed an IPO of6.0 million shares of common stock for proceeds to the Company of $31.9million, net of underwriting discounts, commissions and offering expenses.  On July 23, 2004 the Company closed thesale of an additional 450,000 shares of common stock pursuant to the exerciseby the underwriters of an over-allotment option which resulted in proceeds tothe Company of $2.4 million, net of underwriting discounts, commissions andoffering expenses.

***Public Offering***

On November 9, 2005, the Company completed a publicoffering of 4.0 million shares of common stock for proceeds to the Company of$57.3 million, net of underwriting discounts, commissions and offeringexpenses.  The offering was made under ashelf registration statement and included the exercise by the underwriters ofan over-allotment option of 528,000 shares of common stock.

***ConvertiblePreferred Stock***

The Company’s certificate of incorporation, as amendedand restated, authorizes the Company to issue up to 7,500,000 shares ofpreferred stock, with a par value of $0.001, in one or more series. The Boardof Directors may authorize the issuance of convertible preferred stock withvoting or conversion rights that could adversely affect the voting power orother rights of the holders of the common stock. The issuance of convertiblepreferred stock, while providing flexibility in connection with possibleacquisitions and other corporate purposes, could, among other things, have theeffect of delaying, deferring or preventing a change in control of the Companyand may adversely affect the market price of the common stock and the votingand other rights of the holders of common stock.

Upon the closing of the IPO in June 2004,25,825,826 shares of convertible preferred stock outstanding automaticallyconverted into 16,205,306 shares of common stock.  No shares of convertible preferred stock wereoutstanding as of December 31, 2006 or 2005.

***Equity IncentivePlan***

During 1999, the Company adopted the 1999 Equity IncentivePlan (the “Plan”), which provides for the grant of incentive and non-statutorystock options and restricted stock purchase rights to employees, 

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directors and consultants of the Company. The Plan, asamended, authorizes the Company to issue up to 7,714,412 shares of commonstock.  At December 31, 2006, theCompany has repurchased a total of 131,153 shares and2,398,910 shares remain available for grant under the Plan.  The Company issues new shares upon theexercise of stock options.

The Plan allows the Company to grant restricted stockpurchase rights at no less than 85% of the fair value of the Company’s commonstock as determined by the Board of Directors at the date of the grant. Allrestricted stock purchase rights vest in accordance with a vestingschedule determined by the Board of Directors, typically over a four-yearperiod.  Under the Plan, 457,069restricted stock purchase rights have been granted at exercise prices rangingfrom $0.35 to $0.94 per share, all of which have been exercised as ofDecember 31, 2006, of which no shares are subject to repurchase.

Options granted under the Plan generally expire nolater than 10 years from the date of grant (five years for a 10% stockholder).Options generally vest and become fully exercisable over a period of fouryears.  In certain cases, grants toofficers, directors and consultants can be made fully exercisable at the dateof grant. The exercise price of incentive stock options must be equal to atleast the fair value of the Company’s common stock on the date of grant, andthe exercise price of non-statutory stock options may be no less than 85% ofthe fair value of the Company’s common stock on the date of grant. The exerciseprice of any option granted to a 10% stockholder may be no less than 110% ofthe fair value of the Company’s common stock on the date of grant.  The Company has an option to repurchase allunvested shares, at the original purchase price, upon the voluntary orinvoluntary termination of employment with, or consulting services provided to,the Company for any reason.  At December31, 2006, 59,426 shares of common stock were unvested and subject torepurchase.

The following is a further breakdown of the optionsoutstanding as of December 31, 2006: 
|                   | ** **  | ** **         | ** ** | **Options Outstanding** | ** ** | **Options Vested and Exercisable** | ** ** |
|-------------------|-------------|--------------------|------------|------------------------------|------------|---------------------------------------------------|------------|
| ** **        | ** **  | ** **         | ** ** | **Weighted**                 | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **        | ** **  | ** **         | ** ** | **Average**                  | ** ** | **Weighted**                                      | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| **Range of** | ** **  | ** **         | ** ** | **Remaining**                | ** ** | **Average**                                       | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Exercise**      | ** **  | **Number of** | ** ** | **Contractual**              | ** ** | **Exercise**                                      | ** ** | **Number of** | ** ** | **Exercise** | ** ** |
| **Prices**        | ** **  | **Options**        | ** ** | **Life**                     | ** ** | **Price**                                         | ** ** | **Options** | ** ** | **Price** | ** ** |
| ** **        | ** **  | ** **         | ** ** | ** **                   | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| $                 | 0.74-6.00   |               | 495,135    |                         | 6.3        |                                              | $          | 0.91 |   | 410,041 |   | $ | 0.93 |   |
| $                 | 6.02-6.02   |               | 776,708    |                         | 7.4        |                                              | $          | 6.02 |   | 442,661 |   | $ | 6.02 |   |
| $                 | 6.30-9.50   |               | 719,288    |                         | 7.9        |                                              | $          | 8.69 |   | 342,526 |   | $ | 8.69 |   |
| $                 | 11.78-15.89 |               | 547,893    |                         | 8.8        |                                              | $          | 13.71 |   | 129,436 |   | $ | 13.09 |   |
| $                 | 16.25-18.99 |               | 950,850    |                         | 9.1        |                                              | $          | 16.33 |   | 11,634 |   | $ | 18.15 |   |
|              |        |               |       |                         |       |                                              |       |   |   |   |   |
|                   |        | 3,489,874          |       | 8.0                          |       | $                                                 | 9.86       |   | 1,336,298 |   | $ | 5.94 |   |

 

As of December 31, 2006, the total intrinsic value ofoptions outstanding and exercisable was $14.5 million and $9.5 million,respectively.  At December 31, 2006, theweighted average remaining contractual term for options vested and exercisablewas 7.3 years.

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The following is a summary of stock option and stockaward activity under the Plan through December 31, 2006:

|                                        | ** ** | ** **         | ** ** | **Weighted**            | ** ** |
|----------------------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                             | ** ** | **Number of** | ** ** | **Average**             | ** ** |
| ** **                             | ** ** | **Shares**         | ** ** | **Exercise Price** | ** ** |
| ** **                             | ** ** | ** **         | ** ** | ** **              | ** ** |
| Outstanding at  January 1, 2004   |       | 1,404,474          |       | $                       | 1.04       |   |
| Granted                                |       | 1,358,778          |       | $                       | 6.28       |   |
| Exercised                              |       | (667,509           | )          | $                       | 1.03       |   |
| Cancelled                              |       | (103,033           | )          | $                       | 4.02       |   |
|                                   |       |               |       |                    |       |
| Outstanding at  December 31, 2004 |       | 1,992,710          |       | $                       | 4.46       |   |
| Granted                                |       | 753,733            |       | $                       | 9.88       |   |
| Exercised                              |       | (196,270           | )          | $                       | 3.14       |   |
| Cancelled                              |       | (66,756            | )          | $                       | 6.64       |   |
|                                   |       |               |       |                    |       |
| Outstanding at  December 31, 2005 |       | 2,483,417          |       | $                       | 6.15       |   |
| Granted                                |       | 1,355,290          |       | $                       | 15.50      |   |
| Exercised                              |       | (337,514           | )          | $                       | 5.16       |   |
| Cancelled                              |       | (11,319            | )          | $                       | 10.26      |   |
|                                   |       |               |       |                    |       |
| Outstanding at December 31, 2006  |       | 3,489,874          |       | $                       | 9.86       |   |

 

Thetotal intrinsic value of stock option exercises during the years ended December31, 2006, 2005 and 2004 was $3.1 million, $2.2 million and $1.1 million,respectively.

***Employee StockPurchase Plan***

During 2004, theCompany adopted the 2004 Employee Stock Purchase Plan (the “Purchase Plan”),which allows all eligible employees to purchase shares of the Company’s commonstock at the lower of: (i) 85% of the fair market value on the first day of atwo-year offering period; or (ii) 85% of the fair market value on the last dateof each six-month purchase period within the two-year offering period.  Employees may authorize the Company towithhold up to 15% of their compensation during any purchase period, subject tocertain limitations.  The Purchase Planauthorizes up to 673,096 shares to be granted. At December 31, 2006, 273,755 shares of common stock have been issuedunder the Purchase Plan at an average price of $6.97 per share.

***Shares Reserved forFuture Issuance***

The following shares of common stock are reserved forfuture issuance:

|                                                        | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------------------|------------|-----------------------------|------------|
| Common stock options  granted and outstanding          |       | 3,489,874                   |       |
| Common stock options  reserved for future grant        |       | 2,398,910                   |       |
| Common stock reserved  under Purchase Plan             |       | 399,341                     |       |
| Total common stock shares reserved for future issuance |       | 6,288,125                   |       |

 

***Shareholders’ Rights Plan***

In February 2005, the Company entered into aShare Purchase Rights Plan (the “Rights Plan”). Terms of the Rights Plan provide for a dividend distribution of onepreferred share purchase right (a “Right”) for each outstanding share of commonstock, par value $0.001 per share (the “Common Shares”), of the Company.  Thedividend was payable on February 21, 2005 to the stockholders of record onthat date.  Each Right entitles the registered holder to purchase from theCompany one one-hundredth of a share of Series A Junior ParticipatingPreferred Stock, par value $0.001 per share (the “Preferred Shares”), at a price of$100.00 per one one-hundredth of a Preferred Share, subject toadjustment.  Each one one-hundredth of 

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a share of Preferred Shares has designations andpowers, preferences and rights, and the qualifications, limitations andrestrictions which make its value approximately equal to the value of a CommonShare.  The description and terms of the Rights are set forth in a RightsAgreement, dated as of February 14, 2005 entered into between the Companyand Mellon Investor Services LLC, as rights agent.

**6. Income Taxes**

Significant components of the Company’s net deferredtax assets at December 31, 2006 and 2005 are shown below (in thousands). Avaluation allowance of $45.5 million and $37.0 million has beenestablished to offset the net deferred tax assets as of December 31, 2006and 2005, respectively, as realization of such assets is uncertain.

|                                              | ** ** | **Years ended**  | ** ** |
|----------------------------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **December 31,** | ** ** |
| ** **                                   | ** ** | **2006**              | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | ** **            | ** ** | ** ** | ** ** |
| Deferred tax  assets:                        |       |                  |       |   |   |
| Net operating  loss carryforwards            |       | $                     | 33,465     |   | $ | 28,819 |   |
| Capitalized  research and development        |       | 3,976                 |       | 3,309 |   |
| Research and  development credits            |       | 3,830                 |       | 3,159 |   |
| Deferred revenue                             |       | 2,128                 |       | 704 |   |
| Stock  compensation                          |       | 1,176                 |       | — |   |
| Other, net                                   |       | 889                   |       | 969 |   |
|                                         |       |                  |       |   |   |
| Total deferred tax  assets                   |       | 45,464                |       | 36,960 |   |
|                                         |       |                  |       |   |   |
| Total deferred tax  liabilities              |       | —                |       | — |   |
|                                         |       |                  |       |   |   |
| Net deferred tax assets                      |       | 45,464                |       | 36,960 |   |
| Valuation allowance for  deferred tax assets |       | (45,464               | )          | (36,960 | ) |
|                                         |       |                  |       |   |   |
| Net deferred tax assets                      |       | $                     | —     |   | $ | — |   |

 

Theprovision for income taxes on earnings subject to income taxes differs from thestatutory Federal rate at December 31, 2006, 2005 and 2004, due to thefollowing (in thousands):

|                                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal income taxes at  35%                       |       | $        | (8,070     | )        | $          | (6,940   | )          | $ | (6,900 | ) |
| State income tax, net  of Federal benefit          |       | (1,324   | )          | (963     | )          | (793     | )          |
| Tax effect on  non-deductible expenses and credits |       | 890      |       | 459      |       | 1,528    |       |
| Increase in valuation  allowance                   |       | 8,504    |       | 7,444    |       | 6,165    |       |
|                                               |       |     |       |     |       |     |       |
|                                               |       | $        | —     |     | $          | —   |       | $ | — |   |

 

As a result of the adoption of SFAS 123R the Companyrecognizes windfall tax benefits associated with the exercise of stock optionsdirectly to stockholders’ equity only when realized.  Accordingly, deferred tax assets are notrecognized for net operating loss carryforwards resulting from windfall taxbenefits occurring from January 1, 2006 onward. At December 31, 2006, deferred tax assets do not include excess taxbenefits from stock-based compensation of approximately $873,000.

At December 31, 2006, the Company had federal andCalifornia tax net operating loss carryforwards of approximately$93.9 million and $25.4 million, respectively. The federal andCalifornia tax loss carryforwards will begin to expire in 2019 and 2009,respectively, unless previously utilized. The Company 

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also had federal and California research anddevelopment tax credit carryforwards of approximately $2.6 million and$1.9 million, respectively, which will begin to expire in 2019 unlesspreviously utilized.

Pursuant to Internal Revenue Code Section 382 and383, use of the Company’s net operating loss and credit carryforwards may belimited if a cumulative change in ownership of more than 50% occurs within athree-year period.

**7. Summary of Quarterly FinancialData (unaudited)**

The following is a summary of the unaudited quarterlyresults of operations for the years ended December 31, 2006 and 2005 (inthousands, except per share amounts):

|                                              | ** ** | **Year Ended December 31, 2006** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                   | ** ** | **First  Quarter**                                   | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| **Selected  Quarterly Financial Data:**      |       |                                                 |       |   |   |   |   |   |   |
| Revenues                                     |       | $                                                    | 2,411      |   | $ | 3,215 |   | $ | 3,204 |   | $ | 3,400 |   |
| Total operating expenses                     |       | 9,913                                                |       | 10,321 |   | 9,246 |   | 9,648 |   |
| Net loss                                     |       | (6,628                                               | )          | (6,159 | ) | (5,015 | ) | (5,255 | ) |
| Basic and  diluted net loss per common share |       | $                                                    | (0.22      | ) | $ | (0.21 | ) | $ | (0.17 | ) | $ | (0.17 | ) |

 

|                                              | ** ** | **Year Ended December 31, 2005** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                   | ** ** | **First  Quarter**                                   | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| **Selected Quarterly Financial  Data:**      | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                     |       | $                                                    | 2,966      |   | $ | 2,022 |   | $ | 2,130 |   | $ | 2,267 |   |
| Total operating  expenses                    |       | 7,783                                                |       | 7,457 |   | 7,050 |   | 8,269 |   |
| Net loss                                     |       | (4,592                                               | )          | (5,185 | ) | (4,663 | ) | (5,390 | ) |
| Basic and diluted net  loss per common share |       | $                                                    | (0.18      | ) | $ | (0.20 | ) | $ | (0.18 | ) | $ | (0.19 | ) |

 

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** **

**Item9.    *Changes in andDisagreements with Accountants on Accounting and Financial Disclosure***

There were nochanges in or disagreements with Ernst & Young LLP on accounting andfinancial disclosure required to be reported under this Item 9.

**Item9A.    *Controls andProcedures***

**ConclusionRegarding the Effectiveness of Disclosure Controls and Procedures**

Under thesupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of our disclosure controls and procedures, as such term is definedunder Rule 13a-15(e) promulgated under the Securities Exchange Act of1934, as amended, or the Exchange Act. Based on this evaluation, our principalexecutive officer and our principal financial officer concluded that ourdisclosure controls and procedures were effective as of the end of the periodcovered by this annual report.

**Management’sReport on Internal Control Over Financial Reporting**

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting, as such term is defined in Exchange Act Rule 13a-15(f).Under the supervision and with the participation of our management, includingour President and Chief Executive Officer and our Senior Vice President andChief Financial and Business Officer, we conducted an evaluation of theeffectiveness of our internal control over financial reporting based on theframework in *Internal Control - IntegratedFramework*issued by the Committee of Sponsoring Organizations of theTreadway Commission. Based on our evaluation under the framework in *Internal Control — Integrated Framework*,our management concluded that our internal control over financial reporting waseffective as of December 31, 2006.

Our management’sassessment of the effectiveness of our internal control over financialreporting as of December 31, 2006 has been audited by Ernst &Young LLP, anindependent registered public accounting firm, as stated in their report whichis included herein.

**Changesin Internal Control Over Financial Reporting**

There was nochange in our internal control over financial reporting during our most recentfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal controls over financial reporting.

**Reportof Independent Registered Public Accounting Firm on Internal Control overFinancial Reporting**

The Board of Directorsand StockholdersSenomyx, Inc.

We have auditedmanagement’s assessment, included in the accompanying “Management’s Report onInternal Control Over Financial Reporting,” that Senomyx Inc. maintainedeffective internal control over financial reporting as of December 31,2006, based on criteria established in Internal Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(the COSO criteria).  Senomyx, Inc.’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the company’sinternal control over financial reporting based on our audit.

We conducted ouraudit in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable 

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assurance aboutwhether effective internal control over financial reporting was maintained inall material respects. Our audit included obtaining an understanding ofinternal control over financial reporting, evaluating management’s assessment,testing and evaluating the design and operating effectiveness of internal control,and performing such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

A company’sinternal control over financial reporting is a process designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control overfinancial reporting includes those policies and procedures that (1) pertain tothe maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company;(2) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that receipts and expenditures ofthe company are being made only in accordance with authorizations of managementand directors of the company; and (3) provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use, ordisposition of the company’s assets that could have a material effect on thefinancial statements.

Because of itsinherent limitations, internal control over financial reporting may not preventor detect misstatements. Also, projections of any evaluation of effectivenessto future periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion,management’s assessment that Senomyx, Inc. maintained effective internalcontrol over financial reporting as of December 31, 2006, is fairlystated, in all material respects, based on the COSO criteria. Also, in ouropinion, Senomyx, Inc. maintained, in all material respects, effective internalcontrol over financial reporting as of December 31, 2005, based on theCOSO criteria**.**

We also haveaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the balance sheets as of December 31,2006 and 2005, and the related statements of operations, stockholders’ equityand cash flows for each of the three years in the period endedDecember 31, 2006 of Senomyx, Inc. and our report dated February 20, 2007expressed an unqualified opinion thereon.
|                       | /s/ Ernst & Young  LLP |   |
|-----------------------|----------------------------|--------|
|                  |                       |
| San Diego, California |                       |
| February 20, 2007     |                       |

 

**Item9B.    *Other Information***

None.

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** **

**PART III**

Certaininformation required by Part III of this Form 10-K is omittedfrom this report because registrant will file a definitive Proxy Statementwithin 120 days after the end of its fiscal year pursuant to Regulation 14A forits 2007 Annual Meeting of Shareholders to be held on May 31, 2007, referred toas the Proxy Statement, and the information included therein is incorporatedherein by reference.

**Item10.    *Directors,Executive Officers and Corporate Governance***

The informationwith respect to executive officers required by this item is set forth inPart I of this report.

We have adopted aCode of Business Conduct and Ethics Policy that applies to our directors andemployees (including our principal executive officer, principal financialofficer, principal accounting officer and controller), and have posted the textof the policy on our website (www.senomyx.com) in connection with “InvestorRelations” materials. In addition, we intend to promptly disclose (i) thenature of any amendment to the policy that applies to our principal executiveofficer, principal financial officer, principal accounting officer orcontroller, or persons performing similar functions and (ii) the nature ofany waiver, including an implicit waiver, from a provision of the policy thatis granted to one of these specified individuals, the name of such person whois granted the waiver and the date of the waiver on our website in the future.

The otherinformation required by this item is incorporated by reference to the ProxyStatement under the sections entitled “Election of Directors” and “Section16(a) Beneficial Ownership Reporting Compliance.”

**Item 11.    *Executive Compensation***

The informationrequired by this Item is incorporated herein by reference to the informationfrom the Proxy Statement under the sections entitled “ExecutiveCompensation,” “Compensation Committee Report” and “Compensation CommitteeInterlocks and Insider Participation.”

**Item12.    *SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters***

The informationrequired by this Item is incorporated herein by reference to the informationfrom the Proxy Statement under the sections entitled “Security Ownershipof Certain Beneficial Owners and Management” and “Securities Authorized forIssuance under Equity Compensation Plans.”

**Item 13.    *Certain Relationships and Related Transactions, andDirector Independence***

The informationrequired by this Item is incorporated herein by reference to the informationfrom the Proxy Statement under the sections entitled “Election ofDirectors” and “Certain Relationships and Related Transactions.”

**Item 14.    *Principle Accountant Fees and Services***

The informationrequired by this Item is incorporated by herein by reference to the informationfrom the Proxy Statement under the section entitled “Principal AccountantFees and Services.”

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** **

**PART IV**

**Item 15.    *Exhibits and Financial Statement Schedules***

**(a)**           1. ***FinancialStatements***

See Index toFinancial Statements in Item 8 of this annual report on Form 10-K,which is incorporated herein by reference.

2. ***Financial Statement Schedules***

All schedules havebeen omitted because they are not applicable or required, or the informationrequired to be set forth therein is included in the Financial Statements ornotes thereto included in Item 8 of this annual report on Form 10-K.

3.***Exhibits***
| Exhibit  Footnote | ** ** | **Exhibit Number** | ** ** | **Description of Document**                                                                                                                                                                                                                                                            |
|-------------------|------------|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1)               |       | 3.1                |       | Amended and Restated Certificate of Incorporation as  currently in effect.                                                                                                                                                                                                             |
| (1)               |       | 3.2                |       | Amended and Restated Bylaws as currently in effect.                                                                                                                                                                                                                                    |
| (2)               |       | 3.3                |       | Certificate of Designation of Series A Junior  Participating Preferred Stock, as filed with the Secretary of State of  Delaware on February 14, 2005.                                                                                                                                  |
| (1)               |       | 4.1                |       | Form of Common Stock Certificate.                                                                                                                                                                                                                                                 |
| (1)               |       | 4.2                |       | Fourth Amended and Restated Investor Rights  Agreement dated November 14, 2001, as amended February 27, 2002,  between the Registrant and certain of its stockholders.                                                                                                       |
| (2)               |       | 4.3                |       | Form of Rights Certificate.                                                                                                                                                                                                                                                            |
| (2)               |       | 4.4                |       | Rights Agreement, dated February 14, 2005 by and  between the Registrant and Mellon Investor Services LLP.                                                                                                                                                                             |
| (1)               |       | 10.1+              |       | Form of Indemnity Agreement.                                                                                                                                                                                                                                                      |
| (1)               |       | 10.2+              |       | Amended and Restated 2004 Equity Incentive Plan and  Form of Stock Option Agreement thereunder.                                                                                                                                                                                   |
| (1)               |       | 10.3+              |       | 2004 Employee Stock Purchase Plan and Form of  Offering Document thereunder.                                                                                                                                                                                                      |
| (1)               |       | 10.4+              |       | Employment letter agreement dated February 21,  2000 between the Registrant and Mark Zoller, Ph.D.                                                                                                                                                                                |
| (1)               |       | 10.5+              |       | Employment letter agreement dated June 2, 2003  between the Registrant and Kent Snyder.                                                                                                                                                                                           |
| (1)               |       | 10.6+              |       | Employment letter agreement dated August 25,  2003 between the Registrant and Harry Leonhardt, Esq.                                                                                                                                                                          |
| (1)               |       | 10.7+              |       | Employment letter agreement dated September 8,  2003 between the Registrant and John Poyhonen.                                                                                                                                                                                    |
| (1)               |       | 10.8               |       | Expansion Lease dated November 20, 1995 between  Health Science Properties, Inc. and Sequana Therapeutics, Inc., as  amended, and Assignment and Assumption of Lease, dated July 12, 2000, as  amended, between the Registrant and Axys Pharmaceuticals, Inc. |
| (1)               |       | 10.9*              |       | Exclusive License and Bailment Agreement dated  March 10, 2000 between the Registrant and the Regents of the University  of California.                                                                                                                                           |
| (1)               |       | 10.10*             |       | Collaborative Research and License Agreement dated  November 1, 2000, as amended April 16, 2002, between the Registrant  and Aurora Biosciences Corporation.                                                                                                                 |
| (1)               |       | 10.11*             |       | Collaborative Research and License Agreement dated  December 6, 2000, as amended May 2, 2002, between the Registrant  and Kraft Foods, Inc.                                                                                                                             |
| (1)               |       | 10.12*             |       | Collaborative Research and License Agreement dated  March 28, 2001, as amended July 26, 2002, November 5, 2002 and  February 19, 2004 between the Registrant and Campbell Soup Company.                                                                            |
| (1)               |       | 10.13*             |       | Collaborative Research and License Agreement dated  April 18, 2002, as amended October 23, 2003, between the Registrant  and Nestec, Ltd.                                                                                                                                    |

 

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| (1)    |   | 10.14* |   | Collaborative Research, Development,  Commercialization and License Agreement dated April 22, 2002 between the  Registrant and the Coca-Cola Company.                                                                          |
|--------|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1)    |   | 10.17+ |   | 1999 Equity Incentive Plan and Form of Stock  Option Agreement thereunder.                                                                                                                                                     |
| (2)    |   | 10.18* |   | Collaborative Research and License Agreement, dated  October 26, 2004, between the Registrant and Nestec Ltd.                                                                                                                  |
| (3)    |   | 10.19* |   | Second Amendment to the Collaborative Research and  License Agreement dated April 18, 2002, as amended October 23, 2003, between  the Registrant and Nestec, Ltd.                                                                   |
| (4)    |   | 10.20* |   | Second Amendment to the Collaborative Research and  License Agreement dated December 6, 2000, as amended May 2, 2002, between the  Registrant and Kraft Foods Global, Inc.                                                          |
| (5)    |   | 10.21* |   | Third Amendment to the Collaborative Research and  License Agreement dated December 6, 2000, as amended May 2, 2002 and April  29, 2005, between the Registrant and Kraft Foods Global, Inc.                                        |
| (6)    |   | 10.22+ |   | Summary Description of Senomyx, Inc. Incentive  Cash Bonus Program.                                                                                                                                                            |
| (7)    |   | 10.23* |   | Lease Agreement between ARE-NEXUS CENTRE II, LLC and  Registrant.                                                                                                                                                                   |
| (7)    |   | 10.24  |   | Seventh Amendment to Expansion Lease by and between  ARE-11099 NORTH TORREY PINES, LLC, and Registrant.                                                                                                                             |
| (7)    |   | 10.25* |   | Amended and Restated Fourth Amendment to the  Collaborative Research and License Agreement dated December 6, 2000, as  amended May 2, 2002, April 29, 2005 and July 29, 2005, between the Registrant  and Kraft Foods Global, Inc.  |
| (8)    |   | 10.26* |   | Fourth Amendment to the Collaborative Research and  License Agreement dated March 28, 2001, as amended July 26, 2002, November 5,  2002, February 19, 2004 and February 24, 2006 between the Registrant and  Campbell Soup Company. |
| (8)    |   | 10.27* |   | Third Amendment to the Collaborative Research and  License Agreement dated April 18, 2002, as amended October 23, 2003, April  17, 2005 and March 22, 2006 between the Registrant and Nestec, Ltd.                                  |
| (8)    |   | 10.28* |   | Collaborative Research, Development,  Commercialization and License Agreement dated March 23, 2006 between the  Registrant and Ajinomoto Co., Inc.                                                                                  |
| (9)    |   | 10.29  |   | Statement dated June 9, 2006 re: extension of  Collaborative Research and License Agreement dated October 26, 2004 between the  Registrant and Nestec, Ltd.                                                                         |
| (10)   |   | 10.30  |   | Description of director compensation provided to Jay  Short.                                                                                                                                                                        |
| (11)   |   | 10.31+ |   | Change in Control Agreement dated October 10, 2006  by and between the Registrant and Kent Snyder.                                                                                                                                  |
| (11)   |   | 10.32+ |   | Change in Control Agreement dated October 10, 2006  by and between the Registrant and Mark J. Zoller, Ph.D.                                                                                                                         |
| (11)   |   | 10.33+ |   | Change in Control Agreement dated October 10, 2006  by and between the Registrant and Harry J. Leonhardt, Esq.                                                                                                                      |
| (11)   |   | 10.34+ |   | Change in Control Agreement dated October 10, 2006  by and between the Registrant and John Poyhonen.                                                                                                                                |
|   |   | 10.35* |   | First Amendment to the Collaborative Research,  Development, Commercialization and License Agreement dated March 23, 2006  between the Registrant and Ajinomoto Co., Inc.                                                           |
|   |   | 10.36* |   | Collaborative Research, Commercialization and  License Agreement dated October 6, 2006 between the Registrant and Ajinomoto  Co., Inc.                                                                                              |
|   |   | 10.37* |   | License Agreement between the Registrant and The  Regents of the University of California dated October 11, 2006.                                                                                                                   |
|   |   | 10.38* |   | Letter Agreement between the Registrant and The  Regents of the University of California dated October 11, 2006.                                                                                                                    |
|   |   | 10.39* |   | Fifth Amendment to the Collaborative Research and  License Agreement dated December 6, 2000, as amended May 2, 2002, April 29,  2005, July 29, 2005 and December 9, 2005, between the Registrant and Kraft  Foods                   |

 

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|        |   |   |   | Global, Inc.                                                                                                                                                                                                                                                                              |
|--------|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | 10.40+ |   | Employment letter agreement dated March 14, 2006  between the Registrant and Sharon Wicker.                                                                                                                                                                                               |
|   |   | 10.41+ |   | Change in Control Agreement dated October 10, 2006  by and between the Registrant and Sharon Wicker.                                                                                                                                                                                      |
|   |   | 10.42  |   | Statement dated January 9, 2007 re: extension of  Collaborative Research and License Agreement dated October 26, 2004 between the  Registrant and Nestec, Ltd.                                                                                                                            |
|   |   | 23.1   |   | Consent of Independent Registered Public Accounting  Firm.                                                                                                                                                                                                                                |
|   |   | 24.1   |   | Power of Attorney. Reference is made to the signature  page.                                                                                                                                                                                                                              |
|   |   | 31.1   |   | Certification of Kent Snyder, Chief Executive  Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                   |
|   |   | 31.2   |   | Certification of John Poyhonen, Chief Financial and  Business Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                   |
|   |   | 32.1   |   | Certification of Kent Snyder, President, Chief  Executive Officer and Director, and John Poyhonen, Senior Vice President and  Chief Financial and Business Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

----

**+             **Indicatesmanagement contract or compensatory plan.

*              Confidential treatment has beenrequested with respect to certain portions of this exhibit. Omitted portionshave been filed separately with the Securities and Exchange Commission.

(1)           Filed as an exhibit to RegistrationStatement File No. 333-113998 and incorporated herein by reference.

(2)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended September 30, 2004and incorporated herein by reference.

(3)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended March 31, 2005 andincorporated herein by reference.

(4)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended June 30, 2005 and incorporatedherein by reference.

(5)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended September 30, 2005 andincorporated herein by reference.

(6)           Filed as an exhibit to our CurrentReport on Form 8-K filed with the Securities and Exchange Commission onFebruary 6, 2006 and incorporated herein by reference.

(7)           Filed as an exhibit to our AnnualReport on Form 10-K for the year ended December 31, 2005 andincorporated herein by reference.

(8)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended March 31, 2006 andincorporated herein by reference.

(9)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended June 30, 2006 andincorporated herein by reference.

(10)         Filed as our Current Report on Form 8-kfiled with the Securities and Exchange Commission on July 13, 2006 andincorporated herein by reference.

(11)         Filed as an exhibit to our CurrentReport on Form 8-K filed with the Securities and Exchange Commission on October13, 2006 and incorporated herein by reference.

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**(b) Exhibits**

See Item15(a) above.

**(c) Financial Statement Schedules**

See Item15(a) above.

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** **

**SIGNATURES**

Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|                           |   | Senomyx, Inc. |
|---------------------------|--------|--------------------|
|                      |   | By:                | /S/ KENT SNYDER |   |
|                      |   |               | Kent Snyder |
|                      |   |               | President and Chief Executive |
|                      |   |               | Officer |
|                      |   |               |   |
|                      |   |               |   |
| Dated: February  23, 2007 |   |               |   |

 

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**POWER OF ATTORNEY**

KNOW ALL PERSONSBY THESE PRESENTS, that each person whose signature appears below constitutesand appoints Kent Snyder, Mark Leschly and John Poyhonen, and each of them, ashis or her true and lawful attorneys-in-fact and agents, with full power ofsubstitution and resubstitution, for him or her and in his or her name, place,and stead, in any and all capacities, to sign any and all amendments to thisreport, and to file the same, with all exhibits thereto, and other documents inconnection therewith, with the Securities and Exchange Commission, grantingunto said attorneys-in-fact and agents, and each of them, full power andauthority to do and perform each and every act and thing requisite andnecessary to be done in connection therewith, as fully to all intents andpurposes as he or she might or could do in person, hereby ratifying andconfirming that all said attorneys-in-fact and agents, or any of them or theiror his substitute or substituted, may lawfully do or cause to be done by virtuehereof.

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.
| Signature                  | ** ** | **Title**                                       | ** ** | **Date**           |
|----------------------------|------------|-------------------------------------------------|------------|--------------------|
|                       |       |                                            |       |               |
| /S/ KENT SNYDER            |       | President, Chief Executive Officer and Director |       | February  23, 2007 |
| Kent Snyder                |       |                                            |       |               |
|                       |       |                                            |       |               |
|                       |       |                                            |       |               |
| /S/ JOHN POYHONEN          |       | Senior Vice President and Chief Financial and   |       | February  23, 2007 |
| John Poyhonen              |       | Business Officer                                |       |               |
|                       |       |                                            |       |               |
|                       |       |                                            |       |               |
| /S/ MARK LESCHLY           |       | Chairman of the Board of Directors              |       | February  23, 2007 |
| Mark Leschly               |       |                                            |       |               |
|                       |       |                                            |       |               |
|                       |       |                                            |       |               |
| /S/ STEPHEN A. BLOCK       |       | Director                                        |       | February  23, 2007 |
| Stephen A. Block, Esq.     |       |                                            |       |               |
|                       |       |                                            |       |               |
|                       |       |                                            |       |               |
| /S/ MICHAEL HERMAN         |       | Director                                        |       | February  23, 2007 |
| Michael E. Herman          |       |                                            |       |               |
|                       |       |                                            |       |               |
|                       |       |                                            |       |               |
| /S/ DENNIS F. O’BRIEN |       | Director                                        |       | February  23, 2007 |
| Dennis F. O’Brien     |       |                                            |       |               |
|                       |       |                                            |       |               |
|                       |       |                                            |       |               |
| /S/ JAY M. SHORT           |       | Director                                        |       | February  23, 2007 |
| Jay M. Short, Ph.D.   |       |                                            |       |               |
|                       |       |                                            |       |               |
|                       |       |                                            |       |               |
| /S/ CHRISTOPHER TWOMEY     |       | Director                                        |       | February  23, 2007 |
| Christopher Twomey         |       |                                            |       |               |

 

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** **

**EXHIBIT INDEX**
| Exhibit Footnote | ** ** | **Exhibit Number** | ** ** | **Description of Document**                                                                                                                                                                                                                                                            |
|------------------|------------|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1)              |       | 3.1                |       | Amended and Restated Certificate of Incorporation as  currently in effect.                                                                                                                                                                                                             |
| (1)              |       | 3.2                |       | Amended and Restated Bylaws as currently in effect.                                                                                                                                                                                                                                    |
| (2)              |       | 3.3                |       | Certificate of Designation of Series A Junior  Participating Preferred Stock, as filed with the Secretary of State of  Delaware on February 14, 2005.                                                                                                                                  |
| (1)              |       | 4.1                |       | Form of Common Stock Certificate.                                                                                                                                                                                                                                                 |
| (1)              |       | 4.2                |       | Fourth Amended and Restated Investor Rights  Agreement dated November 14, 2001, as amended February 27, 2002,  between the Registrant and certain of its stockholders.                                                                                                       |
| (2)              |       | 4.3                |       | Form of Rights Certificate.                                                                                                                                                                                                                                                            |
| (2)              |       | 4.4                |       | Rights Agreement, dated February 14, 2005 by and  between the Registrant and Mellon Investor Services LLP.                                                                                                                                                                             |
| (1)              |       | 10.1+              |       | Form of Indemnity Agreement.                                                                                                                                                                                                                                                      |
| (1)              |       | 10.2+              |       | Amended and Restated 2004 Equity Incentive Plan and  Form of Stock Option Agreement thereunder.                                                                                                                                                                                   |
| (1)              |       | 10.3+              |       | 2004 Employee Stock Purchase Plan and Form of  Offering Document thereunder.                                                                                                                                                                                                      |
| (1)              |       | 10.4+              |       | Employment letter agreement dated February 21,  2000 between the Registrant and Mark Zoller, Ph.D.                                                                                                                                                                                |
| (1)              |       | 10.5+              |       | Employment letter agreement dated June 2, 2003  between the Registrant and Kent Snyder.                                                                                                                                                                                           |
| (1)              |       | 10.6+              |       | Employment letter agreement dated August 25,  2003 between the Registrant and Harry Leonhardt, Esq.                                                                                                                                                                          |
| (1)              |       | 10.7+              |       | Employment letter agreement dated September 8,  2003 between the Registrant and John Poyhonen.                                                                                                                                                                                    |
| (1)              |       | 10.8               |       | Expansion Lease dated November 20, 1995 between  Health Science Properties, Inc. and Sequana Therapeutics, Inc., as  amended, and Assignment and Assumption of Lease, dated July 12, 2000, as  amended, between the Registrant and Axys Pharmaceuticals, Inc. |
| (1)              |       | 10.9*              |       | Exclusive License and Bailment Agreement dated  March 10, 2000 between the Registrant and the Regents of the University  of California.                                                                                                                                           |
| (1)              |       | 10.10*             |       | Collaborative Research and License Agreement dated  November 1, 2000, as amended April 16, 2002, between the Registrant  and Aurora Biosciences Corporation.                                                                                                                 |
| (1)              |       | 10.11*             |       | Collaborative Research and License Agreement dated  December 6, 2000, as amended May 2, 2002, between the Registrant  and Kraft Foods, Inc.                                                                                                                             |
| (1)              |       | 10.12*             |       | Collaborative Research and License Agreement dated  March 28, 2001, as amended July 26, 2002, November 5, 2002 and  February 19, 2004 between the Registrant and Campbell Soup Company.                                                                            |
| (1)              |       | 10.13*             |       | Collaborative Research and License Agreement dated  April 18, 2002, as amended October 23, 2003, between the Registrant  and Nestec, Ltd.                                                                                                                                    |
| (1)              |       | 10.14*             |       | Collaborative Research, Development,  Commercialization and License Agreement dated April 22, 2002 between the  Registrant and the Coca-Cola Company.                                                                                                                             |
| (1)              |       | 10.17+             |       | 1999 Equity Incentive Plan and Form of Stock  Option Agreement thereunder.                                                                                                                                                                                                        |
| (2)              |       | 10.18*             |       | Collaborative Research and License Agreement, dated  October 26, 2004, between the Registrant and Nestec Ltd.                                                                                                                                                                     |
| (3)              |       | 10.19*             |       | Second Amendment to the Collaborative Research and  License Agreement dated April 18, 2002, as amended October 23, 2003, between  the Registrant and Nestec, Ltd.                                                                                                                      |
| (4)              |       | 10.20*             |       | Second Amendment to the Collaborative Research and  License Agreement dated December 6, 2000, as amended May 2, 2002, between the  Registrant and Kraft Foods Global, Inc.                                                                                                             |
| (5)              |       | 10.21*             |       | Third Amendment to the Collaborative Research and  License Agreement dated December 6, 2000, as amended May 2, 2002 and April  29, 2005,                                                                                                                                               |

 

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|        |   |   |   | between the Registrant and Kraft Foods Global, Inc.                                                                                                                                                                                 |
|--------|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (6)    |   | 10.22+ |   | Summary Description of Senomyx, Inc. Incentive  Cash Bonus Program.                                                                                                                                                            |
| (7)    |   | 10.23* |   | Lease Agreement between ARE-NEXUS CENTRE II, LLC and  Registrant.                                                                                                                                                                   |
| (7)    |   | 10.24  |   | Seventh Amendment to Expansion Lease by and between  ARE-11099 NORTH TORREY PINES, LLC, and Registrant.                                                                                                                             |
| (7)    |   | 10.25* |   | Amended and Restated Fourth Amendment to the  Collaborative Research and License Agreement dated December 6, 2000, as  amended May 2, 2002, April 29, 2005 and July 29, 2005, between the Registrant  and Kraft Foods Global, Inc.  |
| (8)    |   | 10.26* |   | Fourth Amendment to the Collaborative Research and  License Agreement dated March 28, 2001, as amended July 26, 2002, November 5,  2002, February 19, 2004 and February 24, 2006 between the Registrant and  Campbell Soup Company. |
| (8)    |   | 10.27* |   | Third Amendment to the Collaborative Research and  License Agreement dated April 18, 2002, as amended October 23, 2003, April  17, 2005 and March 22, 2006 between the Registrant and Nestec, Ltd.                                  |
| (8)    |   | 10.28* |   | Collaborative Research, Development,  Commercialization and License Agreement dated March 23, 2006 between the  Registrant and Ajinomoto Co., Inc.                                                                                  |
| (9)    |   | 10.29  |   | Statement dated June 9, 2006 re: extension of  Collaborative Research and License Agreement dated October 26, 2004 between the  Registrant and Nestec, Ltd.                                                                         |
| (10)   |   | 10.30  |   | Description of director compensation provided to Jay  Short.                                                                                                                                                                        |
| (11)   |   | 10.31+ |   | Change in Control Agreement dated October 10, 2006  by and between the Registrant and Kent Snyder.                                                                                                                                  |
| (11)   |   | 10.32+ |   | Change in Control Agreement dated October 10, 2006  by and between the Registrant and Mark J. Zoller, Ph.D.                                                                                                                    |
| (11)   |   | 10.33+ |   | Change in Control Agreement dated October 10, 2006  by and between the Registrant and Harry J. Leonhardt, Esq.                                                                                                                      |
| (11)   |   | 10.34+ |   | Change in Control Agreement dated October 10, 2006  by and between the Registrant and John Poyhonen.                                                                                                                                |
|   |   | 10.35* |   | First Amendment to the Collaborative Research,  Development, Commercialization and License Agreement dated March 23, 2006  between the Registrant and Ajinomoto Co., Inc.                                                           |
|   |   | 10.36* |   | Collaborative Research, Commercialization and  License Agreement dated October 6, 2006 between the Registrant and Ajinomoto  Co., Inc.                                                                                              |
|   |   | 10.37* |   | License Agreement between the Registrant and The  Regents of the University of California dated October 11, 2006.                                                                                                                   |
|   |   | 10.38* |   | Letter Agreement between the Registrant and The Regents  of the University of California dated October 11, 2006.                                                                                                                    |
|   |   | 10.39* |   | Fifth Amendment to the Collaborative Research and  License Agreement dated December 6, 2000, as amended May 2, 2002, April 29,  2005, July 29, 2005 and December 9, 2005, between the Registrant and Kraft  Foods Global, Inc.      |
|   |   | 10.40+ |   | Employment letter agreement dated March 14, 2006  between the Registrant and Sharon Wicker.                                                                                                                                         |
|   |   | 10.41+ |   | Change in Control Agreement dated October 10, 2006  by and between the Registrant and Sharon Wicker.                                                                                                                                |
|   |   | 10.42  |   | Statement dated January 9, 2007 re: extension of  Collaborative Research and License Agreement dated October 26, 2004 between the  Registrant and Nestec, Ltd.                                                                      |
|   |   | 23.1   |   | Consent of Independent Registered Public Accounting  Firm.                                                                                                                                                                          |
|   |   | 24.1   |   | Power of Attorney. Reference is made to the  signature page.                                                                                                                                                                        |
|   |   | 31.1   |   | Certification of Kent Snyder, Chief Executive  Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                             |
|   |   | 31.2   |   | Certification of John Poyhonen, Chief Financial and  Business Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                             |
|   |   | 32.1   |   | Certification of Kent Snyder, President, Chief  Executive Officer and                                                                                                                                                               |

 

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|  |   |   |   | Director, and John Poyhonen, Senior Vice President  and Chief Financial and Business Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|--|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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**+             **Indicatesmanagement contract or compensatory plan.

*              Confidential treatment has beenrequested with respect to certain portions of this exhibit. Omitted portionshave been filed separately with the Securities and Exchange Commission.

(1)           Filed as an exhibit to RegistrationStatement File No. 333-113998 and incorporated herein by reference.

(2)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended September 30, 2004and incorporated herein by reference.

(3)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended March 31, 2005 andincorporated herein by reference.

(4)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended June 30, 2005 andincorporated herein by reference.

(5)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended September 30, 2005 andincorporated herein by reference.

(6)           Filed as an exhibit to our CurrentReport on Form 8-K filed with the Securities and Exchange Commission onFebruary 6, 2006 and incorporated herein by reference.

(7)           Filed as an exhibit to our AnnualReport on Form 10-K for the year ended December 31, 2005 andincorporated herein by reference.

(8)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended March 31, 2006 andincorporated herein by reference.

(9)           Filed as an exhibit to our QuarterlyReport on Form 10-Q for the quarter ended June 30, 2006 andincorporated herein by reference.

(10)         Filed as our Current Report on Form 8-kfiled with the Securities and Exchange Commission on July 13, 2006 andincorporated herein by reference.

(11)         Filed as an exhibit to our CurrentReport on Form 8-K filed with the Securities and Exchange Commission on October13, 2006 and incorporated herein by reference.

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