**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, 2003  OR**[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**

  Commission File Number 0-18311

NEUROGEN CORPORATION  (Exact name of registrant as specified in its charter)

 

| Delaware        (State or other jurisdiction        of incorporation or organization)                                  | 22-2845714        (I.R.S. Employer        Identification No.) |
|------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------|
| 35 Northeast Industrial          Road          Branford, Connecticut          (Address of principal executive offices) | 06405        (Zip Code)                                       |

 

(203) 488-8201  (Registrant's telephone number, including area code)

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

  Securities registered pursuant to Section 12(g) of the Act:  Common Stock, par value $.025 per share (the "Common Stock")  (Title of Class)

  Indicate by check mark whether the registrant (1) has filed all reports required  to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during  the preceding 12 months (or for such shorter period that the registrant was  required to file such reports), and (2) has been subject to filing requirements  for the past 90 days. YES [X] NO [   ]

Indicate by check mark  if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is  not contained herein, and will not be contained, to the best of registrant’s  knowledge, in definitive proxy or information statements incorporated by reference  in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

Indicate by check mark  whether the registrant is an accelerated filer (as defined in Rule 12b-2 of  the Act). YES [X] NO [    ]

The approximate aggregate  market value of the registrant’s Common Stock held by non-affiliates was  $65,622,906, based on the closing price of a share of Common Stock as reported  on the NASDAQ National Market on June 30, 2003, which is the last business day  of the registrant’s most recently completed second fiscal quarter. In  determining the market value of non-affiliate voting stock, shares of Common  Stock beneficially owned by officers and directors and one shareholder owning  more than 20% of the Common Stock have been excluded from the computation. This  number is provided only for purposes of this report and does not represent an  admission by either the registrant or any person as to the status of such person.

As of March 1, 2004, the  registrant had 19,892,646 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED  BY REFERENCE

(1) Portions of the Neurogen  Corporation Proxy Statement for the Annual Meeting of Stockholders to be held  on May 21, 2004 are incorporated by reference into Items 10, 11, 12, 13 and  14 of Part III of this Form 10-K. 

**NEUROGEN CORPORATION   ANNUAL REPORT ON FORM 10-K**

**For the Year Ended December 21, 2003**

**TABLE OF CONTENTS**

| **PART      1**    |
|--------------------|
|               | Item 1. | Business |
|               | 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 Purchase of Equity      Securities |
|               | Item 6. | Selected Financial      Data |
|               | Item 7. | Management’s      Discussion and Analysis of Financial Condition |
|               | 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 |
|               |   |   |
| **PART      III**  |
|               | Item 10. | Directors and Executive      Officers of the Registrant |
|               | Item 11. | Executive Compensation |
|               | Item 12. | Security Ownership      of Certain Beneficial Owners and Management |
|               | Item 13. | Certain Relationships      and Related Transactions |
|               | Item 14. | Principal Accounting      Fees and Services |
|               |   |   |
| **PART        IV** |
|               | Item 15. | Exhibits, Financial      Statement Schedules, and Reports on Form 8-K |

**SIGNATURES**

**EXHIBIT INDEX**

**PART  I**

**ITEM 1. BUSINESS**

**Overview**

Neurogen Corporation (Nasdaq:  NRGN) ("Neurogen" or the "Company"), incorporated under  the laws of the State of Delaware in 1987, is a drug discovery and development  company targeting new small molecule drugs to improve the lives of patients  suffering from disorders with significant unmet medical needs including inflammation,  pain, insomnia, depression and obesity. Neurogen has generated a portfolio of  compelling new drug programs through its fully integrated drug discovery and  development processes. Neurogen’s Accelerated Intelligent Drug Discovery  ("AIDD" TM) process and its expertise in cellular functional  assays enhance the Company's ability to rapidly and cost effectively identify  small molecule drug candidates. Small molecule drugs typically are suitable  for oral administration as a pill, while large molecule drugs typically are  administered by injection. The Company conducts its research and development  independently and, when advantageous, collaborates with leading pharmaceutical  companies during the drug research and development process to obtain additional  resources and to access complementary expertise. Currently, Neurogen has active  collaborations with Pfizer Inc. ("Pfizer"), Aventis Pharmaceuticals,  Inc. ("Aventis"), and Merck Sharp & Dohme Limited ("Merck"),  a subsidiary of Merck & Co., Inc. 

Neurogen has diversified  its drug discovery and development efforts across a broad number of disease-related  targets and employs a strategy designed to efficiently discover multiple drug  candidates for each target. In addition, several of the Company’s programs  focus on medical targets which are implicated in numerous, related disease states.  Throughout the pharmaceutical industry, a small minority of all drug candidates  successfully overcome all of the development obstacles on the way to commercialization.  Because of this very high attrition rate, the Company believes that the  value of a drug discovery and development company’s pipeline is best  measured by the company’s ability to rapidly discover multiple generations  of improved candidates within each of several programs. 

Neurogen believes that  its ability to rapidly and systematically produce multiple generations of incrementally  improved drug candidates in multiple programs represents a competitive  advantage. Although much smaller than major pharmaceutical companies, Neurogen  has discovered ten small molecule drug candidates that, in collaboration with  our pharmaceutical company partners, have entered human clinical trials. During  2003, the Company completed an exploratory Phase IIa trial (see Government Regulation  section below) in asthma of its lead drug candidate for the treatment of inflammatory  disorders (see Neurogen Drug Programs section below). An exploratory Phase IIa  study in rheumatoid arthritis, also begun during 2003, continued into 2004.  Neurogen owns all commercial rights to this program. Our partner, Pfizer, continued  to conduct Phase I human trials, begun in March 2002, for a drug candidate  from the Company's program for the treatment of insomnia. 

**Background on the  Drug Discovery Industry**

Most drugs work by binding  to a particular protein, cell, or receptor, called a target, in the human body,  thereby altering communication between cells or otherwise regulating cellular  activity. Therefore, the traditional path to discovering small molecule drugs  typically begins with the identification of a biological target that is believed  to regulate cellular communication or activities, which could be modulated to  treat a given disorder. A test, or assay, is then developed in order to expose  many chemical compounds to the biological target and determine whether any of  the compounds interact with the target. Such an assay facilitates the screening  of the target against a library of many compounds that have been synthesized  in the laboratory. Compounds that bind to the target protein and alter its activity  are referred to as "hits." Medicinal chemists then create many new  compounds that are chemically similar to the original hit in an effort to improve,  or optimize, these newer hits until they have sufficient potency to become lead  drug candidates and then improve their "drug-like" properties, such  as gastrointestinal absorption, stability, freedom from unwanted activities,  etc., with the goal of producing a successful drug development candidate.

Some drug companies try  to streamline the drug discovery process by copying chemical structures from  known active compounds. Even taking this approach, however, the number of possible  compounds that could be made is too vast to actually test against even a single  target using any available technology. Generally, the search is further narrowed  only by educated guessing. As a result of the uncertainty of this approach,  traditional methods can take many years or may fail entirely.

If it were possible to  predict in advance which compounds would result in a hit, and which chemical  changes would help optimize hits into drug candidates, the drug discovery process  would be vastly simplified. Unfortunately, the traditional drug discovery process  has had to rely on a trial and error approach that has proven extremely expensive,  inefficient and unreliable. Optimization of hits to achieve the extremely delicate  balance of properties necessary for a successful drug is still a daunting task.  Most hits are never optimized into successful drugs despite years of effort.

**Neurogen’s  Competitive Advantage**

Neurogen’s drug discovery  and development platform is designed to rapidly discover small molecule drug  candidates for medical targets where other pharmaceutical or biotechnology companies  have failed or for recently discovered targets. The Company’s proprietary  AIDDTM platform enables the rapid and efficient discovery of compounds  that hit potential drug targets, evaluate the utility of those targets, and  optimize useful hits into new drug candidates. Neurogen’s VR1 program  for the management of pain, now partnered with Merck, is an example of the Company’s  ability to establish a leading position in an important new area of drug discovery.  Neurogen’s ability to rapidly discover small molecule drug candidates  enabled it to quickly generate hits sufficient to evaluate the potential utility  of this new target for the relief of pain and then establish a significant intellectual  property position. In addition to establishing the first patent publications  on small molecule VR1 antagonists, Neurogen has been awarded a patent on a human  VR1 receptor gene sequence, has filed broad applications encompassing highly  potent chemotypes, and has patent applications pending on the general use of  VR1 antagonists for the treatment of pain. 

Neurogen discovers and  develops  small molecule drugs. Small molecule drugs are  usually more stable and easily absorbed than large molecule drugs, and so in  most cases may be administered as an orally-administered pill, a patch, or an ointment. In addition,  small molecule drugs are generally much easier and less expensive to manufacture,  distribute, and store. Protein-based large molecule drugs typically are administered  by injection and require refrigeration, while most small molecule drugs do not.  Small molecule drugs can also be safely shipped and stored at regular temperatures.  Small molecule drugs that can be taken orally currently make up about three  quarters of the sales of the top 100 prescription drugs. Where there is a choice,  patients generally would rather take a pill by the oral route of administration than an injection.

**Neurogen's Business  Strategy**

Neurogen’s goal is  to bring approved drugs to patients suffering from disorders with unmet medical  need. Key elements of the Company’s business strategy to achieve this  goal follow:

- *Create a risk-balanced    drug portfolio.* To increase the probability of successful drug discovery    and development efforts, Neurogen is pursuing multiple targets with multiple    drug candidates. The Company is concentrating its efforts on key therapeutic    areas (inflammation, pain, insomnia, depression and obesity) within which    clinical indications may be developed for a variety of disorders. The Company    believes that its ability to efficiently produce multiple generations of candidates    in multiple programs using AIDDTM represents an important element of    its strategy to address the very high attrition rates inherent in the drug    development process and increase incrementally the probability of successfully    advancing one or more candidates to market.
- *Expand development capability.* Neurogen possesses      a powerful drug discovery capability, which is closely linked to pharmaceutical      development and clinical initiatives to continuously optimize drug properties.      The Company believes this integrated approach will aid in the development      of compounds in the clinic, and is deploying additional resources to support      the early clinical trials of lead drug candidates.
- *Selectively partner drug programs.* Neurogen's partnering strategy      seeks to retain ownership and control of some programs – taking them      further into human clinical testing – while partnering other programs      at earlier stages, so that the Company’s risk is balanced while seeking      to maximize return for shareholders. Neurogen’s development capabilities      enable the Company to pursue a flexible business model of partnering programs      when competitively and economically advantageous. When Neurogen partners programs,      it seeks to collaborate with pharmaceutical leaders with a complementary set      of demonstrated strengths and resources.

**Components of Neurogen's  Discovery and Development Platform**

The Company’s AIDDTM  system, as well as its focused compound library and Virtual LibraryTM,  are key components of the drug discovery infrastructure. AIDDTM is an integrated  system of hardware, software, and processes that allow scientists to improve  on the trial and error approach traditionally associated with drug discovery  and development. This system incorporates automated robotics guided by state-of-the-art  computerization, including neural network-based artificial intelligence, to  aid the Company’s scientists in the design, modeling, synthesis and screening  of new chemical compounds.   Neurogen’s AIDDTM system works in tandem with the Company’s  focused compound library. Instead of randomly generating a compound library  as many other pharmaceutical and drug discovery companies have done, Neurogen  has chosen to bias or "enrich" its compound library in favor of  selected families of compounds. Because the number of small molecule organic  compounds that can be synthesized is virtually infinite, the Company believes  that to be successful in the drug discovery process, it is not the biggest or  most diverse library that counts, but rather the richest and most intelligently  designed.  Also critical to Neurogen’s drug discovery and development capabilities  is the Company’s biological expertise. Neurogen believes that its expertise  in receptor biology is a competitive advantage and utilizes this expertise in  the design and construction of screening assays to capitalize on medical targets.  The Company focuses on discovering novel drugs, and all of the drug candidates  that have entered human testing in clinical trials have worked by distinctly  new target mechanisms, which have the potential to provide significant therapeutic  advantages over existing drugs. 

**Neurogen Drug Programs**

By discovering and developing  drug candidates specifically targeting a new mechanism, Neurogen’s programs  offer the potential for introducing new drugs which are differentiated from  drugs currently on the market. In addition, drugs active against new targets  may offer the possibility of adding to or synergistically improving existing  therapy.

The Company is  in the early stage  of product development and does not expect to have any products resulting from  its research efforts commercially available for a number of years, if at all.  To date, the Company has stopped developing eight compounds which had previously been  in clinical development. Currently, Neurogen has several compounds in preclinical  development, one compound in Phase IIa human clinical trials and one compound  in Phase I human clinical trials. All of the Company's compounds currently being developed,  whether in human clinical trials or not will require significant additional  research, development and testing before they can be commercialized. Neurogen cannot  accurately predict the time required or the cost involved in commercializing  any new drug. In addition, developing new drugs is an extremely uncertain process,  and unanticipated developments such as clinical or regulatory delays, unexpected  side effects in test patients, or ineffectiveness would slow or prevent the  development of a product. If Neurogen is unable to commercialize any drug products,  the Company will never achieve product revenues and may eventually be unable to continue   operating. This result would cause investors to lose all or a substantial  portion of their investment.

The following table summarizesthe most advanced programs in the Company’s current drug pipeline:

| Disorder                                                                                                                                 | Target    Mechanism | Program    Status                                                                                                                                             | Commercial    Rights                    |
|------------------------------------------------------------------------------------------------------------------------------------------|---------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------|
| Inflammation and    Autoimmune Disease:         Rheumatoid    Arthritis         Asthma | C5a                 | Phase IIa (NGD 2000-1)      Phase IIa (NGD 2000-1)      completed       January 2004; did not achieve       statistical significance on primary     endpoint. | Neurogen                                |
| Insomnia                                                                                                                                 | GABA                | Phase I (NGD 96-3)                                                                                                                                            | Pfizer Marketing/Neurogen      Royalty  |
| Pain                                                                                                                                     | VR1                 | Preclinical Development                                                                                                                                       | Merck Marketing/Neurogen      Royalty   |
| Depression and Stress                                                                                                                    | CRF-1               | Preclinical Development                                                                                                                                       | Aventis Marketing/Neurogen      Royalty |
| Obesity                                                                                                                                  | MCH-1               | Preclinical Research                                                                                                                                          | Neurogen                                |

Below, Neurogen’s  most significant active drug development programs are described in detail.

**Inflammation Program:  C5a receptor antagonist**

Inflammatory and autoimmune  conditions are debilitating diseases afflicting millions of Americans, causing  substantial human suffering, and impacting the United States economy with significant  health care costs and lost productivity. These diseases include many different  forms of arthritis, autoimmune diseases, and pulmonary disorders. Most are chronic  and many cause life-long pain, disability, or disfigurement. These diseases  affect people of all ages, racial and ethnic populations, and economic strata.  

The body’s natural  immune system includes a biological response referred to as the complement cascade.  One component of the complement system is represented by the C5a protein, which  promotes inflammation, attracts white blood cells, and may trigger the immune  system to start attacking the body's own tissues, an inappropriate reaction  central to autoimmune and inflammatory diseases. Neurogen scientists believe  that blocking the activation of the C5a receptor of the immune system’s  complement cascade may work to treat inflammation in rheumatoid arthritis (RA)  and other autoimmune diseases.

RA involves inflammation  in the lining of the joints and/or other internal organs. It is a systemic disease  affecting the entire body and is one of the most common forms of arthritis,  characterized by the inflammation of the membrane lining the joint, resulting  in pain, stiffness, warmth, redness and swelling. Industry surveys indicate  that this disease affects 2.6 million Americans. 

Certain types of arthritis  can occur as early as infancy. In children, the most common form is called juvenile  rheumatoid arthritis ("JRA"). The Arthritis Foundation estimates  that this condition affects an estimated 30,000 to 50,000 children in the Unites  States. The American College of Rheumatology estimates that the number of children  in the U.S. suffering from JRA may be as high as 150,000.

Currently, several types  of drugs are used to treat rheumatoid arthritis. Recently, drugs which inhibit  the tumor necrosis factor alpha ("TNFa") protein, such as Enbrel®  and Remicade®, have demonstrated the ability to not only treat the symptoms  of rheumatoid arthritis but also slow the progression of the disease by inhibiting  the destruction of healthy joint tissue. However, as large molecule proteins,  these drugs must be taken by injection and are expensive to manufacture, distribute  and administer. Anti-tumor necrosis factor drugs also have some side effects  such as development of antinuclear antibodies (these are antibodies seen in  various autoimmune diseases such as Lupus); Urticaria (reddish blotchy areas  on the skin), infections, and rejection of these antibodies by the patient’s  own immune system (similar to the body's rejection of an organ transplant).

Other drugs used to treat  rheumatoid arthritis include the COX-2 inhibitors. Since the synthesis of aspirin  in 1897, inhibitors of cyclooxygenase (an enzyme that controls inflammation)  have been a source of relief from arthritis pain. These drugs are now collectively  called non-steroidal anti-inflammatory drugs ("NSAID’s").  The newest generation of NSAID’s is called COX-2 selective inhibitors.  Brand names of this type of medication include Celebrex® and Vioxx®.  While COX-2 inhibitors are small molecule drugs and feature less risk of side  effects such as blood thinning or stomach ulceration than earlier treatments,  these drugs do not slow the tissue destruction associated with the progression  of rheumatoid arthritis.

Neurogen believes that  blocking the C5a receptor in patients with rheumatoid arthritis may inhibit  the destruction of healthy tissue by blunting the immune system’s overreaction  to the presence of the C5a protein. The Company believes that its small molecule  drug candidate, taken as a pill for the treatment of rheumatoid arthritis, may  offer many of the advantages of the COX-2 inhibitors with the potential, because  a small molecule drug should be able to enter the synovial fluid of joints,  to also slow the progression of the disease.

The Company has identified  several small molecule compounds that potently block the activation of C5a receptors.  Phase I study results indicated that the Company’s lead compound in this  program, NGD 2000-1, was safe and well tolerated in single and multiple ascending  doses and also identified that the compound inhibits cytrochrome P450 3A4 ("3A4"),  a metabolic enzyme found in the liver, which metabolizes many drugs. This characteristic  may limit the use of NGD 2000-1 by patients also taking other medications which  are metabolized by the 3A4 enzyme. Further studies will be required to determine  the extent of any such limitation, to development or commercialization.

NGD 2000-1 is currently  in exploratory Phase IIa clinical trials for treatment of RA. In this exploratory  study, Neurogen is examining the ability of the compound to lower the levels  of C-reactive protein ("CRP"), a biomarker in RA, in patients with  mild to moderate conditions. The study is also examining secondary endpoints  of clinical signs and symptoms. The study is multi-centered, double-blinded  and placebo-controlled and explores multiple doses of NGD 2000-1. Neurogen expects  to conclude this study in the second quarter of 2004. The Company will evaluate  its development plan for NGD 2000-1 based on the results of the Phase IIa study  and further testing regarding the 3A4 enzyme inhibition, designed to identify  the extent of specific drug interactions. NGD 2000-1 may be more appropriate  for use in patient populations where the number of medications prescribed per  patient is low. JRA may be an example of a patient population with few concomitant  medications and where NGD 2000-1 might offer therapeutic benefit. It is also  possible that the Company may determine that NGD 2000-1 is not appropriate for  further development.

In January 2004, results  of an exploratory Phase IIa trial studying the safety and preliminary efficacy  of NGD 2000-1 in patients with mild to moderate asthma were reported. The trial  was multi-centered, double-blinded, and placebo-controlled and assessed multiple  doses of NGD 2000-1 using improvement in lung capacity as measured by forced  expiratory volume in one second (FEV-1) as the primary endpoint. In this study,  NGD 2000-1 did not demonstrate a statistically significant therapeutic benefit  with respect to the primary and most secondary predetermined endpoints. 

To date, Neurogen has retained  all rights to its C5a antagonist program. 

**Insomnia Program:  unique GABA modulation profile**

Recent studies indicate  that as many as 20 million people in the United States experience chronic insomnia  and an additional 20 to 30 million Americans experience intermittent sleep disorders.  While currently marketed drugs to treat sleep disorders, known as hypnotics,  are effective, they may cause numerous side effects, including "hangovers,"  rebound insomnia, short-term memory loss and addiction. Neurogen is developing  drugs to treat sleep disorders, primarily insomnia, which selectively modulate  certain subtypes of the gamma-aminobutyric acid ("GABA") neurotransmitter  system.

The link between the GABA  system and sleep is illustrated by the Benzodiazepine class of drugs such as  Valium®, which cause sleepiness, and by drugs marketed to treat insomnia  such as Ambien® and Sonata®, which work through the same broad range  of GABA receptors as the benzodiazepines. Neurogen has identified drug candidates  to treat insomnia that have a more specific GABA receptor binding profile than  currently marketed drugs. Animal studies, to date, suggest that these compounds  are efficacious in inducing sleep with fewer side effects than existing therapies.  Drugs to treat insomnia should not only induce sleep but they should have pharmacokinetic  properties, which cause the drug to work quickly and then be out of the system  before morning. 

Pfizer, Neurogen's partner in  this program, is currently evaluating the Company's lead compound, NGD 96-3, which entered  Phase I clinical studies in the first quarter of 2002. Pfizer has now completed  three single dose studies exploring the safety, pharmacokinetics and preliminary  efficacy of NGD 96-3 and is further assessing the safety profile and commercial  potential of the compound. Neurogen has initiated discussions with Pfizer to  explore various options to advance the clinical development of NGD 96-3.

In a Phase I, placebo-controlled,  single rising dose study of the safety and pharmacokinetics of NGD 96-3, the  compound was well-tolerated in healthy volunteers. Reports of sleepiness by  treated subjects in this study were consistent with the expected action of the  drug.

Pfizer has also performed  a separate human efficacy study of two dose levels of NGD 96-3 in healthy volunteers  using the marketed drug zolpidem (Ambien®) and placebo as controls. In that  study, when compared to subjects taking a placebo, both doses of NGD 96-3 significantly  reduced the latency (or length of time) required for healthy subjects to fall  into an EEG-defined sleep state during the day. 

To further assess the safety  profile of NGD 96-3, Pfizer has also conducted an additional single dose study  in healthy volunteers. Given the broad patient population eligible for treatment  and the availability of existing therapies, assessing the safety profile is  a critical step in the development of drugs for the treatment of insomnia.

**Pain Management  Program: VR1 receptor antagonist**

Industry sources estimate  more than 100 million people in the United States suffer from some type of acute  or chronic pain sufficient to significantly impact their lives. Not only does  such chronic pain adversely affect physical and psychological well being, it  also costs society in lost productivity, health care expenditures, and disability  compensation. Among cancer patients, available estimates suggest that chronic  pain affects up to 95% of patients with advanced disease with less than 50%  of these experiencing effective pain relief.

The Company believes that  its approach to pain management offers the potential to relieve pain without  the side effect profile of existing pain drugs. Neurogen and its partner  Merck have advanced lead candidates from their vanilloid receptor-1 program  into formal preclinical development and are also advancing additional, highly  potent candidates for potential development in this program. The program is  initially targeting pain and urinary incontinence, with additional indications  possible.  Studies which model inflammatory pain in genetically altered mice lacking the  VR1 receptor indicate a role of VR1 role in the sensation of noxious heat as  well as thermal hyperalgesia (heightened sensitivity to pain). Neurogen researchers  believe that a drug which blocks the VR1 receptor could benefit patients suffering  from various types of inflammatory pain states and specific types of nociceptive,  or localized, pain.

Neurogen has established  a significant intellectual property position on this new target for the relief  of pain. In addition to establishing the first patent publications on small  molecule VR1 antagonists, the Company has been awarded a patent on a human VR1  receptor gene sequence, has broad applications filed encompassing highly potent  chemical templates, and has patent applications pending on the general use of  VR1 antagonists for the treatment of pain.

Neurogen entered into a  collaboration agreement for VR1 research and development with Merck (described below) in December 2003.

**Depression/Anxiety  Program: CRF-1 receptor antagonist**

Depression and anxiety  are two of the most prevalent mental illnesses in the United States, affecting  approximately 22 million people or 11.6% and 9 million or 4.8%, respectively,  of the adult population annually, according to recent industry surveys. While  recent pharmaceutical research has led to improved drugs such as Prozac® for the treatment of depression, these medications are limited in their use,  primarily because of slow onset of therapeutic action (often greater than 10  days from the commencement of dosing), lack of efficacy in some patients, and  side effects such as sexual dysfunction. 

Anxiety and stress are  conditions commonly associated with depression. A number of neuropeptide receptors  that appear to be involved in stress responses, including receptors for CRF-1,  exhibit altered characteristics in depressed patients.

Neurogen believes that  an orally available drug candidate that blocks the CRF-1 receptor may be efficacious  in relieving depression, anxiety and/or stress related disorders. A number of  companies are seeking to develop CRF-1 drug candidates. To date, many companies  have experienced difficulties in identifying CRF-1 blockers, which have drug  properties appropriate for commercialization. Neurogen believes this is due  to the fact that the scope of known chemical structures which block CRF-1 is  relatively narrow.

Neurogen has discovered  a number of compounds that block the CRF-1 target and have demonstrated efficacy  in animal models of depression and stress. Importantly, the chemical structure  of these compounds is significantly outside of the scope of known CRF-1 blockers.  The Company believes these novel chemical templates may provide an avenue for  avoiding many of the development issues of earlier CRF-1 structures investigated  in the industry. 

In December of 2001, Neurogen  entered into a collaborative agreement with Aventis (described below) to research  and develop compounds to modulate CRF-1 receptors. Progress in the Company’s  research and development collaboration with Aventis resulted in the achievement  of a preclinical milestone in December 2003, which triggered the payment of  $1 million to Neurogen in January 2004. Neurogen and Aventis are working together  to advance their preclinical compound through the rigorous testing necessary  prior to an IND filing.

**Obesity/Diabetes  Program: MCH-1 receptor antagonist**

Neurogen is optimizing  lead compounds blocking the melanin concentrating hormone receptor-1 ("MCH-1"),  which is an important mediator of food intake. These receptors are expressed  in the hypothalamus, the feeding center of the brain. While obesity is caused  by a complex process involving many hormones, neurotransmitters, nerve cells,  and genes, the MCH neurotransmitter is now known to play a key role in controlling  eating behavior. In preclinical studies, removing the MCH peptide or receptor  gene has resulted in lean animals, while administering MCH caused increased  weight gain. The Company is currently optimizing lead drug candidates in this  program and further exploring in animal models the potential utility of MCH-1  antagonists. Neurogen owns all commercial rights to its MCH-1 receptor antagonist  program.

**Neurogen Collaborations**

Neurogen conducts its research  and development independently and, when advantageous, collaborates with global  pharmaceutical companies during the drug development process to obtain additional  resources and to access complementary expertise. The Company's collaboration  agreements may provide funding for drug discovery and development programs as  well as clinical, manufacturing, marketing, and sales expertise. At the same  time, Neurogen has retained certain rights to future royalties or profit sharing  for successful drugs resulting from collaborative programs. These strategic  alliances balance the Company's exposure to research and development risks inherent  in the industry while retaining a share in the success of future products.

A summary of the material  terms of agreements that relate to three currently partnered programs follows:    The 1994 Pfizer Agreement – covers the Company’s GABA-based sleep  disorder program as partnered with Pfizer

- Pfizer purchased approximately    1.1 million shares of Neurogen common stock for approximately $9.9 million.    
- Neurogen received funding    from 1994 through 2001 for research under this program. Clinical development    of NGD 96-3, a drug candidate discovered under the collaboration, continues    under Pfizer management. 
- Pfizer has the right    to determine when to advance compounds in the clinical process. 
- Neurogen will receive    milestone payments if specified development and regulatory objectives are    achieved. 
- Pfizer received the    exclusive worldwide license to manufacture, use, and sell GABA-based sleep    disorder products discovered during the research collaboration (the period    1994 through 2001). 
- Pfizer is required to    pay Neurogen royalties based on net sales levels, if any, for such products.

The 2001 Aventis Agreement – covers the Company’s CRF-1-based depression and anxiety program

- Aventis paid $10 million    for the licensing of Neurogen’s CRF-1 drug candidates and technology.
- Neurogen receives a    total of $11.25 million in committed research payments for the three-year    period ending in December 2004.
- Neurogen receives milestone    payments if specified development and regulatory objectives are achieved.    The company achieved a preclinical milestone in December 2003 and received the preclinical milestone payment of $1 million in January 2004.
- Aventis received the    exclusive worldwide license to manufacture, use and sell CRF-1 receptor modulator    products developed in the collaboration.
- Aventis is required    to pay Neurogen royalties based on net sales of any such products.

The 2003 Merck Agreement – covers the Company’s VR1-based pain management program

- Merck purchased approximately    1.8 million shares of Neurogen common stock for $15 million.
- Merck paid Neurogen    a $15 million license fee.
- Neurogen receives $16.8    million in committed research funding and license maintenance payments for    the three-year period ending in December 2006.
- Merck has the option    to extend the discovery and research effort for up to an additional two years    or to terminate the agreement after two years and transfer certain rights    to the collaborative program to Neurogen. 
- Neurogen will receive    milestone payments if specified development and regulatory objectives are    achieved. The Company is eligible to receive milestone payments on all VR1    compounds discovered by either company prior to or during the collaboration    with the exception of a single early milestone payment on a Merck compound    in preclinical development at the time the collaboration was struck. Neurogen    is eligible to receive milestone payments on multiple indications.
- Merck received the exclusive    worldwide license to manufacture, use, and sell VR1 receptor modulator products    developed in the collaboration.
- Merck is required to    pay Neurogen royalties based on net sales levels, if any, for such products.    Neurogen is eligible to receive royalty payments on all VR1 compounds discovered    by either company prior to or during the collaborative research program.

Neurogen incurred research  and development costs (net of stock compensation) of $32.8 million, $34.1 million,  and $34.5 million for the years ending December 31, 2003, 2002 and 2001, respectively.  During those same time periods, the Company recognized research and development  revenue from its collaboration agreements (including the agreements described  above and other prior agreements), of $4.8 million, $4.3 million, and $3.1 million  respectively. Thus, during those time periods, overall research and development  revenue, as a percentage of total research and development costs (for both partnered  and unpartnered programs), was 15 percent, 13 percent, and 9 percent, respectively.

**Patents and Proprietary  Technology**

Neurogen’s success  depends, in part, on the Company’s ability to obtain and enforce patents,  maintain trade secrets and operate without infringing the intellectual property  rights of third parties. Neurogen files patent applications both in the United  States and in foreign countries, as the Company deems appropriate, for protection  of both products and processes. As of December 31, 2003, Neurogen is the sole  assignee of 222 issued United States patents and numerous foreign patents.The patent position of  biotechnology and pharmaceutical firms is highly uncertain and involves many  complex legal and technical issues. There is considerable uncertainty regarding  the breadth of claims allowed in such cases and the degree of protection afforded  under such patents. As a result, Neurogen cannot assure you that patent applications  will be successful or that current or future patents will afford the Company  protection against competitors. It is possible that Neurogen patents will be  successfully challenged or that patents issued to others may preclude the Company  from commercializing its products. Litigation to establish the validity of patents,  to defend against infringement claims or to assert infringement claims against  others can be lengthy and expensive, even if a favorable result is obtained.  Moreover, much of the Company’s expertise and technology cannot be patented.

Neurogen also relies heavily  on trade secrets and confidentiality agreements with collaborators, advisors,  employees, consultants, vendors and other service providers. The Company cannot  assure you that these agreements will not be breached or that trade secrets  will not otherwise become known or be independently discovered by competitors.  Neurogen’s business would be adversely affected if competitors were able  to learn the Company’s secrets or if the Company were unable to protect  its intellectual property. Neurogen is not currently party to any contract that would obligate the Company  to pay royalties to any third party on any compound  in its current portfolio.

**Competition**

The biopharmaceutical industry  is highly competitive and subject to rapid and substantial technological change.  Developments by others may render Neurogen’s drug candidates or technologies  noncompetitive or obsolete, or we may be unable to keep pace with technological  developments or other market factors. Technological competition in the industry  from pharmaceutical and biotechnology companies, universities, governmental  entities and others diversifying into the field is intense and is expected to  increase. Many of these entities have significantly greater research and development  capabilities than Neurogen, as well as substantially more marketing, manufacturing,  financial and managerial resources. These entities represent significant competition.  In addition, acquisitions of, or investments in, competing development-stage  pharmaceutical or biotechnology companies by large corporations could increase  such competitors' financial, marketing, manufacturing and other resources.

Competitors have developed  or are in the process of developing products or technologies that are, or in  the future may be, the basis for competitive products. The Company’s competitors  may develop products that are safer, more effective or less costly than any  Neurogen products or may be able to complete their development more quickly.  Neurogen would be at a significant competitive disadvantage if a competitor  developed and successfully commercialized a drug similar to a Neurogen drug  candidate ahead of the Company’s efforts.

**Manufacturing**

Neurogen is currently relying,  in part, on third-party manufacturers to produce large quantities of development  candidate compounds for preclinical development and to produce dosage forms  of these candidates to support clinical trials.

Pfizer manufactures or  will be responsible for manufacturing, drugs for clinical trials which are subject  to the 1994 Pfizer Agreement and has the right to manufacture future products  under this collaboration, if any, for commercialization.

Aventis will be responsible  for manufacturing, or having manufactured, drugs for clinical trials which are  subject to the Aventis Agreement, and has the right to manufacture future products  under the collaboration, if any, for commercialization.

Merck will be responsible  for manufacturing, or having manufactured, drugs for clinical trials which are  subject to the Merck Agreement, and has the right to manufacture future products  under the collaboration, if any, for commercialization.

With respect to compounds  not currently subject to collaborations, the Company currently utilizes third-party  manufacturers for preclinical development and clinical trials.

**Sales and Marketing**

Neurogen’s strategy  is to market any products it develops in the future either directly or through  co-promotion arrangements or other licensing arrangements with large pharmaceutical  or biotechnology companies. The Company does not expect to establish a direct  sales capability for at least the next several years, though it may pursue such  a capability in the future. Pfizer has the right to market worldwide future  products, if any, resulting from the 1994 Pfizer Agreement. Aventis has the  right to market worldwide future products, if any, resulting from the Aventis  Agreement. Merck has the right to market worldwide future products, if any,  resulting from the Merck Agreement.

**Government Regulation**

The production and marketing  of products Neurogen may develop in the future, as well as research and development  activities, are subject to regulation for safety, efficacy and quality by numerous  governmental authorities in the United States and other countries. In the United  States, drugs are subject to rigorous federal regulation (Food and Drug Administration  or FDA) and, to a lesser extent, state regulation. The Federal Food, Drug and  Cosmetic Act, as amended, and the regulations promulgated thereunder, and other  federal and state statutes and regulations govern, among other things, the testing,  manufacture, safety, efficacy, labeling, storage, record keeping, approval,  advertising and promotion of our products. Product development and approval  within this regulatory framework will take a number of years and involve the  expenditure of substantial resources.

The steps required before  a pharmaceutical agent may be marketed in the United States include:

- Preclinical laboratory    tests, in vivo preclinical studies and formulation studies,
- The submission to the    FDA of an Investigational New Drug Application (IND) for human clinical testing    which must become effective before human clinical trials can commence, 
- Adequate and well-controlled    human clinical trials to establish the safety and efficacy of the drug, 
- The submission of a    New Drug Application (NDA) or Product License Application to the FDA, and
- FDA approval of the    NDA or Product License Application prior to any commercial sale or shipment    of the drug.

In addition to obtaining  FDA approval for each product, each domestic drug manufacturing establishment  must be registered with, and approved by, the FDA. Domestic manufacturing establishments  are subject to biennial inspections by the FDA and must comply with the FDA's  Good Manufacturing Practices for both drugs and devices. To supply products  for use in the United States, foreign manufacturing establishments must comply  with Good Manufacturing Practices and are subject to periodic inspection by  the FDA or by regulatory authorities in such countries under reciprocal agreements  with the FDA.

Preclinical testing includes  laboratory evaluation of product chemistry and formulation, as well as animal  studies to assess the potential safety and efficacy of the product. Preclinical  safety tests must be conducted by laboratories that comply with FDA regulations  regarding Good Laboratory Practices. The results of the preclinical testing  are submitted to the FDA as part of an IND and are reviewed by the FDA prior  to the commencement of human clinical trials. Unless the FDA objects to an IND,  the IND will become effective 30 days following its receipt by the FDA.

Clinical trials involve  the administration of the new drug to healthy volunteers or to patients under  the supervision of a qualified principal investigator. Clinical trials must  be conducted in accordance with Good Clinical Practices under protocols that  detail the objectives of the study, the parameters to be used to monitor safety  and the efficacy criteria to be evaluated. Each protocol must be submitted to  the FDA as part of the IND. Further, each clinical study must be conducted under  the auspices of an Independent Institutional Review Board at the institution  where the study will be conducted. The Institutional Review Board will consider,  among other things, ethical factors, the safety of human subjects, and the possible  liability of the institution. Compounds must be formulated according to Good  Manufacturing Practices.

Clinical trials are typically  conducted in three sequential phases, but the Phases may overlap. In Phase I,  the initial introduction of the drug into healthy human subjects, the drug is  typically tested for safety (no adverse side effects), absorption, dosage tolerance,  metabolism, bio-distribution, excretion and pharmacodynamics (clinical pharmacology).  Phase II typically involves studies in a limited patient population to:

- Determine the efficacy    of the drug for specific, targeted indications.
- Determine dosage tolerance    and optimal dosage.
- Identify possible adverse    side effects and safety risks.

When a compound is found  to be effective and to have an acceptable safety profile in Phase II evaluations,  Phase III trials are undertaken to further evaluate clinical efficacy and to  test for safety within an expanded patient population at geographically dispersed  clinical study sites. Neurogen or the FDA may suspend clinical trials at any  time if it is believed that the individuals participating in such trials are  being exposed to unacceptable health risks.

The results of the pharmaceutical  development, preclinical studies, and clinical studies are submitted to the  FDA in the form of an NDA for approval of the marketing and commercial shipment  of the drug. The testing and approval process is likely to require substantial  time and effort. The approval process is affected by a number of factors, including  the severity of the disease, the availability of alternative treatments and  the risks and benefits demonstrated in clinical trials. Consequently, there  can be no assurance that any approval will be granted on a timely basis, if  at all. The FDA may deny an NDA if applicable regulatory criteria are not satisfied,  require additional testing or information or require post-marketing testing  and surveillance to monitor the safety of a company’s products if it does  not believe the NDA contains adequate evidence of the safety and efficacy of  the drug. Notwithstanding the submission of such data, the FDA may ultimately  decide that an NDA does not satisfy its regulatory criteria for approval. Moreover,  if regulatory approval of a drug is granted, such approval may entail limitations  on the indicated uses for which it may be marketed. Finally, product approvals  may be withdrawn if compliance with regulatory standards is not maintained or  if problems occur following initial marketing.

Among the conditions for  NDA approval is the requirement that any prospective manufacturer's quality  control and manufacturing procedures conform to Good Manufacturing Practices.  In complying with standards set forth in these regulations, manufacturers must  continue to expend time, money and effort in the area of production and quality  control to ensure full technical compliance. Manufacturing establishments, both  foreign and domestic, also are subject to inspections by or under the authority  of the FDA and by other federal, state or local agencies.

Whether or not FDA approval  has been obtained, approval of a product by regulatory authorities in foreign  countries must be obtained prior to the commencement of commercial sales of  the product in such countries. The requirements governing the conduct of clinical  trials and product approvals vary widely from country to country, and the time  required for approval may be longer or shorter than that required for FDA approval.  Although there are some procedures for unified filings for certain European  countries, in general, each country at this time has its own procedures and  requirements.

In addition to regulations  enforced by the FDA, Neurogen is also subject to regulation under the Occupational  Safety and Health Act, the Environmental Protection Act, the Toxic Substances  Control Act, the Resource Conservation and Recovery Act and other present and  potential future federal, state or local regulations. The Company’s research  and development involves the controlled use of hazardous materials, chemicals,  and various low-level radioactive compounds. Although the Company believes that  safety procedures for handling and disposing of such materials comply with the  standards prescribed by state and federal regulations, the risk of accidental  contamination or injury from these materials cannot be completely eliminated.  In the event of any accident, Neurogen could be held liable for any damages  that result and any such liability could exceed our resources.

**Employees**

As of December 31, 2003,  the Company had 155 full-time employees, of which 123 persons were scientists  and, of these scientists, 59 had Ph.D.s or other doctoral degrees. None of the  employees are covered by collective bargaining agreements, and the Company considers  relations with employees to be good. All current scientific personnel have entered  into confidentiality and non-competition agreements with the Company. 

**Research and Development  Expenses**

The Company incurred research  and development expenses of $32.8 million, $34.1 million and $34.5 million in  2003, 2002, and 2001, which exclude non-cash stock compensation charges of $0.3  million, $0.1 million and $0.9 million, respectively.

**Available Information**

The Company’s website  address is www.neurogen.com. We have included our website address as an inactive  textual reference and do not intend it to be an active link to our website.  The information that appears on our website is not part of this Form 10-K. Neurogen  makes available free of charge through its website all of the Company’s  filings with the Securities and Exchange Commission ("SEC"), including  its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports  on Form 8-K and all amendments to these reports. The Company’s filings  are made available as soon as reasonably practicable after such material is  electronically filed with the SEC. Copies without exhibits are also available,  without charge, from Neurogen Corporation, 35 Northeast Industrial Road, Branford,  CT 06405.

**ITEM 2. PROPERTIES**

The Company conducts its  operations in laboratory and administrative facilities on a single site located  in Branford, Connecticut. The total facilities under ownership comprise approximately  148,000 square feet, of which 106,000 square feet is in use. Approximately 27,000  square feet has not yet been adapted for the Company’s research and development  efforts and approximately 15,000 square feet is currently leased to a third  party.

In 1995, the Company leased  approximately 24,000 square feet of a 39,000 square foot building under a ten-year  agreement, which provided an option to purchase the entire facility effective  after the fifth year of the original term of the lease. In January 2001, Neurogen  acquired the entire facility for $2.4 million. The additional 15,000 square  feet continues to be leased through Neurogen to the third-party tenants who  occupied the facilities at the time of purchase.

**ITEM 3. LEGAL PROCEEDINGS**

The Company knows of no  material litigation or proceeding pending or threatened to which Neurogen is,  or may become, a party.

**ITEM 4. SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS**

None.

**CAUTIONARY  STATEMENT FOR PURPOSES OF THE"SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES  LITIGATION REFORM ACT OF 1995**

Except for historical matters,  the matters discussed in this Form 10-K are "forward-looking statements"  within the meaning of the Private Securities Litigation Reform Act of 1995 or  any rules, regulations or releases of the Securities and Exchange Commission  with respect thereto. Forward-looking statements in this Form 10-K include,  but are not limited to, statements in Item 1 under the caption "Neurogen’s  Business Strategy" and "Business – Neurogen Drug Programs"  with respect to the Company’s various product development programs and  statements in Item 7 under the caption "Management’s Discussion  and Analysis of Financial Condition and Results of Operations" with respect  to the sufficiency of the Company's cash balance to fund planned operations.  In addition, the Company may from time to time make forward-looking statements  in the future.

Neurogen wishes to caution  readers and others to whom forward-looking statements are addressed, that any  such forward-looking statements are not guarantees of future performance and  that actual results may differ materially from estimates in the forward looking  statements. In addition to the important factors described elsewhere in this  Form 10-K and the Company’s other filings with the Securities and Exchange  Commission, the following important factors, among others, could affect Neurogen's  actual future results and could cause such results to differ materially from  estimates expressed in any forward-looking statements made by, or on behalf  of, Neurogen:

- Failures, difficulties    or delays in discovery, research, development, testing, regulatory approval,    production and marketing of any of the Company's drug candidates, including    without limitation any unanticipated pre-clinical or clinical failures, delays,    delays in regulatory approvals, the failure to develop follow-on candidates    in a given program, the failure to attract or retain scientific and management    personnel, adverse side effects or inadequate therapeutic efficacy or inadequate    drug properties which could prevent or slow product development efforts at    any stage of product development by delaying or preventing clinical trials,    delaying or preventing regulatory approval for commercialization or adversely    affecting the risks and potential rewards of individual candidates and the    ultimate acceptance by the market. A very significant majority (estimated    to be between 80 and 90 percent) of all drugs which enter human clinical trials    fail to reach the market.

- Vigorous competition    within the Company’s anticipated product markets, including without    limitation competition from fully integrated pharmaceutical companies, specialty    biotechnology companies and platform technology companies, many or all of    which may have substantially greater capabilities, experience and resources    than the Company.

- Risk that competitors    will succeed in developing technologies (including drug discovery techniques)    and products that are more effective than those of the Company or that are    commercialized prior to similar technologies or products of the Company.
- Neurogen’s dependence on decision-making and performance      of its corporate partners with respect to research and development funding,      preclinical evaluation of drug candidates, human clinical trials of drug candidates,      regulatory filings and manufacturing and marketing expertise with respect      to most of its most advanced compounds.
- Risk that Neurogen’s interests will not coincide with those of its      collaborators with respect to the evaluation of candidates, the timing or      conduct of clinical development of compounds, the future production of developed      products or strategies with respect to development and commercialization of      such products.
- Risk that actual research and development costs and associated general and        administrative costs may exceed budgeted amounts for a variety of reasons,        including the uncertainty of product development in the pharmaceutical industry.
- Risk that drug targets pursued by the company may prove to be invalid after        substantial investments by the Company.
Inability to obtain sufficient funds through future collaborative arrangements,              technology transfers, equity or debt financings or other sources to continue              the operation of the Company’s business which may require the Company              to reduce substantially or eliminate expenditures for product development,              to relinquish rights to certain of its technologies or potential products              or to cease operations.

- Risk that the Company's patents and trade secrets and confidentiality agreements        with collaborators, employees, consultants or vendors will be invalidated        or not adequately protect the Company's intellectual property.
Uncertainty of the scope and enforceability of patents in the pharmaceutical      and biotechnology industries, which purport to enable competitors to restrict      others from pursuing certain drug targets.

- Risk that the Company may be prohibited or otherwise restricted from working      on certain targets relevant to the Company's business. 
- The Company's dependence upon third parties for the manufacture of its potential      products and the Company’s inexperience in manufacturing if the Company      establishes internal manufacturing capabilities, each of which could adversely      affect the Company’s future profit margins, if any, and its ability      to develop and manufacture products on a timely and competitive basis.
Neurogen’s dependence on third parties to market potential products                and Neurogen's lack of sales and marketing capabilities, each of which could                adversely affect the success of any sales and marketing efforts for the Company's                products.
Unavailability or inadequacy of medical insurance or other third-party reimbursement    for the cost of purchases of the Company's products.
Inability of the Company to attract and retain qualified management, employees    and consultants.

 

PART II  

**ITEM 5. MARKET  FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES  OF EQUITY SECURITIES**

The common stock of Neurogen  is traded on the NASDAQ Stock Market under the symbol NRGN. As of March 1, 2004,  there were approximately 202 holders of record of the Company's common stock.  No dividends have been paid on the common stock to date, and the Company currently  intends to retain any earnings for further development of the Company's business.  

The following table sets  forth the high and low sales prices for the common stock as reported by NASDAQ.  

**Equity Compensation  Plan Information**

The following table sets  forth, for the Company's equity compensation plans, the number of outstanding  option grants under such plans, the weighted-average exercise price of outstanding  options, and the number of shares that remain available for issuance under such  plans, as of December 31, 2003. 

**ITEM 6. SELECTED  FINANCIAL DATA**

**ITEM 7. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**OVERVIEW**

Since its inception in  September 1987, Neurogen has been engaged in the discovery and development of  drugs. The Company has not derived any revenue from product sales and has incurred,  and expects to continue to incur significant losses in most years prior to deriving  any such product revenues. Revenues to date have come from six collaborative  research agreements, one license agreement and one technology transfer agreement.

Collaborative research  agreements have been and are expected to continue to be an important source  of funding for the Company. In addition, such arrangements not only drive current  revenue (through the recognition of upfront and subsequent license fees, research  funding and potential milestone payments over the respective contract periods)  but over the longer term also, potential future product revenues in the form  of royalties if the agreements result in successful drug development and commercialization.  The initialization, expiration and specific terms of such agreements have contributed  to, and will continue to cause, significant fluctuations in the Company's recognizedrevenues and losses. 

In December 2003, the Company  entered into a collaboration agreement (the "Merck Agreement") with  Merck Sharp & Dohme Limited ("Merck") to discover and develop  next-generation drugs targeting the vanilloid receptor (VR1) for the treatment  of pain. While the impact of the agreement on 2003 results was not significant,  it is expected to be a meaningful driver of revenues and liquidity over the  next three to five years. The agreement became effective in late December 2003  upon approval by the Federal Trade Commission under the Hart-Scott Rodino Act.  In January 2004, Neurogen received $30.0 million from Merck, including $15.0  million in up-front license fees and another $15.0 million for the purchase  of 1,783,252 shares of newly issued Neurogen common stock (representing approximately  9% of Neurogen's common shares outstanding). Merck will provide Neurogen with  research funding and license payments totaling $16.8 million during the initial  three-year term of the contract (subject to Merck's right of termination in  the third year). Should Merck exercise its right to extend the collaborative  research program for up to two years, Neurogen may also receive further payments  of between $2.8 million and $4.2 million per year. In addition, Neurogen will  be eligible to receive research, development, and approval milestone payments  of up to $118.0 million for the successful commercialization of a collaboration  drug for a single therapeutic indication. Beyond that, Merck will pay to Neurogen  royalties on the sale of products from the collaboration. Revenue related to  this collaboration will be recognized pursuant to the methodology discussed  under the "Critical Accounting Policies" section below. 

Drug discovery and development  activities, excluding stock compensation charges, have accounted for between  84% and 85% of total expenses over the last three years. During 2003, the company  incurred significant expenses in conducting Phase IIa exploratory clinical trials in asthma  and rheumatoid arthritis for  NGD 2000-1, an oral C5a antagonist. In January 2004, at the conclusion  of the asthma trial, the Company announced that NGD 2000-1 did not demonstrate a  therapeutic benefit for treatment of asthma with respect to the primary predetermined endpoint. The exploratory Phase IIa clinical  trial using NGD 2000-1 for the treatment of rheumatoid arthritis is stillongoing. 

**CRITICAL ACCOUNTINGPOLICIES**

The preparation of Neurogen's  financial statements in conformity with generally accepted accounting principles  requires management to make certain estimates and assumptions that affect the  reported amounts of assets and liabilities and disclosure of contingent liabilities  at the date of the financial statements and the reported amounts of revenues  and expenses during the reporting period. Management makes estimates in, among others, the  areas of revenue recognition, income taxes, stock-based compensation and marketable  securities and investments. Estimates are based on historical experience and  on various other assumptions that management believes to be reasonable underthe circumstances. Actual amounts could differ from those estimates. 

The Company believes the  following critical accounting policies affect management's more significant  judgments and estimates used in the preparation of Neurogen's financial statements: 

**Revenue Recognition**

Each of Neurogen's collaborative research, licensing and technology transfer agreements are significant since the terms of such arrangements may cause the Company's operating results to vary considerably from period to period. 

The Company has entered into collaborative research agreements that provide for the funding of specified projects in exchange for the grant of certain rights related to potential discoveries. Revenue under these arrangements typically includes upfront non-refundable fees, ongoing payments for specified levels of staffing for research and milestone payments upon occurrence of certain events. Since the adoption of SEC Staff Accounting Bulletin ("SAB") 101 in 2000, the upfront fees are recognized as revenue ratably over the period of performance under the research agreement. The research funding is recognized as revenue as the related research effort is performed. Revenue derived from the achievement of milestones, each of which represents a substantive stage of development towards a long-term goal such as the nomination of a development or clinical candidate or the start of a specific phase of clinical trials or the filing of a New Drug Application with the Food and Drug Administration, is recognized when the milestone event occurs and collectibility is reasonably certain. Emerging Issues Task Force ("EITF") Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables," became effective for all contracts entered into after June 15, 2003. EITF Issue No. 00-21 addresses, for arrangements with multiple deliverables, how the arrangement consideration should be measured, whether the arrangement should be divided into separate units of accounting and how the arrangement consideration should be allocated among the separate units of accounting. Under EITF Issue No. 00-21, the multiple elements typically included in Neurogen's collaborative arrangements (as discussed above) may not meet the criteria for consideration as separate accounting units and may have to be accounted for as a combined unit. The adoption of EITF Issue No. 00-21 did not have a material effect on the company's results of operations in 2003 since only one collaborative arrangement, the Merck Agreement, which became effective upon receiving regulatory approval in late December 2003, was entered into after the pronouncement became effective. Revenue recognized from the Merck Agreement was  less than $0.1 million in 2003. The Company will review the Merck Agreement and subsequent collaborative arrangements to determine whether the deliverables included in each arrangement qualify for treatment as separate accounting units. 

**Research and DevelopmentCosts**

Research and developmentcosts are expensed when incurred. 

**Stock-Based Compensation**

Neurogen utilizes the intrinsic  value method to account for stock-based employee compensation. The Company  primarily grants qualified stock options for a fixed number of shares to employees  with an exercise price equal to the fair market value of the shares at the date  of grant. The Company has also issued restricted stock to key executives and  records an expense over the vesting periods. The Company accounts for grants  of stock options and restricted stock in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and, accordingly, recognizes no  compensation expense for the options when the option grants have an exercise  price equal to the fair market value at the date of grant. The Company has adopted  the disclosure-only provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based  Compensation" as amended by Statement of Financial Accounting Standards SFAS No. 148, "Accounting for Stock-Based Compensation- Transition and Disclosure." 

The Company occasionally  grants stock option awards to consultants. Such grants are accounted for pursuant  to EITF Issue No. 96-18, "Accounting for Equity  Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction  with Selling, Goods or Services," and, accordingly, recognizes compensation  expense equal to the fair value of such awards and amortizes such expense over  the performance period. The fair value of each award is estimated using the  Black-Scholes model with certain weighted average assumptions (described inNote 7 to the consolidated financial statements). 

**Marketable Securities**

The Company invests in  U.S. government and corporate debt securities. The fair value of these securities  is subject to volatility and change. The Company considers its investment portfolio  to be available-for-sale securities as defined in SFAS No. 115, "Accounting  for Certain Investments in Debt and Equity Securities." Marketable securities  at each of December 31, 2003 and December 31, 2002 consisted of debt securities with maturities of  one month to approximately five years. Available for sale securities are carried  at fair value with the unrealized gains and losses reported as other comprehensive  income. Realized gains and losses have been determined by the specific identification  method and are included in investment income. Different classifications of the  Company's marketable securities pursuant to SFAS No. 115 would possibly result  in material impacts to the valuation of the securities and investment income. 

**Income Taxes**

The liability method of  SFAS No. 109, "Accounting for Income Taxes," is used to account for income taxes.  Deferred tax assets and liabilities are determined based on net operating loss  carryforwards, research and development credit carryforwards, and differences between financial reporting and income tax bases  of assets and liabilities. Deferred items are measured using the enacted tax  rates and laws that are expected to be in effect when the differences reverse.  Deferred tax assets may be reduced by a valuation allowance to reflect the uncertainty  associated with their ultimate realization. Any subsequently recognized tax  benefits relating to the valuation allowance for deferred tax assets would be  recorded as an income tax benefit in the Statement of Operations or a chargeto Additional Paid-In Capital. 

**Long-lived Assets**

In August 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 144 addresses the financial accounting and reporting for impairment or disposal of long-lived assets. This statement provides that (a) an impairment loss should only be recognized if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows, and (b) the measurement of impairment loss should be based on the difference between the carrying amount and the fair value of the asset. It also provides that a long-lived asset (or asset group) should be tested for recoverability whenever events or changes in circumstances indicate that potential impairment has occurred. In addition, it provides for the use of probability-weighted cash flow estimates in the recoverability test. Neurogen adopted the provisions of SFAS No. 144 as of January 1, 2002. The Company will periodically review its long-lived assets for potential impairment and recoverability. 

**RESULTS OF OPERATIONS**

Results of operations may  vary from period to period depending on numerous factors, including the timing  of income earned under existing or future collaborative research agreements,  technology transfer agreements or joint ventures, the progress of the Company's  partnered and unpartnered research and development projects, the size of the  Company's staff and the level of preclinical and clinical development spending  on drug candidates in unpartnered programs. Neurogen believes its research and  development costs may increase significantly over the next several years as  its drug development programs progress. In addition, general and administrative  expenses would be expected to increase to support any expanded research anddevelopment activities. 

**Years Ended December 31,2003 , 2002 and 2001**

The Company's fiscal 2003  operating revenues decreased 57% to $6.8 million from 2002 operating revenues  of $15.7 million. The revenue decrease is due primarily to the completion in 2002 of the  Company's 1999 Technology Transfer Agreement with Pfizer Inc. ("Pfizer") (described below).  License fees decreased from $11.4 million in 2002 to $2.0 million in 2003 due  to the recognition in 2002 of the final $9.4 million in license fees earned  pursuant to the Pfizer Technology Transfer Agreement. The Company recognized  $2.0 million in license fees from Aventis Pharmaceuticals, Inc. ("Aventis") as part of the Aventis Agreement (described  below) in both 2003 and 2002. Research revenues increased by 11% to $4.8 million  in 2003 from $4.3 million in 2002 due to the recognition of a $1.0 million milestone  payment from Aventis upon the successful nomination of a development candidate, offset in part by a $0.5 million decrease in Aventis research funding. 

Fiscal 2002 operating revenues  increased 37% to $15.7 million from 2001 operating revenues of $11.5 million.  The revenue increase consisted of a $3.0 million increase in license fees and  a $1.2 million increase in research revenues. The $3.0 million increase in license  fees was due to the recognition of a one-time $2.0 million payment from Pfizer  to satisfy all remaining obligations related to Pfizer's use of the Accelerated Intelligent Drug Discovery ("AIDD"TM) technology  under the 1999 Technology Transfer Agreement, a $1.8 million increase in license  fees recognized under the Aventis Agreement, and an offsetting  $0.8 million  decrease in revenue from AIDDTM technology development and improvement services  provided to Pfizer. The increase in research revenues was due to a $4.1 million  increase in research revenues from Aventis (reflecting a full year of research  funding under the companies' December 2001 collaboration agreement) offset in  part by a $2.9 million decrease in revenues from Pfizer due to the scheduled  conclusion in December 2001 of the companies' joint research collaboration ongamma-aminobutyric acid (GABA)-based drugs. 

Research and development  expenses, excluding non-cash stock compensation charges, decreased by $1.3 million  or 4% to $32.8 million in 2003 from $34.1 million in 2002. Following the implementation  of the Company's Operational Excellence program in late 2002 (which was designed to enhance  the efficiency of the Company's drug development platform, reduce costs and  more closely align the Company's investment of resources with long-term business  goals), the Company's research and development related salaries and benefits  decreased by $1.4 million (reflecting a 17% reduction in average headcount compared to the prior year) and lab supplies  decreased by $2.4 million. These cost reductions were partially offset by  increases in expenses related to the Company's exploratory Phase IIa clinical trials (for both asthma and rheumatoid  arthritis indications) in its C5a program, chemical manufacturing and other outsourced research  studies associated with the preclinical VR1 pain program, as well as patentexpenses. 

Research and development  expenses of $34.1 million, excluding non-cash stock compensation charges, for  fiscal 2002 were comparable to $34.5 million in 2001. External development costs  related to potential drug candidates decreased from $5.5 million in 2001 to  $3.5 million in 2002, due partly to the assumption by Aventis (pursuant to the  terms of the Aventis Agreement) commencing in December 2001 of the costs of  developing potential drug candidates for treating depression and anxiety disorders.  This decrease was offset by an overall increase in the Company's ongoing investment  in scientific personnel and research supplies. Research and development expenses  represented 85%, 84% and 84% of total operating expenses (excluding non-cash  stock compensation charges) for the years ended December 31, 2003, 2002 and  2001, respectively. 

The Company expenses all  research and development costs as incurred. While the Company maintains a system  to record the level of staffing time spent on each of its research and development  projects, it does not maintain a historical cost accounting system with sufficient  accuracy to reliably estimate its research and development costs on a specific  project-by-project basis. A significant portion of the Company's research and  development expenses (such as laboratory supplies, travel, information systems  and services and facilities costs) benefit multiple projects and are not individually  tracked to a specific project. Further, the Company's staff timekeeping system  does not account for differences in compensation costs between lower level technicians  and more senior scientists. 

General and administrative  expenses, excluding non-cash stock compensation charges, decreased by 12% to  $5.9 million in 2003 as compared to $6.7 million in 2002 and $6.6 million in  2001. The decrease is primarily due to $0.3 million lower legal expenses in  2003 (as the Company incurred higher legal expenses in 2002 in connection with the filing of a  shelf  registration), $0.1 million lower salaries and benefits (due to an 18%  reduction in average headcount compared to the prior year), and $0.2 million lower investor relations expenses, offset by a  $0.2 million increase in insurance costs. 

Total stock compensation  expenses were $1.0 million in 2003 compared to $0.6 million in 2002 and $1.5  million in 2001. Both the 2003 and 2002 stock compensation expenses are primarily  composed of continuing non-cash charges for grants of certain stock awards in  1997, 2001 and 2002 to certain officers of the Company. The 2001 expense included  non-cash charges to income for grants of certain stock awards in 1997 and 2001,  as well as one-time non-cash charges totaling $1.0 million for the modification  of certain stock options held by two executive officers. A portion of the stock  compensation charges (those relating to the 1997 awards) is variable and as  a result may fluctuate significantly in the future. 

Other income was $1.0 million  in 2003 compared to $1.7 million in 2002 and $4.5 million in 2001. The decrease  in 2003 is due to reduced investment income caused by a decline in average cash  and marketable securities and lower overall returns on invested funds, partially  mitigated by a decrease in interest expense resulting from lower outstanding  loan balances. The decrease in 2002 (from 2001) was driven by an increase in  interest expense of $1.0 million following a $17.5 million first mortgage debt  financing entered into in December 2001 and a decrease in investment income,  reflecting both lower average cash and marketable securities balances and lower  overall returns on invested funds. 

For the years ended December  31, 2003, 2002 and 2001, the Company recognized Connecticut income tax benefits  of $0.3 million, $0.3 million and $1.2 million, respectively, in the Statement  of Operations. The Company recorded total income tax benefits of $0.3 million,  $0.6 million and $2.0 million for the years ended December 31, 2003 , 2002 and  2001, respectively, a portion of which  related to employee stock options and was recorded to Additional Paid-In  Capital. The benefits are the result of Connecticut legislation which allowed  the Company to obtain cash refunds from the State of Connecticut for a portion  of research and development tax credits in exchange for foregoing the carryforward  of these credits into future tax years. 

The Company recognized  a net loss of $31.6 million for the year ended December 31, 2003, $23.7 million  for the year ended December 31, 2002, and $25.4 million for the year ended  December 31, 2001. The increase in the 2003 net loss was primarily due to an  $8.9 million decrease in operating revenues. The decrease in the 2002 net loss  from the 2001 level was primarily due to the increase in operating revenues.  

LIQUIDITY AND CAPITAL  RESOURCES 

At December 31, 2003 and  2002, cash, cash equivalents and marketable securities in the aggregate were  $45.9 million and $79.4 million, respectively. At December 31, 2003, $17.7  million of the marketable securities have maturities greater than one year.  However, the Company can and may liquidate such investments prior to maturity  to meet its operating needs and strategic and/or investment objectives. The  Company's cash and other short-term investment levels decreased progressively  throughout 2003 to fund operating expenses as well as $4.8 million in annual  principal repayments on outstanding loans (described below). The 2003 ending  level of cash and marketable securities also reflected the receipt of $3.8 million  in research funding, $0.7 million in proceeds from stock option exercises, and  $0.3 million in income tax benefits from the State of Connecticut (described  herein). 

Under the terms  of the Merck Agreement in December 2003, the Company received $30.0 million from  Merck in January 2004, including $15.0 million in up-front license fees and another $15.0 million  for the purchase of 1,783,252 shares of newly issued Neurogen common stock (representing approximately 9% of Neurogen's  common shares outstanding). 

The levels of cash, cash  equivalents and marketable securities have fluctuated significantly in the past  and are expected to do so in the future as a result of the factors described  below. The Company plans to use its cash, cash equivalents and marketable securities  for its research and development activities, working capital and general corporate  purposes. Neurogen's cash requirements to date have been met by the proceeds  of its equity financing activities, amounts received pursuant to collaborative  research, licensing or technology transfer arrangements, certain debt arrangements  and interest earned on invested funds. The Company's equity financing activities  have included underwritten public offerings of common stock, private placement  offerings of common stock and private sales of common stock in connection with  collaborative research and licensing agreements. To date, total funding received  from these financing activities was approximately $161.6 million. The Company's  expenditures were primarily to fund research and development and general and  administrative expenses and to construct and equip its research and development  facilities. 

The Company is in the early  stage of product development. The Company has not derived any product revenues  from product sales and does not expect to derive any product revenues for at  least the next several years, if at all. Prior to deriving any such product  revenues, the Company expects to incur significant losses and negative cash  flows that in the aggregate could exceed the Company's existing cash resources.  To provide cash to fund its operations until such time as it achieves sustainable  revenues, the Company relies extensively on its ability to develop drug discovery  programs of sufficient value to either partner the programs with pharmaceutical  companies or raise capital through equity financings. 

To the extent that drug  candidates progress in the Company's currently unpartnered programs, such as  its program for the treatment of inflammatory disorders or earlier stage programs,  such progress could lead to the opportunity to partner on terms which provide  capital, revenues and cash flows to the Company or the opportunity to raise  capital through equity offerings. If unpartnered programs do not progress or  do not progress on schedule, such opportunities would be delayed or may not  materialize at all. 

To the extent that drug  candidates progress in the Company's partnered programs, such as the Company's  insomnia program partnered with Pfizer or its depression and anxiety program  partnered with Aventis or the pain program partnered with Merck, such progress  could result in milestone payments and additional research and development funding  to the Company under the respective collaboration agreements. Such progress  could also provide the opportunity to raise capital through equity offerings.  If partnered programs do not progress or do not progress on schedule, such opportunities  would be delayed or may not materialize at all. The Company does not have control  over the progress of partnered programs. 

Lack of progress, scheduling  delays or failures in any of the Company's major programs could significantly  reduce the Company's levels of revenues, cash flows and cash available to fund  its business. It could also significantly increase the Company's cost of capital  and limit its ability to raise equity capital. All of the Company's compounds  in development, whether in human clinical trials or not, will require significant  additional research, development and testing before they can be commercialized.  Furthermore, the scope, magnitude and timing of future research and development  expenses, as well as anticipated project completion dates, are a series of steps,  ranging from preclinical testing to clinical studies in humans. Each step in  the process is typically more expensive than the previous step, but actual timing  and cost for completion depends on the specific progress of each product being  tested. 

While the Company cannot  accurately predict the time required or the cost involved in commercializing  any one of its candidates, new drug development typically takes many years and  tens or hundreds of millions of dollars. In addition, developing new drugs is  an extremely uncertain process where most candidates fail and uncertain developments  such as clinical or regulatory delays, side effects, undesirable drug properties  or ineffectiveness of a drug candidate would slow or prevent the development  of a product. If Neurogen or its partners are unable to commercialize one or  more of our drug products, the Company may never achieve product revenues and  may eventually be unable to continue our operations. This result would cause  our shareholders to lose all or a substantial portion of their investment. 

The debt agreements entered  into by the Company to date include the commercial term mortgage loan financing  in December 2001 with Webster Bank, and a construction loan entered into in  October 1999 with Connecticut Innovations, Inc. ("CII"). Total proceeds received  under these agreements were $22.5 million, which are repayable through monthly  installments over a maximum term of 15 years, bearing various interest rates,  which approximated 3.6%-7.5% from 1999 through 2003. Of these amounts received,  $11.8 million and $4.5 remained outstanding as of December 31, 2003 under the  Webster Bank facility and the CII facility, respectively. An approximate aggregate  amount of $1.4 million is due and payable in each of the next five years, excluding  the March 2004 payment described below. Thereafter, approximately $7.5 million  is payable in regular installments until the scheduled maturity dates, including  a balloon payment of $1.0 million on the mortgage loan upon maturity in December  2011. The loan with CII contains certain subjective acceleration clauses, which  upon occurrence of certain events may cause amounts due under the agreement  to become immediately due and payable. The Company has no indication that it  is in default of any such clauses and therefore has classified its debt based  on the dates regular payments are due. As of December 31, 2003, Neurogen is  not engaged in any significant lease or capital expenditure commitments. 

Under the original terms  of the Webster Bank facility agreement, the Company is required to comply with  certain covenants, including a requirement that the Company maintain at least  $25.0 million in cash and marketable securities and that the ratio of the outstanding  loan balance less any cash collateral to the appraised value of the real property  ("loan to value" ratio), as periodically determined by the Bank in its sole  but reasonable discretion, will not exceed 72%. In the second quarter of 2003,  the Company received notice from the Bank asserting that this ratio exceeded  72%. Neurogen was informed by the Bank that it was using a different standard  in calculating the Company's compliance with this covenant than that used when  Neurogen and the Bank entered into the loan agreement and that federal regulations  required the bank to use this different standard. In the third quarter, the  Company and the Bank agreed to amend the loan to value ratio from 72% to 85%,  and the Company agreed to and did pay $3.4 million of the loan balance, in addition  to the previously scheduled loan repayments. 

In January of 2004 the  Company was notified by Webster Bank that another appraisal was received by  the Bank which indicated that the value of the property had declined. After discussions with the bank, the Company agreed  to and did pay down the balance of the principal by $1.6 million in March 2004  in exchange for amending the loan agreement to remove the loan to value covenant  mentioned above. Therefore, the Company has classified an additional $1.6 million to short term debt as of December 31, 2003 for the payment made in  March 2004. As of December 31, 2003 the Company believes it is in compliance  with all loan covenants.  

Following notification from Webster Bank of the lower appraised    value of its property, the Company reviewed the carrying value of its buildings    and improvements for possible impairment and recoverability pursuant to SFAS    144, "Accounting for the Impairment of Long-Lived Assets." Based on the Company's    estimated future cash flows for the remaining useful lives of the building and    improvements, the Company concluded that the carrying value of the assets was    recoverable as defined by SFAS 144. Therefore, it was unnecessary to record    an impairment loss or adjust the carrying value of the Company's building and    improvements. 

In October 2002, as a part  of its Operational Excellence Program, Neurogen reorganized certain departments  and eliminated 24 employee positions, representing approximately 10% of its  total workforce. The Company recorded a charge of approximately $0.3 million  in the fourth quarter of 2002 for employee termination costs, such as severance  pay, continuation of benefits and personal outplacement support. All accrued  charges under this program have been paid out. 

Neurogen anticipates that  under the restructured operating program, its current cash balance, as supplemented  by research funding pursuant to its collaborative research agreements with Aventis  and Merck, will be sufficient to fund its current and planned operations into  the second quarter of 2006. However, Neurogen's funding requirements may change  and will depend upon numerous factors, including but not limited to: the progress  of the Company's research and development programs; the timing and results of  preclinical testing and clinical studies; the timing of regulatory approvals;  technological advances; determinations as to the commercial potential of its  proposed products; the status of competitive products and the ability of the  Company to establish and maintain collaborative arrangements with others for  the purpose of funding certain research and development programs; conducting  clinical studies; obtaining regulatory approvals and, if such approvals are  obtained, manufacturing and marketing products. Many of these factors could  significantly increase the Company's expenses and use of cash. The Company anticipates  that it may augment its cash balance through financing transactions, including  the issuance of debt or equity securities and further corporate alliances. No  assurances can be given that adequate levels of additional financing can be  obtained on favorable terms, if at all. 

The Company has filed an  S-3 registration statement which became effective in February 2003, which provided  the Company the opportunity to issue debt, common or preferred stock or warrants  of up to $75.0 million in total financing of common stock under the shelf registration  statement. In January 2004, the Company issued 1,783,252 shares to Merck for  $15.0 million in cash consideration in conjunction with signing the VR1 collaboration  agreement (discussed below). 

As of December 31, 2003, the Company had approximately $145.1 million and $8.2 million of net operating  loss and research and development credit carryforwards, respectively, available  for federal income tax purposes, which expire in the years 2004 through 2022.  The Company also had approximately $120.8 million of Connecticut State tax net  operating loss carryforwards which expire in the years 2004 through 2023, $0.7  million of Connecticut State incremental research and development credit carryforwards  which expire in the years 2014 through 2018 and $4.6 million of Connecticut  non-incremental research and development credit carryforwards with an unlimited  carryforward period. The Company applied to exchange 2000, 2001 and 2002 Connecticut  research and development credits for cash proceeds under Connecticut tax law  provisions effective at that time (as mentioned above), resulting in the receipt  of a $0.3 million from the State of Connecticut in 2003 and $2.6 million in  2002 relating to the exchange of the 2001 and 2000 research and development  credits. Because of "change in ownership" provisions of the Tax Reform Act of  1986, the Company's utilization of its net operating loss and research and development  credit carryforwards may be subject to an annual limitation in future periods. 

The following table sets  forth a summary of the Company's commitments as of December 31, 2003 (in thousands):  

The Company has no off-balance sheet arrangements.

**COLLABORATIVE RESEARCH  AGREEMENTS**

In December 2003, Neurogen  entered into a collaboration agreement with Merck to research, develop, and commercialize  small molecule medicines which work by targeting the vanilloid receptor (VR1),  a key integrator of pain signals in the nervous system.  In January 2004 under the terms of the agreement the Company received from Merck  a payment of $15.0 million for license fees and sold to Merck 1,783,252 shares of newly issued Neurogen common stock for an additional $15.0 million. Merck has agreed,  among other things, to fund a specified level of resources for three years for  the Company's program for the discovery and research and to pay additional license  fees on the first three anniversary dates of the collaboration. Merck has the  option to extend the discovery and research effort for up to an additional two  years or to terminate the agreement after two years and transfer certain rights  to the collaborative program to Neurogen. The Company is eligible to receive  milestone payments if certain compound discovery, product development or regulatory  objectives are achieved through the collaboration. Also under the Agreement,  Merck is responsible for funding the cost of development, including clinical  trials, manufacturing and marketing of collaboration products, if any. Merck  will pay Neurogen royalties based upon net sales levels, if any, for collaborationproducts. 

In December 2001, Neurogen  entered into a collaboration and license agreement with Aventis (the "Aventis  Agreement"), pursuant to which Aventis made an initial payment of $10.0  million and agreed, among other things, to fund a specified level of resources  for three years for Neurogen's program for the discovery and research of CRF-1  receptor-based drugs for a broad range of applications, including the therapeutic  treatment of depression and anxiety disorders. Aventis has the option to extend  the discovery and research effort for up to an additional two years or terminate  the collaboration prior to its scheduled conclusion and transfer all rights  to the collaborative program to Neurogen. As of December 31, 2003, the Company  has received $7.4 million of research funding from Aventis. Neurogen is also  eligible to receive milestone payments if certain compound discovery, product  development or regulatory objectives are achieved through the collaboration.  In return, Aventis received the exclusive worldwide rights to develop, manufacture  and market collaboration drugs that act through the CRF-1 receptor, for all  therapeutic indications for which the drugs may be used. Aventis will pay Neurogen  royalties based upon net sales levels, if any, for collaboration products. Also  under the Agreement, Aventis is responsible for funding the cost of development,  including clinical trials, manufacturing and marketing of collaboration products,  if any. In December 2003, due to progress in the collaboration, Neurogen achieved  a preclinical milestone that triggered a payment of $1.0 million, which was  received in January 2004. 

In June 1999, Neurogen  and Pfizer entered into the Pfizer Technology Transfer Agreement.  Under the terms of this agreement, Pfizer agreed to pay Neurogen up to a total  of $27.0 million over a three year period for the licensing and transfer to  Pfizer of certain of Neurogen's AIDDTM technologies for the discovery of new  drugs, along with the installation of an AIDDTM system. Additional payments were  also possible upon Pfizer's successful utilization of this technology. Pfizer  received a non-exclusive license to certain AIDDTM intellectual property and  the right to employ this technology in its own drug discovery programs. As of  December 31, 2003, Pfizer had provided $29.0 million pursuant to the Pfizer  Technology Transfer Agreement, which terminated on schedule in June 2002, and,  therefore, no additional fees were received in 2003. Total fees include a $2.0  million one-time payment in December 2002 to satisfy all obligations from Pfizer'suse of the AIDDTM technology. 

In 1994, Neurogen and Pfizer  entered into a collaborative research agreement (the "1994 Pfizer Agreement")  pursuant to which Pfizer made a $9.9 million equity investment in the Company  and agreed, among other things, to fund a specified level of resources for up  to four years (later extended to December 2001) for Neurogen's research program  for the development of GABA-based drugs for the treatment of sleep disorders.  In return, Pfizer received the exclusive worldwide license to manufacture,  use and sell GABA-based sleep disorder products developed in the collaboration.  Pfizer is currently evaluating a lead candidate NGD-96-3 from this collaboration in Phase  I studies and evaluating other candidates from the program to determine whether  further development is desirable. Pfizer has the right to determine when to  advance compounds in the clinical process, and the Company will receive milestone  payments if specified development and regulatory objectives are achieved. In  addition, Pfizer is required to pay the Company royalties based on net saleslevels, if any, for such products. Neurogen has initiated discussions with Pfizer to explore various options to advance the clinical development of NGD 96-3. 

**RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS**

In January 2003, the FASB issued EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." EITF Issue No. 00-21 addresses, for arrangements with multiple deliverables, how the arrangement consideration should be measured, whether the arrangement should be divided into separate units of accounting and how the arrangement consideration should be allocated among the separate units of accounting. The guidance in EITF Issue No. 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003.  Under EITF Issue No. 00-21, the multiple elements typically included in Neurogen's collaborative arrangements (such as upfront license fees, annual license maintenance fees, research funding, and milestone payments) may not meet the criteria for consideration as separate accounting units and may have to be accounted for as a combined unit. The adoption of EITF Issue No. 00-21 did not have a material effect on the company's results of operations in 2003 since only one collaborative arrangement, the Merck Agreement, which became effective upon receiving regulatory approval in late December 2003, was entered into after the pronouncement became effective. Revenue recognized from the Merck Agreement was less than $0.1 million in 2003. The Company will review the Merck Agreement and subsequent collaborative arrangements to determine whether the deliverables included in each arrangement qualify for treatment as separate accounting units.

 In December 2003, the SEC released SAB No. 104, "Revenue Recognition." SAB 104 clarifies existing guidance regarding revenues for contracts which contain multiple deliverables to make it consistent with EITF Issue No. 00-21. 

In January 2003, the Financial Accounting Standards Board issued FASB Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities" to improve financial reporting by enterprises involved with variable interest entities. The Interpretation addresses how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. The Interpretation is effective immediately for variable interest entities created after January 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not hold any investments or interest that would be considered variable interest entities and, accordingly, the adoption of FIN No. 46 did not have any impact on the Company's operating results or financial position. 

In April 2003 the FASB  issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and  Hedging Activities." SFAS No. 149 amends and clarifies financial accounting  and reporting for derivative instruments, including certain derivative instruments  embedded in other contracts (collectively referred to as derivatives) and for  hedging activities under FASB Statement No. 133, "Accounting for Derivative  Instruments and Hedging Activities." The standard is effective for transactions  after June 30, 2003. The adoption of SFAS No. 149 was not material to the Company'soperating results or financial position. 

In May 2003 the FASB issued  SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics  of Both Liabilities and Equity." SFAS No. 150 establishes standards for how  an issuer classifies and measures financial instruments. The standard is effective  for new or modified financial instruments after May 31, 2003, and otherwise  is effective at the beginning of the first interim period beginning after June  15, 2003. The Company does not currently have any financial instruments within  the scope of SFAS No. 150 and, accordingly, the adoption of SFAS No. 150 wasnot material to the Company's operating results or financial position. 

**ITEM 7A. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

*Interest rate risk*.  The Company's investment portfolio includes investment grade debt instruments.  These securities are subject to interest rate risk, and could decline in value  if interest rates fluctuate. Due to the short duration and conservative nature  of these instruments, the Company does not believe that it has a material exposure  to interest rate risk. Additionally, funds available from investment activities  are dependent upon available investment rates. These funds may be higher or  lower than anticipated due to interest rate volatility. 

*Capital market risk*.  The Company currently has no product revenues and is dependent on funds raised  through other sources. One source of funding is through further equity offerings.  The ability of the Company to raise funds in this manner is dependent upon capital  market forces affecting the stock price of the Company. 

**ITEM 8. FINANCIAL STATEMENTSAND SUPPLEMENTARY DATA**

**INDEX TO CONSOLIDATEDFINANCIAL STATEMENTS**

Consolidated Balance Sheetsat December 31, 2003 and 2002 

Consolidated Statementsof Operations for the years ended December 31, 2003 , 2002 and 2001 

Consolidated Statementsof Stockholders' Equity for the years ended December 31, 2003 , 2002 and 2001

Consolidated Statementsof Cash Flows for the years ended December 31, 2003 , 2002 and 2001

Notes to Consolidated FinancialStatements

Report of Independent Auditors