**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

 
| **ý**                                                  | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| ** **                                                  | ** ** | ** **                                                                                               |
| **For the  quarterly period ended September 30, 2005** |
| ** **                                                  | ** ** | ** **                                                                                               |
| **OR**                                                      |
| ** **                                                  | ** ** | ** **                                                                                               |
| **o**                                                       | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For thetransition period from          to         **

 

**CommissionFile Number: 000-30289**

 

**PRAECIS PHARMACEUTICALSINCORPORATED**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                     | ** ** | **04-3200305**                         |
|------------------------------------------------------------------|------------|----------------------------------------|
| (State or  other jurisdiction of  incorporation or organization) |       | (I.R.S.  Employer  Identification No.) |

 

**830 WinterStreet, Waltham, MA 02451-1420**

(Address of principal executiveoffices and zip code)

 

**(781) 795-4100**

(Registrant’s telephone number,including area code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes ý No o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes ý No o

 

Indicate by check mark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

 

As of November 1, 2005, there were 10,494,174 shares ofthe registrant’s common stock, $.01 par value, outstanding.*

 

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*       Adjustedto reflect a 1-for-5 reverse split of the registrant's common stock effected onNovember 1, 2005.

 

 

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**PRAECISPHARMACEUTICALS INCORPORATED**

**FORM 10-Q**

 

**FOR THEQUARTER ENDED SEPTEMBER 30, 2005**

 

**INDEX**

 
| **PART I.**       | **FINANCIAL INFORMATION**                                                                                             | ** ** |
|------------------------|-----------------------------------------------------------------------------------------------------------------------|------------|
| ** **             | ** **                                                                                                            | ** ** |
| Item 1.                | Financial  Statements (Unaudited)                                                                                     |       |
|                   |                                                                                                                  |       |
|                   | Condensed  Consolidated Balance Sheets – December 31, 2004 and September 30,  2005                     |       |
|                   |                                                                                                                  |       |
|                   | Condensed  Consolidated Statements of Operations – three and nine months ended September 30,  2004 and 2005 |       |
|                   |                                                                                                                  |       |
|                   | Condensed  Consolidated Statements of Cash Flows – nine months ended September 30,  2004 and 2005           |       |
|                   |                                                                                                                  |       |
|                   | Notes  to Condensed Consolidated Financial Statements                                                                 |       |
|                   |                                                                                                                  |       |
| Item  2.               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           |       |
|                   |                                                                                                                  |       |
| Item 3.                | Quantitative  and Qualitative Disclosures About Market Risk                                                           |       |
|                   |                                                                                                                  |       |
| Item 4.                | Controls and  Procedures                                                                                              |       |
|                   |                                                                                                                  |       |
| **PART II.**      | **OTHER INFORMATION**                                                                                                 |       |
| ** **             | ** **                                                                                                            |       |
| Item 1.                | Legal Proceedings                                                                                                     |       |
|                   |                                                                                                                  |       |
| Item  6.               | Exhibits                                                                                                              |       |
|                   |                                                                                                                  |       |
| **SIGNATURE**          |                                                                                                                  |       |
| ** **             |                                                                                                                  |       |
| **EXHIBIT INDEX** | ** **                                                                                                            |

 

2

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**PART I.  FINANCIALINFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS.**

 

**PRAECISPHARMACEUTICALS INCORPORATED**

**CondensedConsolidated Balance Sheets**

**(Inthousands, except share data)**

**(Unaudited)**

 
| ** **                                                                                                                                     | ** ** | **December 31,  2004** | ** ** | **September 30,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| **Assets**                                                                                                                                     |       |                        |       |                         |       |
| Current assets:                                                                                                                                |       |                        |       |                         |       |
| Cash and  cash equivalents                                                                                                                     |       | $                           | 11,178     |                         | $          | 41,621 |   |
| Marketable  securities                                                                                                                         |       | 72,171                      |       | 6,467                        |       |
| Accounts  receivable                                                                                                                           |       | 1,052                       |       | 282                          |       |
| Inventory                                                                                                                                      |       | 93                          |       | 185                          |       |
| Building -  held-for-sale                                                                                                                      |       | —                      |       | 39,811                       |       |
| Prepaid  expenses and other current assets                                                                                                     |       | 952                         |       | 1,118                        |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Total  current assets                                                                                                                          |       | 85,446                      |       | 89,484                       |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Property and equipment, net                                                                                                                    |       | 64,538                      |       | 4,055                        |       |
| Inventory                                                                                                                                      |       | 4,136                       |       | 1,344                        |       |
| Other assets                                                                                                                                   |       | 187                         |       | —                       |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Total assets                                                                                                                                   |       | $                           | 154,307    |                         | $          | 94,883 |   |
|                                                                                                                                           |       |                        |       |                         |       |
| **Liabilities and Stockholders’ Equity**                                                                                                  |       |                        |       |                         |       |
| Current liabilities:                                                                                                                           |       |                        |       |                         |       |
| Accounts  payable                                                                                                                              |       | $                           | 2,191      |                         | $          | 1,334 |   |
| Accrued expenses                                                                                                                               |       | 6,085                       |       | 3,164                        |       |
| Accrued  restructuring                                                                                                                         |       | —                      |       | 3,198                        |       |
| Deferred  revenue                                                                                                                              |       | 167                         |       | —                       |       |
| Current  portion of long-term debt                                                                                                             |       | 596                         |       | 31,573                       |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Total  current liabilities                                                                                                                     |       | 9,039                       |       | 39,269                       |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Long-term accrued restructuring                                                                                                                |       | —                      |       | 3,174                        |       |
| Long-term deferred revenue                                                                                                                     |       | 1,722                       |       | —                       |       |
| Long-term debt                                                                                                                                 |       | 31,373                      |       | —                       |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Commitments and contingencies                                                                                                                  |       |                        |       |                         |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Stockholders’ equity:                                                                                                                     |       |                        |       |                         |       |
| Common  Stock, $0.01 par value; 200,000,000 shares authorized; 10,475,664 shares in  2004 and 10,494,174 shares in 2005 issued and outstanding |       | 105                         |       | 105                          |       |
| Additional  paid-in capital                                                                                                                    |       | 356,140                     |       | 356,235                      |       |
| Accumulated  other comprehensive loss                                                                                                          |       | (169                        | )          | (114                         | )          |
| Accumulated  deficit                                                                                                                           |       | (243,903                    | )          | (303,786                     | )          |
|                                                                                                                                           |       |                        |       |                         |       |
| Total  stockholders’ equity                                                                                                               |       | 112,173                     |       | 52,440                       |       |
|                                                                                                                                           |       |                        |       |                         |       |
| Total  liabilities and stockholders’ equity                                                                                               |       | $                           | 154,307    |                         | $          | 94,883 |   |

 

*See accompanying notes.*

 

3

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**PRAECISPHARMACEUTICALS INCORPORATED**

**CondensedConsolidated Statements of Operations**

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

**(Unaudited)**

 
| ** **                                                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                              | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| **Revenues:**                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Product  sales                                                          |       | $                                          | 1,032      |                                      | $          | 282 |   | $ | 2,088 |   | $ | 1,437 |   |
| Licensing  and other revenues                                           |       | 42                                         |       | 1,806                                     |       | 120 |   | 1,924 |   |
| Total  revenues                                                         |       | 1,074                                      |       | 2,088                                     |       | 2,208 |   | 3,361 |   |
|                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| **Costs and expenses:**                                                 |       |                                       |       |                                      |       |   |   |   |   |
| Cost of  goods sold                                                     |       | 181                                        |       | 97                                        |       | 1,461 |   | 3,889 |   |
| Research and  development                                               |       | 7,369                                      |       | 5,333                                     |       | 23,044 |   | 18,892 |   |
| Sales and  marketing                                                    |       | 5,559                                      |       | 203                                       |       | 14,983 |   | 5,988 |   |
| General and  administrative                                             |       | 1,885                                      |       | 1,489                                     |       | 7,063 |   | 5,456 |   |
| Restructuring  and asset impairment                                     |       | —                                     |       | —                                    |       | — |   | 28,680 |   |
| Total costs  and expenses                                               |       | 14,994                                     |       | 7,122                                     |       | 46,551 |   | 62,905 |   |
|                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Operating loss                                                          |       | (13,920                                    | )          | (5,034                                    | )          | (44,343 | ) | (59,544 | ) |
|                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Interest (expense) income, net                                          |       | (34                                        | )          | (134                                      | )          | 167 |   | (339 | ) |
|                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Net loss                                                                |       | $                                          | (13,954    | )                                         | $          | (5,168 | ) | $ | (44,176 | ) | $ | (59,883 | ) |
|                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Basic and diluted net loss per common share                             |       | $                                          | (1.33      | )                                         | $          | (0.49 | ) | $ | (4.22 | ) | $ | (5.71 | ) |
|                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Weighted  average number of basic and diluted common shares outstanding |       | 10,476                                     |       | 10,494                                    |       | 10,457 |   | 10,488 |   |

 

*See accompanying notes.*

 

4

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**PRAECIS PHARMACEUTICALSINCORPORATED**

**CondensedConsolidated Statements of Cash Flows**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                               | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                               | ** ** | **2004**                             | ** ** | **2005** | ** ** |
| **Operating activities:**                                                |       |                                 |       |   |   |
| Net loss                                                                 |       | $                                    | (44,176    | ) | $ | (59,883 | ) |
| Adjustments to reconcile net loss to cash  used in operating activities: |       |                                 |       |   |   |
| Non-cash  asset impairment                                               |       | —                               |       | 23,169 |   |
| Depreciation                                                             |       | 3,484                                |       | 2,165 |   |
| Stock  compensation                                                      |       | 18                                   |       | — |   |
| Changes in  operating assets and liabilities:                            |       |                                 |       |   |   |
| Accounts  receivable                                                     |       | (1,715                               | )          | 770 |   |
| Inventory                                                                |       | (2,513                               | )     | (793 | ) |
| Prepaid  expenses and other assets                                       |       | (976                                 | )          | 21 |   |
| Due from  officer                                                        |       | 833                                  |       | — |   |
| Accounts  payable                                                        |       | (2,018                               | )          | (857 | ) |
| Accrued  expenses                                                        |       | (465                                 | )          | (2,921 | ) |
| Accrued  restructuring                                                   |       | —                               |       | 6,372 |   |
| Deferred  revenue                                                        |       | 1,931                                |       | (1,889 | ) |
|                                                                     |       |                                 |       |   |   |
| Net cash used in operating activities                                    |       | (45,597                              | )          | (33,846 | ) |
|                                                                     |       |                                 |       |   |   |
| **Investing activities:**                                                |       |                                 |       |   |   |
| Purchase of available-for-sale securities                                |       | (112,003                             | )          | (13,094 | ) |
| Sales or maturities of available-for-sale  securities                    |       | 152,500                              |       | 78,853 |   |
| Proceeds from disposition of property and  equipment                     |       | 50                                   |       | 15 |   |
| Purchase of property and equipment                                       |       | (967                                 | )          | (1,184 | ) |
|                                                                     |       |                                 |       |   |   |
| Net cash provided by investing activities                                |       | 39,580                               |       | 64,590 |   |
|                                                                     |       |                                 |       |   |   |
| **Financing activities:**                                                |       |                                 |       |   |   |
| Repayments of long-term debt                                             |       | (515                                 | )          | (396 | ) |
| Proceeds from the issuance of common stock                               |       | 334                                  |       | 95 |   |
|                                                                     |       |                                 |       |   |   |
| Net cash used in financing activities                                    |       | (181                                 | )          | (301 | ) |
|                                                                     |       |                                 |       |   |   |
| (Decrease) increase in cash and cash  equivalents                        |       | (6,198                               | )          | 30,443 |   |
| Cash and cash equivalents, beginning of  period                          |       | 15,687                               |       | 11,178 |   |
|                                                                     |       |                                 |       |   |   |
| Cash and cash equivalents, end of period                                 |       | $                                    | 9,489      |   | $ | 41,621 |   |

 

*Seeaccompanying notes.*

 

5

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**PRAECISPHARMACEUTICALS INCORPORATED**

**Notes toCondensed Consolidated Financial Statements**

(Unaudited)

 

# **1.**             Basis of Presentation

 

Theaccompanying condensed consolidated financial statements have been prepared byPRAECIS PHARMACEUTICALS INCORPORATED (the “Company”) in accordance withaccounting principles generally accepted in the United States and pursuant tothe rules and regulations of the Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States have beencondensed or omitted pursuant to such rules and regulations.  It is suggested that the financial statementsbe read in conjunction with the audited financial statements and theaccompanying notes included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004.

 

Theinformation furnished reflects all adjustments which, in the opinion ofmanagement, are considered necessary for a fair presentation of results for theinterim periods.  Such adjustmentsconsist only of normal recurring items. It should also be noted that results for the interim periods are notnecessarily indicative of the results expected for the full year or any futureperiod.

 

Thepreparation of these financial statements requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosures of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

 

# **2.**             Summary of Significant Accounting Principles

 

***Principles of Consolidation***

 

The accompanying condensed consolidatedfinancial statements include the Company’s accounts and the accounts of itswholly owned subsidiaries, 830 Winter Street LLC and PRAECIS Europe Limited.All significant intercompany account balances and transactions between thecompanies have been eliminated.

 

***Inventory***

 

Inventory is stated at the lower of cost or market with cost determinedunder the first-in/first-out (“FIFO”) method. The Company will write down anyobsolete, excess or otherwise unmarketable inventory to its estimated netrealizable value, as necessary.  If thenet realizable value is determined to be less than that estimated by theCompany, additional inventory write-downs may be required in future periods.  In connection with the Company’sstrategic restructuring announced in May 2005, the Company discontinuedpromotional activities related to Plenaxis® and the sale of Plenaxis®for new patients in the United States. As a result, during the second quarter of 2005, the Company wrote downapproximately $3.5 million of inventory that it estimated to be in excess ofits expected requirements.  This amountis classified in cost of goods sold in the Condensed Consolidated Statement ofOperations for the nine months ended September 30, 2005.  The remaining inventory balance consists ofmaterials that are expected to be used in connection with the commercializationof Plenaxis® by a third party following a license or sale transactionrelating to the product. In September 2005, the Company received marketingauthorization for Plenaxis® in Germany. (See Note 4) The Company intends to licenseor sell the rights to Plenaxis® in order to enable the commercialization of the productin Europe and other territories.

 

6

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The components ofinventory are as follows: 

 
| ** **           | ** ** | **December 31,  2004** | ** ** | **September 30,  2005** | ** ** |
|----------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **           | ** ** | **(in thousands)**          | ** ** |
| Raw materials        |       | $                           | 1,644      |                         | $          | — |   |
| Work-in-process      |       | 2,442                       |       | 1,529                        |       |
| Finished goods       |       | 143                         |       | —                       |       |
| Total inventory      |       | 4,229                       |       | 1,529                        |       |
| Less current portion |       | (93                         | )          | (185                         | )          |
| Long-term inventory  |       | $                           | 4,136      |                         | $          | 1,344 |   |

 

Rawmaterials, work-in-process and finished goods inventories consist of materials,labor and manufacturing overhead.  TheCompany classifies any inventory that is estimated to be sold in the nexttwelve months as current inventory, with the remaining amount classified aslong-term inventory.  The current portionof inventory at September 30, 2005 was approximately $185,000.

 

***Impairment or Disposal of Long-Lived Assets***

 

Statement of Financial Accounting Standards (“SFAS”)No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets* (“SFAS No. 144”), requires that if the sum ofthe undiscounted future cash flows expected to result from a company’s asset,net of interest charges, is less than the reported value of the asset, an assetimpairment may be recognized in the financial statements if the reported valueof the asset exceeds the fair value determined by either a quoted market price,if any, or a value determined by utilizing a discounted cash flowtechnique.  The Company evaluates itsproperty, plant and equipment for impairment whenever indicators of impairment exist.  The amount of the impairment to be recognizedis calculated by subtracting the fair value of the asset from the reportedvalue of the asset.  In connection withthe Company’s strategic restructuring announced in May 2005, the Companyperformed an assessment and determined that its approximately 180,000 squarefoot corporate headquarters and research facility (the “Facility”) wasimpaired.  As a result, during the secondquarter of 2005, the Company recorded a non-cash impairment charge ofapproximately $19.7 million related to the Facility as part of restructuringand asset impairment expenses under SFAS No. 144.  The Company obtained an independent appraisalthat was based upon a fee simple expected present value technique incombination with an evaluation of comparable assets in the geographic area inorder to estimate the fair value of its Facility.

 

***Stock-Based Compensation***

 

The Company has elected to follow AccountingPrinciples Board Opinion No. 25, *Accountingfor Stock Issued to Employees* (“APB No. 25”) and relatedinterpretations, in accounting for its stock-based employee compensation plansusing the intrinsic value method, rather than the alternative fair valueaccounting method provided for under SFAS No. 123, *Accounting for Stock-Based Compensation* (“SFASNo. 123”), as SFAS No. 123 requires the use of option valuationmodels that were not developed for use in valuing employee stock options. UnderAPB No. 25, when the exercise price of options granted to employees underthese plans equals the market price of the underlying stock on the date ofgrant, no compensation expense is required. The Company also follows the provisions of SFAS No. 148, *Accounting for Stock-Based Compensation-Transition and Disclosure, anamendment of FASB Statement No. 123*.

 

Had compensation expense for the Company’sstock option plans been determined based on the fair value at the grant datefor awards under these plans, consistent with the methodology prescribed underSFAS No. 123, the Company’s net loss and net loss per common share wouldhave approximated the pro forma amounts indicated below (in thousands, exceptper share data):

 

7

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| ** **                                                                                                                                                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net loss, as reported                                                                                                                                                                |       | $                                          | (13,954    | )                                         | $          | (5,168 | ) | $ | (44,176 | ) | $ | (59,883 | ) |
| Add: Stock  based compensation cost as computed under APB No. 25, included in the  determination of net loss as reported                                                        |       | 1                                          |       | —                                    |       | 18 |   | — |   |
| Deduct:  Stock-based employee compensation cost that would have been included in the  determination of net loss as reported if the fair value method had been  applied to all awards |       | (3,275                                     | )          | (1,747                                    | )          | (8,824 | ) | (7,217 | ) |
| Pro forma net loss                                                                                                                                                                   |       | $                                          | (17,228    | )                                         | $          | (6,915 | ) | $ | (52,982 | ) | $ | (67,100 | ) |
| Diluted net loss per common share, as  reported                                                                                                                                      |       | $                                          | (1.33      | )                                         | $          | (0.49 | ) | $ | (4.22 | ) | $ | (5.71 | ) |
| Diluted net loss per common share, pro  forma                                                                                                                                        |       | $                                          | (1.64      | )                                         | $          | (0.66 | ) | $ | (5.07 | ) | $ | (6.40 | ) |

 

The fair value of the stock options at thedate of grant was estimated using the Black-Scholes option pricing model withthe following weighted average assumptions: 

 
| ** **               | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Risk-free  interest rate |       | 4.00     | %          | 4.14     | %          |
| Expected  life (years)   |       | 6.0      |       | 5.0      |       |
| Volatility               |       | 89.0     | %          | 86.2     | %          |

 

The Company has never declared nor paid anycash dividends on any of its capital stock and does not expect to do so in theforeseeable future.

 

In December 2004, the FASB issued SFAS No. 123R,*Share-Based Payment – An Amendment of FASBStatements No. 123 and 95* (“SFAS No. 123R”), whichrequires all companies to measure compensation cost for all share-basedpayments, including employee stock options, at fair value.  SFAS No. 123R was originally effectivefor public companies for interim or annual periods beginning after June 15,2005.  In April 2005, the SECamended the compliance dates for SFAS No. 123R to allow companies toimplement SFAS No. 123R at the beginning of their next fiscal year, January 2006for the Company.  Generally, the approachin SFAS No. 123R is similar to the approach described in SFAS No. 123.  However, SFAS No. 123R requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the income statement based on their fair values.  Pro forma disclosure is no longer analternative. The adoption of SFAS No. 123R will have a significant impacton the Company’s results of operations, although it will have no impact on theCompany’s overall financial position. In March 2005, the SEC issued StaffAccounting Bulletin (“SAB”) No. 107 (“SAB No. 107”), whichexpressed the views of the SEC regarding the interaction between SFAS No. 123Rand certain SEC rules and regulations. SAB No. 107 providesguidance related to the valuation of share-based payment arrangements forpublic companies, including assumptions such as expected volatility andexpected term. The Company is evaluating SFAS No. 123R and SAB No. 107and has not yet determined the amount of stock option expense that will beincurred in future periods.

 

***Revenue Recognition***

 

The Company follows the provisions of the SEC’sSAB No. 104,*Revenue Recognition*.  Revenues from product sales are recognized inthe period when the product is delivered, provided there is persuasive evidencethat an arrangement exists, the price is fixed or determinable and collectionof the related receivable is reasonably assured.  Revenues are recorded net of applicableallowances as provision is made for estimated sales returns, rebates,distributor fees and other applicable discounts and allowances.  Shipping and other distribution costs arecharged to cost of product sales.

 

The Company prepares its provisions for salesreturns and allowances, rebates and discounts based primarily onestimates.  Contractual allowances andrebates result primarily from sales under contracts with healthcare providers,Medicaid programs and other government agencies.  The

 

8

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Company’s policy for sales returns has historically allowed authorizeddistributors to return the product three months prior to, and six months after,product expiration.  In connection withthe Company’s strategic restructuring announced in May 2005, the Companymodified its policy for sales returns to eliminate these restrictions in orderto accommodate returns resulting from the announcement of the discontinuationof promotional activities for Plenaxis® and the sale of Plenaxis® for new patientsin the United States. The reserve for sales returns is determined by reviewingthe history of returns for products with similar characteristics to Plenaxis®.The Company also utilizes daily reports itemizing sales to physicians andhospital pharmacies, obtained directly from its authorized distributors, inorder to analyze specific account ordering trends.  This data is reviewed to monitor productmovement through the supply chain to identify remaining inventory that mayresult in chargebacks or sales returns. The reserves are reviewed at each reporting period and adjusted toreflect data available at that time.  TheCompany had accrued approximately $0.2 million in sales return and otherrevenue reserves as of September 30, 2005. To the extent the Company’s estimates of contractual allowances, rebatesand sales returns are different from actuals, the Company adjusts the reservewhich impacts the amount of product sales revenue recognized in the period ofthe adjustment.

 

The Company currently provides substantiallyall of its distributors with payment terms of up to 120 days on purchases ofPlenaxis®.  Through September 30,2005, payments have generally been made in a timely manner.

 

The Company analyzes multiple elementarrangements to determine whether the elements can be separated and accountedfor individually as separate units of accounting in accordance with EITF No. 00-21,*Revenue Arrangements with MultipleDeliverables.*  Nonrefundableupfront licensing fees and certain guaranteed, time-based payments that requirecontinuing involvement in the form of development, manufacturing or othercommercialization efforts by the Company are recognized as licensing revenueratably over the period under which the Company is obligated to perform thoseservices.  Milestone payments are recognized as licensing revenue orproduct sales when the performance obligations, as defined in the contract, areachieved, so long as the milestone is deemed to be substantive.  Performance milestones typically consist ofmilestones in the development and/or commercialization of a product, such asobtaining approval from regulatory agencies and the achievement of targetedsales levels.  Reimbursements of developmentcosts are recognized as licensing revenue as the related costs are incurred.

 

When the period over which a fee or paymentwill be recognized as revenue cannot be specifically identified from thecontract, management estimates the deferral period based upon other criticalfactors contained within the contract, including but not limited to patent lifeor contract term.  The Companycontinually reviews these estimates which could result in a change in thedeferral period and might impact the timing and the amount of revenuerecognized.

 

***Net Loss Per Share***

 

Basic net loss per common share is based onthe weighted average number of shares of common stock, par value $.01 per share(“Common Stock”), outstanding. For all periods presented, diluted net loss percommon share is the same as basic net loss per common share as the inclusion ofCommon Stock equivalents, including the effect of stock options, would beantidilutive due to the Company’s net loss position for all periodspresented.  Diluted net loss per commonshare excluded 1,586,110 and 1,747,277 Common Stock options as of September 30,2004 and 2005, respectively.

 

***Comprehensive Loss***

 

SFAS No. 130, *ReportingComprehensive Income*, establishes standards for the reporting anddisplay of comprehensive income (loss) and its components in the condensedconsolidated financial statements.  TheCompany’s accumulated other comprehensive loss is comprised of net unrealizedgains or losses on available-for-sale securities.  For the three and nine months ended September 30,2004 and 2005, comprehensive loss was as follows (in thousands):

 

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| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                  |       |                                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Net loss                                              |       | $                                          | (13,954    | )                                         | $          | (5,168 | ) | $ | (44,176 | ) | $ | (59,883 | ) |
| Changes in comprehensive loss:                        |       |                                       |       |                                      |       |   |   |   |   |
| Net  unrealized holding gains/(losses) on investments |       | 193                                        |       | 25                                        |       | (209 | ) | 55 |   |
| Total comprehensive loss                              |       | $                                          | (13,761    | )                                         | $          | (5,143 | ) | $ | (44,385 | ) | $ | (59,828 | ) |

 

**3.****            ****Restructuring**

 

On May 19,2005, the Company’s Board of Directors approved a strategic restructuring tofocus the Company’s resources on its most promising assets and programs andsignificantly reduce its cost structure. The strategic restructuring included voluntarily discontinuingpromotional activities related to Plenaxis® and the sale of Plenaxis®for new patients in the United States; voluntarily suspending the ongoingclinical development of ApanTM, the Company’s drug candidate for Alzheimer’sdisease; and implementing a reduction of the Company’s 182-person headcount byapproximately 60%.

 

Duringthe nine months ended September 30, 2005, the Company recordedapproximately $28.7 million of restructuring and asset impairment expensesunder SFAS No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities. *The Company also recorded a non-cash impairment charge incost of goods sold of approximately $3.5 million related to inventory due tothe discontinuation of promotional activities relating to Plenaxis®in the United States.  Included inrestructuring and asset impairment expenses are cash charges of approximately$2.6 million for employee severance, benefits and related costs, approximately$0.2 million associated with the termination of various contracts andapproximately $0.2 million of other associated costs.  In addition, a non-cash impairment charge ofapproximately $19.7 million was recorded under SFAS No. 144 relating tothe Company’s Facility. The Company also concluded that its commitments undercertain existing Plenaxis® manufacturing and supply agreements withthird parties exceeded the Company’s estimated future Plenaxis®requirements by approximately $7.2 million. During the second quarter of 2005, the Company recorded a charge ofapproximately $6.0 million which represents the net present value of excessfuture commitments.  The Company expectsto expense the remaining $1.2 million of these excess commitments over theremaining term of the applicable manufacturing and supply agreements, rangingfrom two to five years.

 

Thefollowing table outlines the components of the Company’s restructuring andasset impairment expenses for the three and nine months ended September 30,2005 (in thousands):

 
| ** **                                       | ** ** | **Charges  for the Six  Months  Ended  June, 30  2005** | ** ** | **Non-Cash  Write-off** | ** ** | **Amounts  Paid  Through  September  30, 2005** | ** ** | **Amounts  Accrued as of  September 30,  2005** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------|------------|-------------------------------------------------|------------|------------------------------------------------------|------------|
| Employee  severance, benefits and related costs  |       | $                                                       | 2,555      |                    | $          | —                                          |       | $                                                    | 2,317      |   | $ | 238 |   |
| Contract  termination costs                      |       | 168                                                     |       | —                  |       | 123                                             |       | 45                                                   |       |
| Other costs                                      |       | 247                                                     |       | —                  |       | 193                                             |       | 54                                                   |       |
| Impairment  on building                          |       | 19,676                                                  |       | 19,676                  |       | —                                          |       | —                                               |       |
| Manufacturing  commitments restructuring expense |       | 6,034                                                   |       | —                  |       | —                                          |       | 6,034                                                |       |
| Total  restructuring and asset impairment        |       | 28,680                                                  |       | 19,676                  |       | 2,633                                           |       | 6,371                                                |       |
| Impairment  on Inventory                         |       | 3,493                                                   | *          | 3,493                   | *          | —                                          |       | —                                               |       |
| Total                                            |       | $                                                       | 32,173     |                    | $          | 23,169                                          |       | $                                                    | 2,633      |   | $ | 6,371 |   |
| Less current  portion                            |       |                                                    |       |                    |       |                                            |       | (3,197                                               | )          |
| Long-term  restructuring accrual                 |       |                                                    |       |                    |       |                                            |       | $                                                    | 3,174      |   |

 

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*****Amount was recorded in cost of goods sold.

 

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**4.**             **Schering AG Agreement**

 

In April 2004, the Company entered intoa license, supply and distribution agreement with Schering AG (“Schering AG”),of Berlin, Germany (the “Schering AG Agreement”), under which the Companygranted exclusive rights to Schering AG to commercialize Plenaxis®in the field of prostate cancer in Europe, Russia, the Middle East, SouthAfrica, Australia and New Zealand.  On September 27,2005, the Company received marketing authorization for Plenaxis® inGermany. On September 28, 2005, the Company received written notice fromSchering AG that it was exercising its right to terminate the Schering AGAgreement due to the Company not having received marketing authorization forPlenaxis® in Germany with a requisite label by June 30,2005.  Under the Schering AG Agreement,as a result of the termination, all of Schering AG’s rights and licenses withrespect to Plenaxis® have ceased.

 

The Schering AG Agreement provided for acombination of upfront, regulatory approval and performance-based milestonepayments, as well as a share of revenue through transfer price payments.  The Company received a $2.0 million signingpayment from Schering AG during the second quarter of 2004, which the Companywas recognizing into revenues through 2016, which represented the remainingpatent life of Plenaxis® in Europe. Due to the termination of the Schering AG Agreement, the Companyrecognized approximately $1.8 million in revenues for the three months ended September 30,2005, representing the remaining deferred revenue from the $2.0 million signingpayment.  On October 19, 2005, inconnection with the termination of the Schering AG Agreement, the partiesentered into a settlement agreement under which Schering AG paid the Company$4.0 million, representing full and complete satisfaction of Schering AG’sobligations under the Schering AG Agreement arising prior to itstermination.  The settlement agreementalso included mutual releases of any and all claims under or relating to theSchering AG Agreement.

 

**5.****             MortgageFinancing**

 

In July 2000,in connection with the purchase of the Facility, the Company entered into anacquisition and construction loan agreement providing for up to $33.0 millionin financing for the acquisition of, and improvements to, the Facility. In June 2004,the acquisition and construction loan agreement was amended (the “Amended LoanAgreement”) to extend the maturity date of the loan and modify certain otherterms of the original agreement.  Theinterest was fixed at 5.95% through April 2009 and at a floating rate forthe remainder of the term.  Principal andinterest were payable through a fixed monthly payment of approximately$207,000, with the principal portion being calculated using a 25-yearamortization schedule.

 

On October 18,2005, the Company completed the sale of its Facility to Intercontinental RealEstate Investment Fund III, LLC, an affiliate of Intercontinental Real EstateCorporation.  In connection with the saleof the Facility, the Company retired the outstanding loan under the AmendedLoan Agreement and terminated the mortgage on the Facility. Interest paid underthe Amended Loan Agreement approximated interest expense during both the threeand nine months ended September 30, 2004 and 2005.

 

**6.****             Saleof Facility and Partial Leaseback**

 

Inconnection with the Company’s strategic restructuring in May 2005, the Companyrecorded a non-cash impairment charge of approximately $19.7 million related tothe Facility as part of restructuring and asset impairment expenses under SFAS No. 144.  In July 2005, the Company determinedthat the plan of sale criteria had been met under SFAS No. 144.  Accordingly, the carrying value of theFacility is separately presented under the caption “Building - held-for-sale”in the September 30, 2005 Condensed Consolidated Balance Sheet andtherefore, the Facility is no longer being depreciated.

 

Asset forth in Note 5 above, on October 18, 2005, the Company sold itsFacility for gross proceeds of $51.25 million, and realized proceeds, net offees and expenses, of approximately $50.4 million.  The Company used a portion of the proceedsfrom the sale to retire the loan under the Amended Loan Agreement ofapproximately $31.6 million and terminate the mortgage on the Facility.

 

Inconnection with the closing of the sale of the Facility, the Companysimultaneously executed a lease (the “Lease Agreement”) for approximately65,464 square feet of office and

 

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laboratory space in the Facilityfor an initial term of five years at an initial annual rate of approximately$2.1 million, subject to an increase in years three through five of theinitial term.  Under the Lease Agreement,the Company has options to extend the lease for up to three additionalfive-year terms.

 

Inconnection with the closing of the sale of the Facility, the Company realized atotal gain of approximately $10.5 million representing the difference betweenthe purchase price, net of broker commissions and closing costs, and the netbook value of the Facility.  The difference between the total gain on thesale of the Facility and the net present value of the future minimum leasepayments under the Lease Agreement is approximately $1.4 million which will berecognized during the three months ended December 31, 2005, while theremaining amount of the gain of approximately $9.1 million will be amortizedover the initial term of the Lease Agreement.

 

**7.****            ****Litigation**

 

In December 2004and January 2005, the Company, Chairman and (now former) Chief ExecutiveOfficer Malcolm Gefter, President and (now former) Chief Operating OfficerKevin F. McLaughlin, Chief Financial Officer and Treasurer Edward C. English,and former President and Chief Operating Officer William K. Heiden, were namedas defendants in three purported class action securities lawsuits filed in theUnited States District Court for the District of Massachusetts.  The complaints generally allege securitiesfraud during the period from November 25, 2003 through December 6,2004.  Each of the complaints purports toassert claims under Sections 10(b) and 20(a) of the Securities andExchange Act of 1934 and Rule 10b-5 promulgated thereunder, and allegesthat the Company and the individually named defendants made materially falseand misleading public statements concerning the Company’s business andfinancial results, particularly relating to statements regarding thecommercialization of Plenaxis®.

 

On February 7,2005, a motion was filed to consolidate the three actions and to appoint leadplaintiffs and lead counsel.  On February 18,2005, the Company and the individual defendants filed a brief response to thatmotion, reserving their rights to challenge the adequacy and typicality, amongother things, of the proposed lead plaintiffs in connection with classcertification proceedings, if any.  On April 13,2005, the Court entered an Order granting the plaintiffs’ motion to consolidatethe three actions (as well as each case that relates to the same subject matterthat may be subsequently filed in or transferred to the United States DistrictCourt for the District of Massachusetts), appoint lead plaintiffs and approvesuch plaintiffs’ selection of co-lead counsel. On August 1, 2005, lead plaintiffs filed a consolidated amendedcomplaint.  On September 12, 2005,the Company and the individual defendants filed a Motion to Dismiss theconsolidated amended complaint.  On October 24, 2005, lead plaintiffsfiled an Opposition to the Motion to Dismiss. At this time, plaintiffs have not specified the amount of damagesthey are seeking in the actions.

 

TheCompany has not recorded an estimated liability associated with the legalproceedings described above.  Due to theuncertainties related to both the likelihood and the amount of any potentialloss, the Company is unable to make a reasonable estimate of the liability thatcould result from an unfavorable outcome. Management believes that the allegations against the Company are withoutmerit, and the Company intends to vigorously defend against the plaintiffs’claims.  However, if the Company is not successful in defending these actions, its businessand financial condition could be adversely affected.

 

**8.****             SubsequentEvent**

 

On October 27, 2005, the Company’sstockholders authorized the Company’s Board of Directors to effect a reversestock split of the Company’s Common Stock through an amendment to the Company’sAmended and Restated Certificate of Incorporation.  On October 27, 2005, following thisstockholder action, the Board of Directors authorized implementation of areverse stock split of the outstanding Common Stock at a split ratio of oneshare for each five shares, with cash being paid in lieu of fractionalshares.  The reverse stock split becameeffective at 5:00 p.m., eastern standard time, on November 1,2005.  As a result, the number of issuedand outstanding shares of the Company’s Common Stock was reduced fromapproximately 52.5 million shares to approximately 10.5 million shares, subjectto reduction for fractional shares.  The number of authorized shares ofCommon Stock was not changed by the reverse stock split and remains at200,000,000.  The par value of the CommonStock was not affected by the reverse stock split and remains at $0.01 pershare.  Consequently, on the Company’s Condensed Consolidated Balance Sheets,the aggregate par value of the issued Common Stock was reduced by reclassifyingthe par value amount of the

 

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eliminated shares of Common Stock to “Additional paid-in capital.” All per share amounts and outstanding shares, including all Common Stockequivalents (stock options), have been retroactively restated for all periodspresented to reflect the reverse stock split.

 

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**ITEM 2.****  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

*Thefollowing discussion of our financial condition and results of operationsshould be read together with the condensed consolidated financial statementsand accompanying notes to those statements included elsewhere in this Form 10-Q.  This Form 10-Q contains forward-lookingstatements within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended, that involve risks and uncertainties.  All statements other than statements ofhistorical information set forth herein are forward-looking and may containinformation about financial results, events, economic conditions, trends andknown uncertainties.  Actual results andevents could differ materially from those discussed in these forward-lookingstatements as a result of a number of factors, which include those discussed inthis section and elsewhere in this report, and the risks discussed in ourother filings with the Securities and Exchange Commission.  Readers are cautioned not to place unduereliance on these forward-looking statements, which reflect management’sanalysis, judgment, belief or expectation only as of the date hereof.  PRAECIS undertakes no obligation to publiclyreissue or modify these forward-looking statements to reflect events orcircumstances that arise after the date hereof.*

 

**Overview**

 

We are a biopharmaceutical company focused onthe discovery, development and commercialization of innovative therapies thateither address unmet medical needs or offer improvements over existingtherapies.  On May 19, 2005, ourBoard of Directors approved a strategic restructuring to focus the Company’sresources on our most promising assets and programs and significantly reduceour cost structure.  As a result, we arenow focusing our resources on:

 

•      Continuing toadvance our Direct SelectTM drug discovery technology and seeking researchcollaborations and partnerships with respect to that technology; and

 

•      Continuing theclinical development of PPI-2458, our novel, proprietary oral compound for thetreatment of cancer and autoimmune diseases.

 

We are focusing our early stage researchefforts on the further development and enhancement of our novel Direct SelectTMdrug discovery technology.  We believethat Direct SelectTM technology, through the creation ofultra-large advanced combinatorial chemistry libraries of drug-like molecules,will allow us to more rapidly and directly identify orally available compoundswith high affinity and specificity than has routinely been possible usingtraditional drug discovery methods.  During the third quarter of 2005, wecontinued to expand our library collection to over 3.5 billion moleculesthrough the generation of additional sub-libraries that comprised new chemicalscaffolds and an expanded building block set.  As stated above, thecontinued development and enhancement of Direct SelectTM is a key part of ouroperating plan and we continue to believe that this technology will be animportant tool for the future of drug discovery and development.  We arein discussions regarding potential partnership opportunities for DirectSelectTM.  We also intend to utilize this technology in identifyingnew compounds for internal development.

 

We are also focusing our research anddevelopment efforts on PPI-2458, a novel, proprietary oral compound targeted atthe inhibition of the enzyme methionine aminopeptidase type 2, or MetAP-2. Webelieve that, due to its antiproliferative and antiangiogenic activity, PPI-2458has the potential to address broad therapeutic areas and we are currently inthe process of establishing a long-term clinical development plan for thiscompound.  During the fourth quarter of2003, we initiated our first clinical trial for PPI-2458 evaluating an oralformulation in non-Hodgkin’s lymphoma patients who were no longer benefitingfrom other therapies.  In March 2004,the FDA placed this trial on clinical hold. In June 2004, we received clearance from the FDA to resume clinicaltrials and in late 2004, we opened a new phase 1 clinical trial of PPI-2458 innon-Hodgkin’s lymphoma patients.  Duringthe second quarter of 2005, we expanded the enrollment criteria of this trialto include patients with solid tumors. While the clinical trial is still in its early stages, thus far we haveobserved that MetAP-2 is inhibited following oral dosing with PPI-2458.  In addition to the ongoing clinical programin cancer patients, we also continue to conduct extensive preclinicalevaluations of the use of PPI-2458 for treating certain inflammatory andautoimmune disorders, including rheumatoid arthritis.  In light of the significant

 

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anticipated development costs associated with the PPI-2458 clinicalprogram, we anticipate seeking a partner for this program as clinicaldevelopment advances.

 

In late September 2005, we receivedmarketing authorization for Plenaxis®from the German regulatory authorities.  In Germany, Plenaxis® is indicated to initiate hormonal castrationin patients with advanced or metastatic, hormone-dependent prostate cancer, ifandrogen suppression is appropriate. Shortly after our receipt of the German approval, we received notice from Schering AG, ofBerlin, Germany, that it was exercising its right to terminate its license,supply and distribution agreement with us due to our not having receivedmarketing authorization for Plenaxis® in Germany with a requisitelabel by June 30, 2005.  Under theagreement, as a result of the termination, all of Schering AG’s rights andlicenses with respect to Plenaxis® have ceased.

 

Under the agreement, Schering AG hadexclusive rights to commercialize Plenaxis® in the field of prostatecancer in Europe, Russia, the Middle East, South Africa, Australia and NewZealand.  We received a $2.0 millionsigning payment from Schering AG during the second quarter of 2004, which wewere recognizing into revenues through 2016, which represented the remainingpatent life of Plenaxis® in Europe. Due to the termination of the Schering AG agreement on September 28,2005, we recognized approximately $1.8 million in revenues for the three monthsended September 30, 2005, representing the remaining deferred revenue fromthe $2.0 million signing payment.

 

On October 19, 2005, in connection withthe termination of the Schering AG agreement, the parties entered into asettlement agreement under which Schering AG paid us $4.0 million, representingfull and complete satisfaction of its obligations under the agreement arisingprior to its termination.  The settlementagreement also included mutual releases of any and all claims under or relatingto the Schering AG agreement.

 

Our strategic restructuring in May 2005included voluntarily discontinuing promotional activities related to Plenaxis®and the sale of Plenaxis® for new patients in the UnitedStates.  Plenaxis® continuesto be available to those patients in the United States who had already receivedthe drug at the time we announced our strategic restructuring in May 2005.

 

Due to our discontinuation of promotionalactivities related to Plenaxis® in the United States and the terminationof the Schering AG agreement, we intend to explore various opportunities forthis product, including a license or sale transaction that would enablecommercialization of the product in Europe and other territories. However, we cannot assure investors that we will be able to enter into acollaboration agreement or sell the rights to Plenaxis® on favorableterms, or at all.

 

In connection with our strategicrestructuring, we also voluntarily suspended the clinical development programfor ApanTM.  We began this program in 2000and, prior to its suspension, completed both a phase 1a single dose escalationstudy, identifying a maximum tolerated dose, or MTD, in healthy volunteers, anda phase 1b single dose escalation study, identifying the MTD in Alzheimer’spatients.  Enrollment in a phase 1/2amultiple dose study was suspended prior to completion.  As previously stated, the suspension ofclinical development for ApanTM was not due to any unexpected or undesirableevent or clinical result, but rather to conserve funds.  We anticipate continuing to explorepartnering opportunities for this compound to enable its further development inthe future.

 

On October 18, 2005, we completed thesale of our approximately 180,000 square foot corporate headquarters and researchfacility to Intercontinental Real Estate Investment Fund III, LLC, an affiliateof Intercontinental Real Estate Corporation, for $51.25 million.  We realized proceeds, net of fees andexpenses, of approximately $50.4 million from this sale, and used approximately$31.6 million of the proceeds to retire the outstanding loan under ouracquisition and construction loan agreement and terminate the mortgage on thefacility.  The remaining net proceeds of approximately $18.8million will be used to further our research and development efforts.

 

In connection with the closing of the sale ofthe facility, we simultaneously executed a lease for approximately 65,464square feet of office and laboratory space in the facility.  The lease has an initial term of five yearsat an annual base rent of approximately $2.1 million for the first twoyears, increasing to approximately $2.3 million per year through theremainder of the initial term.  We have options to extend the lease for upto three additional five-year terms at then current market rates.  Underthe lease, we are also responsible for our pro-rata share of real propertytaxes, insurance and operating costs.

 

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During the nine months ended September 30,2005, we recorded approximately $28.7 million of restructuring and assetimpairment expenses under Statement of Financial Accounting Standards No. 146,*Accounting for Costs Associated with Exit orDisposal Activities*, or SFAS No. 146.  We also recorded a non-cash impairment chargeof approximately $3.5 million related to inventory due to the discontinuationof promotional activities relating to Plenaxis® in the UnitedStates.  Included in restructuring andasset impairment expenses are cash charges of approximately $2.6 million foremployee severance, benefits and related costs, approximately $0.2 millionassociated with the termination of various contracts and approximately $0.2million of other associated costs.  Inaddition, a non-cash impairment charge of approximately $19.7 million wasrecorded under Statement of Financial Accounting Standards No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*,or SFAS No. 144, relating to our corporate headquarters and researchfacility.  We also concluded that ourcommitments under certain existing Plenaxis® manufacturing andsupply agreements with third parties exceeded our estimated future Plenaxis®requirements by approximately $7.2 million. During the nine months ended September 30, 2005, we recorded acharge of approximately $6.0 million which represents the net present value ofthese excess commitments.  We expect toexpense the remaining $1.2 million of these excess commitments over theremaining term of the applicable manufacturing and supply agreements, rangingfrom two to five years.

 

On October 27, 2005, our stockholdersauthorized our Board of Directors to effect a reverse stock split of our commonstock through an amendment to our amended and restated certificate ofincorporation.  On October 27, 2005,following this stockholder action, the Board of Directors authorizedimplementation of a reverse stock split of our outstanding common stock at asplit ratio of one share for each five shares, with cash being paid in lieu offractional shares.  The reverse stocksplit became effective at 5:00 p.m., eastern standard time, on November 1,2005.  As a result, the number of sharesof our issued and outstanding common stock was reduced from approximately 52.5million shares to approximately 10.5 million shares, subject to reduction forfractional shares.  All per share amounts and outstanding shares,including all common stock equivalents (stock options), have been retroactivelyrestated for all periods presented to reflect the reverse stock split in our condensedconsolidated financial statements and in the notes thereto appearing elsewherein this report.

 

Most of our expenditures to date have beenfor drug development, the development of our drug discovery technologies,commercialization activities and for general and administrative expenses.

 

* *Dueprimarily to the costs associated with the commercialization of Plenaxis®in the United States and its continued development, as well as other researchand development and general and administrative expenses, we had a net operatingloss for the first nine months of 2005. Our accumulated deficit as of September 30, 2005 was approximately$303.8 million.  We expect to continue tohave net operating losses for at least the next several years.

 

We continue to expect that, as a result ofthe strategic restructuring, our annual cash utilization will decrease fromapproximately $60.0 million per year to approximately $30.0 million per yearfor 2006, and that we should have available resources to allow us to pursue ourcurrent operating plan through approximately the end of 2007, and possiblylonger assuming the successful partnering of either our Direct SelectTMtechnology or our PPI-2458 program, or the license or sale of Plenaxis®for commercialization on a regional or worldwide basis.  However, we cannot assure investors that wewill be able to enter into appropriate collaborative arrangements relating toour Direct SelectTM technology or our PPI-2458 program, or a license or saletransaction relating to Plenaxis®, in a timely manner and onfavorable terms, or at all.** **If we are unable to carry out thekey elements of our operating plan, we may have to obtain additional sources offunding or significantly modify our operating plan, including by curtailingcertain elements of our operations.  Wehave no committed sources of capital and do not know whether additionalfinancing will be available when needed, or, if available, that the terms willbe favorable to us.  If we are requiredto raise money in the future and we experience difficulties or are unable to doso, it could become necessary for us to cease operations or seek protectionunder state or federal insolvency or bankruptcy laws.

 

At September 30, 2005, we had 72full-time employees, 57 of whom were research and development personnel and 15of whom were general and administrative personnel, compared to 180 full-timeemployees at September 30, 2004, 99 of whom were research and developmentpersonnel, 27 of whom were general and administrative personnel and 54 of whomwere sales and marketing personnel.  Thedecrease in headcount is due primarily to the approximate 60% reduction inheadcount effected as part of our strategic restructuring.

 

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**Critical Accounting Policies**

 

While our significant accounting policies aremore fully described in Note 2 to our condensed consolidated financialstatements appearing elsewhere in this report, we believe the followingaccounting policies to be critical:

 

*Use of Estimates.*  We prepare our financial statements inaccordance with accounting principles generally accepted in the UnitedStates.  These principles require that wemake estimates and use assumptions that affect the reporting of our assets andour liabilities as well as the disclosures that we make regarding assets andliabilities and revenues and expenses that are contingent upon uncertainfactors as of the reporting date.  Actualamounts, and thus our actual results, could differ from our estimates.

 

*Revenue Recognition. *We follow theprovisions of the Securities and Exchange Commission’s Staff AccountingBulletin No. 104, *Revenue Recognition*.  We recognize revenues from product sales inthe period when the product is delivered, provided there is persuasive evidencethat an arrangement exists, the price is fixed or determinable and collectionof the related receivable is reasonably assured.  Revenues are recorded net of applicableallowances as provision is made for estimated sales returns, rebates,distributor fees and other applicable discounts and allowances.  Shipping and other distribution costs arecharged to cost of product sales.

 

We prepare our provisions for sales returnsand allowances, rebates and discounts based primarily on estimates.  Contractual allowances and rebates resultprimarily from sales under contracts with healthcare providers, Medicaidprograms and other government agencies. Our policy for sales returns has historically allowed authorizeddistributors to return the product three months prior to, and six months after,product expiration.  In connection withour strategic restructuring announced in May 2005, we modified our policyfor sales returns to eliminate these restrictions in order to accommodatereturns resulting from the announcement of the discontinuation of promotionalactivities for Plenaxis® and the sale of Plenaxis® for new patientsin the United States. The reserve for sales returns is determined by reviewingthe history of returns for products with similar characteristics to Plenaxis®.  We also utilize daily reports itemizing salesto physicians and hospital pharmacies, obtained directly from our authorizeddistributors, in order to analyze specific account ordering trends.  This data is reviewed to monitor productmovement through the supply chain to identify remaining inventory that mayresult in chargebacks or sales returns. The reserves are reviewed at each reporting period and adjusted toreflect data available at that time.  Wehad accrued approximately $0.2 million in sales return and other revenuereserves as of September 30, 2005. To the extent our estimates of contractual allowances, rebates and salesreturns are different from actuals, we adjust the reserve which impacts theamount of product sales revenue recognized in the period of the adjustment.

 

We currently provide substantially all of ourdistributors with payment terms of up to 120 days on purchases of Plenaxis®.  Through September 30, 2005, paymentshave generally been made in a timely manner.

 

We analyze our multiple element arrangementsto determine whether the elements can be separated and accounted forindividually as separate units of accounting in accordance with EITF No. 00-21,*Revenue Arrangements with MultipleDeliverables.*  Nonrefundableupfront licensing fees and certain guaranteed, time-based payments that requirecontinuing involvement in the form of development, manufacturing or othercommercialization efforts by us are recognized as licensing revenue ratablyover the period under which we are obligated to perform those services. Milestone payments are recognized as licensing revenue or product saleswhen the performance obligations, as defined in the contract, areachieved.  Performance milestonestypically consist of significant milestones in the development and/orcommercialization of a product such as obtaining approval from regulatoryagencies and the achievement of targeted sales levels. Reimbursements ofdevelopment costs are recognized as licensing revenue as the related costs areincurred.

 

When the period over which a fee or paymentwill be recognized as revenue cannot be specifically identified from thecontract, management estimates the deferral period based upon other criticalfactors contained within the contract, including but not limited to patent lifeor contract term.  We continually reviewthese estimates which could result in a change in the deferral period and mightimpact the timing and the amount of revenue recognized.

 

*Restructuring and AssetImpairment Expenses. *On May 19, 2005, our Board of Directorsapproved a strategic restructuring to focus the Company’s resources on our mostpromising assets and programs and significantly reduce our cost structure.  The strategic restructuring includedvoluntarily

 

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discontinuing promotional activities related toPlenaxis® and the sale of Plenaxis® for new patients inthe United States; voluntarily suspending the ongoing clinical development ofApanTM, our drug candidate for Alzheimer’s disease; and implementing a reductionof our 182-person headcount by approximately 60%. These restructuring chargeswere accounted for in accordance with SFAS No. 146.  In determining the manufacturing commitmentsrestructuring expense and inventory impairment, various assumptions were madewith respect to future Plenaxis® sales.****Theseassumptions will be reviewed periodically and should these estimates change,adjustments to the net present value of remaining commitments as well asinventory may be necessary in future periods. Please refer to the discussion of*Inventory* and*Impairmentor Disposal of Long-Lived Assets*appearing directly below, as wellas Note 3 to our condensed consolidated financial statements includedelsewhere in this report, for additionalinformation regarding our strategic restructuring.

 

*Inventory.*  We value inventory at the lower of cost ormarket value. We determine cost using the first-in, first-out method.  We analyze our inventory levels quarterly andwrite down inventory that has become obsolete, inventory that has a cost basisin excess of its expected net realizable value and inventory in excess ofexpected requirements, to cost of goods sold. Expired inventory is disposed of and the related costs are writtenoff.  If actual market conditions are less favorable than that estimated by us,additional write-downs of existing inventory may be required in futureperiods.  In connection with our strategic restructuringannounced in May 2005, we discontinued promotional activities related toPlenaxis® and the sale of Plenaxis® for new patients inthe United States.  As a result, duringthe second quarter of 2005, we wrote down approximately $3.5 million ofinventory that we estimated to be in excess of our expected requirements.  This amount is classified as cost of goodssold in the condensed consolidated statements of operations for the nine monthsended September 30, 2005 appearing elsewhere in this report.  The remaining inventory balance consists ofmaterials that are expected to be used in connection with the commercializationof Plenaxis® by a third party following a license or saletransaction relating to the product.  Weintend to license or sell the rights to Plenaxis® in order to enable thecommercialization of the product in Europe and other territories.

 

*Impairment or Disposal of Long-Lived Assets*.  SFAS No. 144 requires that if the sum ofthe undiscounted future cash flows expected to result from a company’s asset,net of interest charges, is less than the reported value of the asset, an assetimpairment may be recognized in the financial statements if the reported valueof the asset exceeds the fair value determined by either a quoted market price,if any, or a value determined by utilizing a discounted cash flowtechnique.  We evaluate our property,plant and equipment for impairment whenever indicators of impairmentexist.  The amount of the impairment tobe recognized is calculated by subtracting the fair value of the asset from thereported value of the asset.

 

We believe that the application of SFAS No. 144and the method used to determine the impairment of our property, plant andequipment involve critical accounting estimates because they are highlysusceptible to change from period to period and because they require managementto make assumptions about future cash flows, including residual values.  In addition, we believe that had alternativeassumptions been used, the impact of recognizing an impairment, if any, on theassets reported on our balance sheet, as well as our net loss, may have beenmaterial.

 

In connection with our strategicrestructuring announced in May 2005, we performed an assessment anddetermined that our corporate headquarters and research facility wasimpaired.  As a result, a non-cashimpairment charge of approximately $19.7 million related to the facility wasrecorded as part of restructuring and asset impairment expenses under SFAS No. 144.We obtained an independent appraisal that was based upon a fee simple expectedpresent value technique in combination with an evaluation of comparable assetsin the geographic area in order to estimate the fair value of our corporateheadquarters and research facility.

 

Management has discussed thedevelopment, selection and disclosure of these critical accounting policieswith the audit committee of our Board of Directors.

 

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**Results of Operations**

 

**Three Months Ended September 30, 2005 Compared To Three Months Ended September 30, 2004**

 

Revenues for the three months ended September 30,2005 were approximately $2.1 million compared to approximately $1.1 million forthe corresponding period in 2004.  Due tothe termination of the Schering AG agreement on September 28, 2005, werecognized approximately $1.8 million in revenues for the three months ended September 30,2005, representing the remaining deferred revenue from the $2.0 million signingpayment.  During the three months ended September 30,2005 and 2004, revenues of approximately $0.3 million and $1.0 million,respectively, were related to sales of Plenaxis®.  The decrease in revenues was due primarily tothe voluntary discontinuation of promotional activities related to Plenaxis®and the sale of Plenaxis® for new patients in the UnitedStates.  We expect to continue to have asmall amount of revenues from Plenaxis® sales during the remainderof 2005.  In the fourth quarter of 2005,we expect to record $4.0 million in revenues consisting of a one-time paymentfrom Schering AG under our settlement agreement, representing full and completesatisfaction of Schering AG's obligations under our license agreement arisingprior to its termination.  Other sourcesof revenues during 2005 and thereafter may be from potential payments underfuture corporate collaborations relating to our Direct SelectTM drug discoverytechnology and PPI-2458 or from a license or sale transaction relating toPlenaxis®, in each case if consummated.  The amount and timing of these otherpotential sources of revenues will depend on the success of our Direct SelectTMtechnology and our PPI-2458 clinical development program, and our ability toenter into partnerships with respect to these programs, and the interest ofthird parties, if any, to enter into a license or sale transaction relating toPlenaxis®.  We cannot assureinvestors as to if or when we will receive any such revenues.

 

Cost of goods sold for the three months endedSeptember 30, 2005 was $0.1 million compared to approximately $0.2 millionfor the three months ended September 30, 2004.  We expect cost of goods sold to remainconsistent with current levels for the remainder of 2005 and thereafter.

 

We currently have several ongoing researchand development programs.  Using industryestimates, typical drug development programs may last for ten or more years andmay cost hundreds of millions of dollars to complete. As our programs progress,we assess the possibility of entering into corporate collaborations to offset aportion or all of our research and development costs. The ultimate success ofour research and development programs and the impact of these programs on ouroperations and financial results cannot be accurately predicted and willdepend, in large part, upon the outcome and timing of many variables outside ofour control.

 

Members of our research and development teamtypically work on a number of projects concurrently. In addition, a substantialamount of our fixed costs such as facility and equipment depreciation,utilities and maintenance are shared by our various programs. Accordingly, wehave not specifically identified, and do not plan to specifically identify, allcosts related to each of our research and development programs. We estimatethat during the three and nine months ended September 30, 2005 and during2004, the majority of our research and development expenses consisted ofsalaries, benefits, clinical trial costs, manufacturing costs and lab suppliesrelated to our Plenaxis® and PPI-2458 clinical development programs andthe development of our Direct SelectTM technology.

 

Research and development expenses for thethree months ended September 30, 2005 decreased approximately 28% toapproximately $5.3 million, from approximately $7.4 million for thecorresponding period in 2004.  Thedecrease was due primarily to lower personnel-related expenses of approximately$1.4 million during the three months ended September 30, 2005 due to thestrategic restructuring announced in May 2005, as well as the eliminationof depreciation on our facility due to the reclassification of the facility to “held-for-sale.”  The decrease also reflects reduced spendingin our clinical and preclinical programs. Spending on the Plenaxis® program during the three monthsended September 30, 2005 decreased by approximately $0.3 million dueprimarily to lower development-related costs. Spending on our ApanTM program during the three months ended September 30,2005 increased compared to the corresponding period in the prior year due to anincrease of approximately $0.6 million of clinical expenses offset by adecrease in preclinical expenses of approximately $0.3 million.  Spending related to our PPI-2458 programduring the three months ended September 30, 2005 decreased byapproximately $0.2 million due primarily to lower development-relatedcosts.  Although we are unable to predictthe precise level of spending on individual clinical programs due to theuncertain nature of clinical development, we expect our research anddevelopment expenses for the remainder of 2005 and thereafter to remain lowerthan 2004 levels, as we continue to advance our clinical trial of PPI-2458,enhance our Direct SelectTM technology and complete the wind-down of ApanTM andPlenaxis® clinical development activities.

 

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Sales and marketing expenses for the threemonths ended September 30, 2005 decreased to approximately $0.2 million,from approximately $5.6 million for the corresponding period in 2004.  The decrease was due primarily to thevoluntary discontinuation of promotional activities related to Plenaxis® inthe United States.  We do not expect toincur significant sales and marketing expenses during the remainder of 2005 orthereafter.

 

General and administrative expenses for thethree months ended September 30, 2005 decreased approximately 21% toapproximately $1.5 million, from approximately $1.9 million for thecorresponding period in 2004.  Thedecrease resulted primarily from lower personnel-related expenses during thethree months ended September 30, 2005. We expect that general and administrative expenses will remainrelatively consistent with current levels for the remainder of 2005.  Asdescribed in detail in this report under Part II, Item 2. “LegalProceedings,” in December 2004 and January 2005, the Company andcertain of its current and former executive officers were named as defendantsin three purported class action securities lawsuits filed in the United StatesDistrict Court for the District of Massachusetts.  Management believes that the allegationsagainst the Company are without merit, and the Company intends to vigorouslydefend against the plaintiffs’ claims. As this litigation is in an early stage, management is unable to predictits outcome or its ultimate effect, if any, on our financial condition.  However, we expect that the costs andexpenses related to this litigation may be significant.  Our current director and officer liabilityinsurance policies (which, subject to the terms and conditions thereof, alsoprovide “entity coverage” for the Company for this litigation) provide that theCompany is responsible for the first $2.5 million of such costs andexpenses.  If we are not successful indefending these actions, our business and financial condition could beadversely affected.

 

Net interest expense for the three monthsended September 30, 2005 was approximately $0.1 million compared to zerofor the corresponding period in 2004. The increase in net interest expense was due primarily to therefinancing of the mortgage on our facility from a lower variable rate to ahigher fixed rate and lower average cash balances.  We expect to have net interest income infuture periods due to the retirement in October 2005 of the outstanding loanunder our acquisition and construction loan agreement and termination of the mortgageon our facility.

 

At December 31, 2004, we had federal netoperating loss carryforwards of approximately $226.0 million and researchtax credits of approximately $7.3 million that will expire in varying amountsthrough 2024, if not utilized. Utilization of net operating loss and tax credit carryforwards will besubject to substantial annual limitations under the Internal Revenue Code of1986, as amended. The annual limitations may result in the expiration of thenet operating loss and tax credit carryforwards before full utilization.

 

**Nine Months Ended September 30, 2005 Compared To Nine Months Ended September 30, 2004**

 

Revenues for the nine months ended September 30,2005 were approximately $3.4 million compared to approximately $2.2 million forthe corresponding period in 2004.  Due tothe termination of the Schering AG agreement on September 28, 2005, werecognized approximately $1.8 million in revenues for the nine months ended September 30,2005, representing the remaining deferred revenue from the $2.0 million signingpayment.  During the nine months ended September 30,2005 and 2004, revenues of approximately $1.4 million and $2.1 million,respectively, were related to sales of Plenaxis®.

 

Cost of goods sold for the nine months ended September 30,2005 was approximately $3.9 million compared to approximately $1.5 million forthe corresponding period in 2004.  Duringthe second quarter of 2005, we recorded a non-cash impairment charge ofapproximately $3.5 million related to inventory due to the discontinuation ofpromotional activities relating to Plenaxis® in the United States.The majority of our cost of goods sold during the first three quarters of 2004was comprised of a $1.0 million milestone payment which became due and payableupon the first commercial sale of Plenaxis® under our licenseagreement with Indiana University Advanced Research and Technology Institute, Inc.

 

Research and development expenses for thenine months ended September 30, 2005 decreased approximately 18% toapproximately $18.9 million, from approximately $23.0 million for thecorresponding period in 2004.  Thedecrease was due primarily to lower personnel-related expenses of approximately$2.9 million during the nine months ended September 30, 2005.  The decrease also reflects reduced spendingon our clinical and preclinical programs. Spending on the Plenaxis® program

 

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during the nine months ended September 30, 2005 increased byapproximately $0.3 million compared to the corresponding period in the prioryear due primarily to higher development-related costs. Spending on our ApanTMprogram during the nine months ended September 30, 2005 decreased byapproximately $0.5 million compared to the corresponding period in the prioryear due to lower preclinical expenses of approximately $0.6 million offset byhigher clinical expenses of approximately $0.1 million.  Spending related to our PPI-2458 programduring the nine months ended September 30, 2005 decreased by approximately$1.0 million compared to the corresponding period in the prior year dueprimarily to reduced spending on preclinical studies.

 

Sales and marketing expenses for the ninemonths ended September 30, 2005 decreased to approximately $6.0 million,from approximately $15.0 million for the corresponding period in 2004.  The decrease resulted primarily from thevoluntary discontinuation of promotional activities related to Plenaxis®in the United States, as well as various one-time costs that were incurredduring 2004 in connection with the launch of Plenaxis® in the UnitedStates.

 

General and administrative expenses for thenine months ended September 30, 2005 decreased approximately 23% toapproximately $5.5 million, from approximately $7.1 million for thecorresponding period in 2004.  Thedecrease resulted primarily from lower personnel and business developmentexpenses during the nine months ended September 30, 2005.

 

Restructuringand asset impairment expenses for the nine months ended September 30, 2005were $28.7 million compared to zero for the corresponding period in 2004.  Please refer to the discussion under “Overview”in this Item 2, as well as Note 3 – Restructuring included in our condensedconsolidated financial statements appearing elsewhere in this report, foradditional information regarding our strategic restructuring.

 

Net interest expense for the nine monthsended September 30, 2005 was $0.3 million compared to net interest incomeof approximately $0.2 million for the corresponding period in 2004.  The decrease in net interest income (expense)was due primarily to the refinancing of the mortgage on our facility from alower variable rate to a higher fixed rate and lower average cash balances.

 

**Liquidity and Capital Resources**

 

To date, our operations and capitalrequirements have been financed primarily with the proceeds of public andprivate sales of common stock and preferred stock, payments received underresearch and development partnerships and collaborative agreements, investmentincome and revenues from product sales. We have no committed sources of capital and do not know whetheradditional financing will be available when needed, or, if available, that theterms will be favorable to us.

 

On May 19, 2005, our Board of Directorsapproved a strategic restructuring to focus the Company’s resources on our mostpromising assets and programs and significantly reduce our cost structure.  The strategic restructuring includedvoluntarily discontinuing promotional activities related to Plenaxis®and the sale of Plenaxis® for new patients in the United States;voluntarily suspending the ongoing clinical development of ApanTM; andimplementing a headcount reduction of approximately 60%.

 

At September 30, 2005, we had cash, cashequivalents and marketable securities of approximately $48.1 million andworking capital of approximately $50.2 million, compared to approximately $83.3million and $76.4 million, respectively, at December 31, 2004.  We expect to end the year with approximately$60.0 million in cash, cash equivalents and marketable securities. We continueto expect that, as a result of the strategic restructuring, our annual cashutilization will decrease from approximately $60.0 million per year toapproximately $30.0 million per year for 2006, and that we should haveavailable resources to allow us to pursue our current operating plan throughapproximately the end of 2007, and possibly longer assuming the successfulpartnering of either our Direct SelectTM technology or our PPI-2458program, or the license or sale of Plenaxis® for commercializationon a regional or worldwide basis.

 

We expect to continue to have net operatinglosses for at least the next several years. We cannot assure investors that we will be able to enter intoappropriate collaborative arrangements relating to our Direct SelectTMtechnology or our PPI-2458 program, or a license or sale transaction relatingto Plenaxis®, in a timely manner and on favorable terms, or at all.** **If we are unable tocarry out the key elements of our operating plan, we may have to obtainadditional sources of funding or significantly modify our operating plan,including by curtailing certain elements of our operations.  We have no committed sources of capital

 

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and do not know whether additional financing will be available whenneeded, or, if available, that the terms will be favorable to us.  If we are required to raise money in thefuture and we experience difficulties or are unable to do so, it could becomenecessary for us to cease operations or seek protection under state or federalinsolvency or bankruptcy laws.

 

For the nine months ended September 30,2005, net cash of approximately $33.8 million was used in operating activities,compared to approximately $45.6 million used in operating activities during thenine months ended September 30, 2004. During the nine months ended September 30, 2005, our use of cash inoperations was due principally to our net loss of approximately $59.9 millionand the reduction in accounts payable and accrued expenses of approximately$3.8 million, offset by non-cash asset impairment expenses of approximately$19.7 million, an increase in accrued restructuring costs of approximately $6.4million, a reduction in inventory of approximately $2.7 million anddepreciation of approximately $2.2 million. Cash utilization will continue for 2005 and thereafter as we continue torefine and enhance our Direct SelectTM drug discovery technology and advance ourclinical development program for PPI-2458, and continue our other research anddevelopment initiatives.  The actual amountof overall expenditures will depend on numerous factors, including the timingof expenses, the timing and terms of collaboration agreements or otherstrategic transactions, if any, and the timing and progress of our research anddevelopment efforts.

 

Net cashprovided by investing activities of approximately $64.6 million for the ninemonths ended September 30, 2005 consisted primarily of net sales ormaturities of marketable securities of approximately $65.8 million.  Thiscompares to net cash provided by investing activities of approximately $39.6million for the corresponding period in 2004, which was also related primarilyto net sales or maturities of marketable securities of approximately $40.5million.

 

In July 2000, in connection with thepurchase of our corporate headquarters and research facility in Waltham,Massachusetts, we entered into an acquisition and construction loan agreementproviding for up to $33.0 million in financing for the acquisition of, andimprovements to, the facility. In June 2004, the acquisition andconstruction loan agreement was amended to extend the maturity date of the loanand modify certain other terms of the original agreement.  The interest was fixed at 5.95% through April 2009and at a floating rate for the remainder of the term.  Principal and interest were payable through afixed monthly payment of approximately $207,000, with the principal portionbeing calculated using a 25-year amortization schedule.

 

On October 18, 2005, we completed thesale of our facility to Intercontinental Real Estate Investment Fund III, LLCfor $51.25 million.  We realizedproceeds, net of fees and expenses, of approximately $50.4 million from thissale, and used approximately $31.6 million of the proceeds to retire theoutstanding loan under the acquisition and construction loan agreement andterminate the mortgage on the facility. The remaining net proceeds of approximately $18.8 million will be used to further ourresearch and development efforts.

 

In connection with the closing of the sale ofthe facility, we simultaneously executed a lease for approximately 65,464square feet of office and laboratory space in the facility.  The lease has an initial term of five yearsat an annual base rent of approximately $2.1 million for the first twoyears, increasing to approximately $2.3 million per year through theremainder of the initial term.  We have options to extend the lease for upto three additional five-year terms at then current market rates.  Underthe lease, we are also responsible for our pro-rata share of real propertytaxes, insurance and operating costs.

 

At December 31, 2004 we had provided avaluation allowance of approximately $110.7 million for our deferred taxassets. The valuation allowance represents the value of the deferred taxassets.  Due to anticipated futureoperating losses, we believe that it is more likely than not that we will notrealize the net deferred tax assets in the future and we have provided anappropriate valuation allowance.

 

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**Recent Accounting Pronouncements**

 

In December 2004, the FinancialAccounting Standards Board issued Statement of Financial Accounting Standards No. 123R,*Share-Based Payment - An Amendment of FASBStatements No. 123 and 95*, or SFAS No. 123R, whichrequires all companies to measure compensation cost for all share-basedpayments, including employee stock options, at fair value, and was originallyeffective for public companies for interim or annual periods beginning after June 15,2005.  In April 2005, the Securities and Exchange Commission amendedthe compliance dates for SFAS No. 123R to allow companies to implementSFAS No. 123R at the beginning of their next fiscal year, January 2006for us.  Generally, the approach in SFAS No. 123Ris similar to the approach described in Statement of Financial AccountingStandards No. 123, *Accounting for Stock-BasedCompensation*.  However, SFAS No. 123R requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair values.  Proforma disclosure is no longer an alternative.  The adoption of SFAS No. 123Rwill have a significant impact on our results of operations, although it willhave no impact on our overall financial position.  In March 2005, the Securities andExchange Commission issued Staff Accounting Bulletin No. 107, or SAB No. 107,which expressed the views of the Commission regarding the interaction betweenSFAS No. 123R and certain rules and regulations of theCommission.  SAB No. 107provides guidance related to the valuation of share-based payment arrangementsfor public companies, including assumptions such as expected volatility andexpected term.  We are evaluating SFAS No. 123Rand SAB No. 107 and have not yet determined the amount of stock optionexpense that will be incurred in future periods.

 

**Risk Factors that May Affect FutureResults**

 

*The risks and uncertainties described beloware not the only ones we face. Additional risks and uncertainties not presently known to us or that arecurrently deemed immaterial may also impair our business, financial conditionand results of operations.  If any ofthese risks actually occur, our business, financial condition and results ofoperations could be materially adversely affected.*

 

**We have a history of losses and we may not beprofitable in the future.**

 

We cannotassure investors that we will be profitable in the future or, if we attainprofitability, that it will be sustainable. In May 2005, our Board of Directors approved astrategic restructuring to focus the Company’s resources on our most promisingassets and programs and significantly reduce our cost structure.  Going forward under our current operatingplan, we will focus our resources on our Direct SelectTM drug discoverytechnology and seeking research collaborations and partnerships with respect tothat technology, and continuing the clinical development of PPI-2458.  We also intend to explore variousopportunities for Plenaxis®, including a license or sale transactionthat would enable commercialization of the product in Europe and other territories.

 

To date, wehave derived substantially all of our revenues from payments under corporatecollaboration and license agreements, and from product sales.  Our marketing and selling efforts with regardto Plenaxis®in the United States were not commercially successful, and we may be unable tosuccessfully develop or market any other products in the future.  Moreover, we may be unable to enter into researchcollaborations or partnerships with respect to Direct SelectTM or PPI-2458, orlicense or sell the rights to Plenaxis®, on favorable terms, or atall.  Our current operating plan includessignificant ongoing expenditures to support the ongoing enhancement of ourDirect SelectTM technology and the continuation of our PPI-2458 clinicaldevelopment program, and for general and administrative purposes.  As of September 30, 2005, we had an accumulated deficit ofapproximately $303.8 million.  We expect that we will continue to incursignificant operating losses for at least the next several years, and we maynever be profitable in the future.

 

**If we are unable to successfully carry outour operating plan, we may have to obtain additional sources of funding or significantlymodify our operating plan.**

 

If we are unable to successfully carry outone or more of the key elements of our operating plan described in theimmediately preceding risk factor, we believe that our existing cash andinvestments will be sufficient to meet our working capital and capitalexpenditure needs through approximately the

 

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end of 2007.  If we are able tosuccessfully carry out one or more of the key elements of our operating plandescribed above, we may be able, without obtaining additional funding, tocontinue to meet our working capital and capital expenditure needs beyond thattime, although we cannot provide any assurances as to if or for how long wewould be able to do so.  If we are unableto successfully carry out the key elements of our operating plan, we may haveto obtain additional sources of funding or significantly modify our operatingplan, including by curtailing or eliminating certain elements of ouroperations.  We have no committed sourcesof capital and do not know whether additional financing will be available whenneeded, or, if available, that the terms will be favorable to us.

 

To date, our operations and capitalrequirements have been financed primarily with the proceeds of public andprivate sales of common stock and preferred stock, payments under research anddevelopment partnerships and collaborative agreements, investment income andrevenues from product sales.  In addition,we recently sold our facility and intend to use the proceeds from that sale tofund our ongoing operations.  However,there can be no assurance that we will be able to sell any securities, enterinto additional partnerships and collaborative agreements or borrow funds inthe future at favorable terms, or at all. If we raise additional funds by issuing equity securities, furtherdilution to existing stockholders will result. In addition, as a condition to giving additional funds to us, futureinvestors may demand, and may be granted, rights superior to those of existingstockholders.  We may also be required totake other actions, which may lessen the value of our common stock or diluteour common stockholders, including borrowing money on terms that are notfavorable to us.  If we are required toraise money in the future and we experience difficulties or are unable to doso, it could become necessary for us to cease operations or seek protectionunder state or federal insolvency or bankruptcy laws.

 

**Our Direct SelectTM drug discovery technologyis still under development, and we may not be able to attract collaboratorswith respect to this technology or discover compounds that lead to marketableproducts.**

 

We are focusing our early stage drugdiscovery efforts on our proprietary Direct SelectTM drug discovery technology,and our future success depends in part on the successful development of thistechnology, as well as our ability to enter into collaborations relating tothis technology.  We believe that DirectSelectTM is a novel technology that will allow us to rapidly and directlyidentify compounds that are orally available and have high affinity andspecificity.  However, if we are unableto obtain adequate patent protection for this technology, another party couldoffer drug discovery capabilities that directly compete with our capabilitiesor could attempt to block our ability to practice our technology.  Furthermore, we cannot assure investors thatthis technology will allow us to offer significant advantages over traditionaldrug discovery methods.  For example, thefeasibility of creating and screening ultra-large advanced combinatorialchemistry libraries resulting in successful leads is still in the developmentstage.  Moreover, we may not be able toidentify novel compounds from the libraries that we create that can address awide spectrum of targets or that can be rapidly taken into clinical developmentand that ultimately lead to marketable products.  If we are not successful in continuing toenhance this technology and in identifying product candidate(s) using thistechnology for either a partner or for internal development, we would berequired to significantly modify our operating plan.

 

Given our strategic focus on formingpartnerships with respect to our Direct SelectTM technology, we are alsodependent upon the extent to which pharmaceutical and biotechnology companiescontinue to collaborate with outside companies to obtain drug discoveryexpertise.  Our revenue will depend, inpart, on research and development expenditures by pharmaceutical andbiotechnology companies, particularly companies outsourcing research anddevelopment projects and adding new and improved technologies to acceleratetheir drug discovery and development initiatives.  Our capabilities include aspects of the drugdiscovery process that pharmaceutical companies have traditionally performedinternally.  Although there is a historyamong pharmaceutical and biotechnology companies of outsourcing drug researchand development functions, this practice may not continue.  Our ability to convince one or more of thesecompanies to use our drug discovery technology and capabilities rather thandevelop them internally will depend on many factors, including our ability to:

 

•                                          continueto enhance and refine our Direct SelectTM technology resulting in theidentification of higher-quality drug candidates;

 

•                                          providescientists and technology that are of the highest caliber; and

 

•                                          achieveintended results in a timely fashion, with acceptable quality and at anacceptable cost.

 

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If we are unable to attract collaborators, we may never generaterevenues from this technology and would be forced to significantly modify ouroperating plan.

 

**We are subject to extensive governmentregulation that increases our costs and could prevent us from developing, andultimately commercializing, potential products.**

 

Thedevelopment and sale of pharmaceutical products, including Plenaxis®, PPI-2458 or other product candidates we maydiscover, is subject to extensive regulation by governmental authorities.  Obtaining regulatory approval typically iscostly and takes many years; maintaining regulatory approval also requiressubstantial resources.  Regulatoryauthorities, most importantly, the FDA, have substantial discretion to place onclinical hold or terminate clinical trials, delay, withhold or withdrawregistration and marketing approval in the United States, and effectivelymandate product recalls. Failure to comply with regulatory requirements mayresult in criminal prosecution, civil penalties, recall or seizure of products,total or partial suspension of production or injunction. Outside the UnitedStates, we can market a product only if we receive marketing authorization fromthe appropriate regulatory authorities. This foreign regulatory approvalprocess includes all of the risks associated with the FDA approval process, andmay include additional risks.

 

To gainregulatory approval from the FDA and foreign regulatory authorities for thecommercial sale of any product, we must demonstrate in clinical trials, andsatisfy the FDA and foreign regulatory authorities as to, the safety andefficacy of the product.  If we develop aproduct to treat a long-lasting disease, such as cancer, we must gather dataover an extended period of time. There are many risks associated with ourclinical trials. For example, we may discover that the product we are testingin clinical trials is not effective, despite positive results in preclinicalstudies.  While our compound, PPI-2458, hasbeen shown to inhibit its target enzyme, MetAP-2, in preclinical and earlyclinical testing, we do not know if this will ultimately result in an effectivetreatment for cancer.  We also may beunable to achieve the same level of success in later trials as we did inearlier ones. Additionally, data we obtain from preclinical and clinicalactivities are susceptible to varying interpretations that could impederegulatory approval. Further, some patients in our PPI-2458 clinical trial havea high risk of death or other adverse medical events due to their advancedcancer that may not be related to our product. These events may affect the statistical analysis of the safety and efficacyof PPI-2458.  If we obtain regulatoryapproval for a product, the approval will be limited to those diseases forwhich our clinical trials demonstrate the product is safe and effective.

 

In addition,many factors could delay or result in termination of our ongoing or futureclinical trials. For example, results from ongoing preclinical studies oranalyses could raise concerns over the safety or efficacy of a productcandidate.  In March 2004, the FDAplaced our phase 1 clinical trial of PPI-2458 on clinical hold.  Although we subsequently received clearancefrom the FDA to resume clinical testing of PPI-2458, we cannot assure investorsthat the FDA will not place this or other clinical trials on hold in thefuture.  A clinical trial may alsoexperience slow patient enrollment.  Astudy could also be delayed due to lack of sufficient drug supply.  Patients may experience adverse medicalevents or side effects, and there may be a real or perceived lack ofeffectiveness of, or of safety issues associated with, the drug we aretesting.  Future governmental action orexisting or changes in FDA or foreign regulatory authority policies orprecedents, may also result in delays or rejection of an application formarketing approval.  The FDA, andcomparable foreign regulatory authorities, have considerable discretion indetermining whether to grant marketing approval for a drug, and may delay ordeny approval even in circumstances where the applicant’s clinical trials haveproceeded in compliance with established procedures and regulations and havemet the established end-points of the trials. Challenges to regulatorydeterminations are generally time-consuming and costly, and rarely, if ever,succeed.  Although we received FDAapproval to market Plenaxis® in the UnitedStates in November 2003 and in Germany in September 2005, we can giveno assurance that we will obtain marketing approval for PPI-2458 or any otherpotential product candidate.

 

Anyregulatory approval may be conditioned upon significant labeling requirementsand, as in the case of the FDA approval of Plenaxis®, marketing restrictions and post-marketingstudy commitments.  Such labeling andmarketing restrictions could, and in the case of Plenaxis® in the United States, did, materiallyadversely affect the marketability and/or value of the product.  As part of our recent restructuring to focusour resources on our most promising assets and programs and significantlyreduce our cost structure, we have voluntarily discontinued promotionalactivities related to Plenaxis® and the sale of Plenaxis® for new patients in the United States. In addition, although Plenaxis® was approved in Germany, our former partner elected to terminate its agreementwith us, and we may not be able to license or sell the product to a third partyto enable its commercialization in Germany or to pursue additional regulatoryapprovals in other countries.

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Even ifregulatory approval is obtained for a product, the product and themanufacturing facilities for the product will be subject to continual reviewand periodic inspection by regulatory authorities.  Later discovery of previously unknownproblems with a product, manufacturer or facility may result in restrictions onthe product, the manufacturer or us, including withdrawal of the product fromthe market. The FDA and comparable foreign regulatory authorities stringentlyapply regulatory standards.  Ourmanufacturing facilities will also be subject to FDA or foreign regulatoryinspections for adherence to good manufacturing practices prior to marketingclearance and periodically during the manufacturing process.  Failure to comply can, among other things,result in fines, denial or withdrawal of regulatory approvals, product recallsor seizures, operating restrictions, injunctions and criminal prosecution.  If there are any modifications to a product,further regulatory approval will be required.

 

In addition, manufacturing, sales, promotion,and other activities following product approval are subject to regulation bynumerous regulatory authorities in addition to the FDA and comparableregulatory authorities outside the United States, including potentially theFederal Trade Commission, the Department of Justice and individual U.S.Attorney offices within the Department of Justice, CMS, other divisions of theDepartment of Health and Human Services, state and local governments andcomparable governmental authorities outside the United States.  Sales, marketing and scientific/educationalprograms must comply with the anti-kickback provisions of the Social SecurityAct, the False Claims Act, and similar state laws.  Pricing and rebate programs must comply withpricing and reimbursement rules, including the Medicaid rebate requirements ofthe Omnibus Budget Reconciliation Act of 1990 and the Veteran’s Health CareAct.  If products are made available toauthorized users of the Federal Supply Schedule of the General ServicesAdministration, additional laws and requirements apply.  All of our activities are potentially subjectto federal and state consumer protection and unfair competition laws andcomparable foreign laws.

 

Depending on the circumstances, failure tomeet these applicable legal and regulatory requirements can result in criminalprosecution, fines or other penalties, injunctions, recall or seizure ofproducts, total or partial suspension of production, denial or withdrawal ofpre-marketing product approvals, private “qui tam” actions brought byindividual whistleblowers in the name of the government, or refusal to allow usto enter into supply contracts, including government contracts.

 

If we areunable to successfully carry out the elements of our operating plan, whichinclude the continued clinical development of PPI-2458 and potentially other productcandidates discovered using our Direct SelectTM technology, we may need to raiseadditional capital and, if we were unable to do so, it could become necessaryfor us to cease operations or seek protection under state or federal bankruptcylaws.

 

**If we lose our key personnel or are unable toattract and retain additional skilled personnel, we may be unable to pursue thedevelopment of our drug discovery technology or our product development andcommercialization efforts.**

 

We dependsubstantially on the principal members of our management and scientific staff,including Kevin F. McLaughlin, our President and Chief Executive Officer, andRichard W. Wagner, Ph.D., our Executive Vice President, DiscoveryResearch.  We do not have employmentagreements with any of our executive officers. Any officer or employee can terminate his or her relationship with us atany time and work for one of our competitors. The loss of these key individualscould result in competitive harm because we could experience delays in thedevelopment of our drug discovery technology or our product research,development and commercialization efforts without their expertise.

 

Recruitingand retaining qualified scientific personnel to perform future research anddevelopment work also will be critical to our success. Competition for skilledpersonnel is intense and the turnover rate can be high. We compete withnumerous companies and academic and other research institutions for experiencedscientists. This competition may limit our ability to recruit and retainqualified personnel on acceptable terms. Moreover, due to our recent strategic restructuring and our limitedresources compared to many of our competitors, we may face additionalchallenges when recruiting qualified personnel in the future.  Failure to attract and retain qualifiedpersonnel would prevent us from continuing to develop our potential products,enhancing our technologies and launching our products commercially.

 

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**Due to the termination by Schering AG of ourcollaboration agreement, absent a third party sale or license agreement, we donot expect that Plenaxis® will be commercialized outside of theUnited States.**

 

We dependedupon our corporate collaborator, Schering AG, to commercialize Plenaxis® in Schering AG’s licensed territory,including Germany, where we recently received marketing authorization.  We also relied on Schering AG to some extentin seeking regulatory approval for Plenaxis® in various othercountries in the European Union and European Economic Area which participate inthe Mutual Recognition Procedure, or MRP, and elsewhere in Schering AG’slicensed territory under local regulatory procedures.  Although we have received marketingauthorization for Plenaxis® in Germany, we do not have the financialresources or expertise to market the product in Germany or in any otherterritories outside of the United States. For this reason, we currently do not plan to seek additional approvalsfor Plenaxis® in the European Union under the MRP or in any otherterritory outside the United States without the financial and regulatorysupport of a corporate collaborator. Accordingly, the termination of our agreement with Schering AG may delayor prevent additional regulatory approvals for Plenaxis®, and theultimate commercialization of Plenaxis®, outside of the UnitedStates.

 

Moreover,due to the termination of the Schering AG agreement, we will likely need todevote funds and other resources to the Plenaxis® program that we hadplanned would be available from Schering AG, in particular to support thecontinuing costly manufacture of the product for limited distribution in theUnited States and to meet our minimum purchase commitments under our Plenaxis®manufacturing agreements.  We have announced our intention to explorevarious opportunities for this product, including a license or sale transactionthat would enable commercialization of Plenaxis® in Europe and other territories. However, we cannot assure investors that we will be able to negotiatesuch a transaction on acceptable terms, or at all, and in that event weanticipate that we would not pursue further the commercialization of Plenaxis® outside of the United States and wouldlikely seek to discontinue all distribution of Plenaxis® in the United States.

 

**Even if we gain marketing approval for PPI-2458or another potential product, we may be unable to establish or maintainmarketing and sales capabilities or enter into and maintain corporatecollaborations necessary to commercialize PPI-2458 or such other potentialproduct in the United States or abroad in the future.**

 

We havelimited experience in marketing or selling pharmaceutical products and havevery limited marketing and sales resources. Even if we gain marketing approval for PPI-2458 or another potentialproduct, to achieve commercial success for the product, we must either relyupon our limited experience and infrastructure, or enter into arrangements withothers to market and sell our products. We cannot assure investors that we will be able to enter into marketingand sales agreements on acceptable terms, if at all, for PPI-2458 or for anyother future product candidate.

 

Until May 2005,we were promoting Plenaxis® in the United States through our own dedicated marketing and salesteam.  We experienced significantturnover in both our sales management and field sales personnel which webelieve had an adverse impact on our ability to commercialize Plenaxis®.  InMay 2005, in connection with the strategic restructuring of ouroperations, we voluntarily discontinued promotional activities related toPlenaxis® and the sale of Plenaxis® for new patients inthe United States, and accordingly, we terminated all of our sales andmarketing personnel.  Competition for experienced and skilledmarketing and sales personnel is intense, and we cannot assure investors thatwe would be able to attract and retain a sufficient number of qualifiedindividuals to successfully promote PPI-2458 (if marketing approval for thisproduct were obtained) or any other potential product in the future.  In addition, establishing the expertisenecessary to successfully market and sell any product requires a substantialcapital investment.  We cannot assureinvestors that we will have the funds to successfully commercialize PPI-2458(if marketing approval for this product were obtained) or any other potentialproduct in the United States or elsewhere. Moreover, a product candidate we may have in development is likely tocompete with products of other companies that currently have extensive andwell-funded marketing and sales operations. Because these companies are capable of devoting significantly greaterresources to their marketing and sales efforts, our future marketing and salesefforts may not compete successfully against the efforts of these othercompanies.

 

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**Because we depend on third parties to conductlaboratory testing and human clinical studies and assist us with regulatorycompliance, we may encounter delays in product development andcommercialization.**

 

We havecontracts with a limited number of research organizations to design and conductour laboratory testing and human clinical studies.  If we cannot contract for testing activitieson acceptable terms, or at all, we may not complete our product developmentefforts in a timely manner.  To theextent we rely on third parties for laboratory testing and human clinicalstudies, we may lose some control over these activities.  For example, third parties may not completetesting activities on schedule or when we request them to do so.  In addition, these third parties may conductour clinical trials in a manner inconsistent with regulatory requirements orotherwise in a manner that yields misleading or unreliable data.  This, or other failures of these thirdparties to carry out their duties, could result in significant additional costsand expenses and could delay or prevent the development and commercializationof PPI-2458 or other future product candidate.

 

**If we fail to develop and maintain ourrelationships with third-party manufacturers, or if these manufacturers fail toperform adequately, we may be unable to develop and commercialize PPI-2458 orany other future product candidate or to continue to support thecommercialization of Plenaxis****®.**

 

Our abilityto conduct large clinical trials for, or to commercialize, PPI-2458 or anyfuture product candidate, will depend in part on our ability to manufacture, orarrange for third-party manufacture of, our products on a large scale, at acompetitive cost and in accordance with regulatory requirements.  We must establish and maintain a commercialscale formulation and manufacturing process for each of our potential productsfor which we seek marketing approval.  Weor third-party manufacturers may encounter difficulties with these processes atany time that could result in delays in clinical trials, regulatory submissionsor in the commercialization of potential products.

 

We have noexperience in large-scale product manufacturing, nor do we have the resourcesor facilities to manufacture all products for use in humans. We currently rely oncontract manufacturers for the manufacture of Plenaxis®, and expect to rely on contractmanufacturers for the foreseeable future for the manufacture of any othercompounds for later-stage preclinical, clinical and commercial purposes.Third-party manufacturers may not be able to meet our needs as to timing,quantity or quality of materials. If we are unable to contract for a sufficientsupply of needed materials on acceptable terms, or if we encounter delays ordifficulties in our relationships with manufacturers, our clinical trials maybe delayed, thereby preventing or delaying the submission of product candidatesfor, or the granting of, regulatory approval and the commercialization of ourpotential products. Any such delays may lower our revenues and delay or preventour attaining or maintaining profitability.

 

If thethird-party manufacturers upon which we rely fail to meet our needs forclinical or commercial supply, we may be required to supplement ourmanufacturing capacity by building our own manufacturing facilities. This wouldrequire substantial expenditures.  Also,we would need to hire and train significant numbers of employees to staff a newfacility. If we are required to build our own facility, we may not be able todevelop sufficient manufacturing capacity to produce drug materials forclinical trials or commercial use in a timely manner, if at all.

 

In addition,we and the third-party manufacturers that we use must continually adhere tocurrent good manufacturing practice requirements enforced by the FDA throughits facilities quality programs.  Foreignregulatory authorities may also inspect our third-party manufacturers as acondition of obtaining and maintaining the requisite approvals.  In complying with these requirements, we andany of our third-party manufacturers will be obligated to expend time, moneyand effort in production, record-keeping and quality control to assure that ourpotential products meet applicable specifications and other requirements.  If we or any of our third-party manufacturersfail to comply with these requirements, we may be subject to regulatorysanctions, manufacturing delays, or the facilities could be shut down.

 

Any of thesefactors could prevent, or cause delays in, obtaining regulatory approvals forPPI-2458 or any other potential product, and the manufacturing, marketing orselling of PPI-2458 or any such other product, and could also result insignificantly higher operating expenses. Any of these factors,

 

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insofar as they affect the manufacture ofPlenaxis®, could also adversely affect our ability to enter into alicense or sale transaction with respect to Plenaxis® on favorableterms, or at all.

 

**If, despite our recent reverse stock split,we fail to meet and maintain the Nasdaq National Market’s minimum bid pricecontinued listing standard, our common stock may be delisted from the NasdaqNational Market.**

 

The marketprice of our common stock has declined substantially.  On June 7, 2005, we received a letterfrom The Nasdaq Stock Market notifying us that for 30 consecutive trading daysthe bid price of our common stock closed below the minimum $1.00 per sharerequired for continued inclusion under the Nasdaq Rules.  If the bid price of our common stock does notequal or exceed $1.00 for a minimum of 10 consecutive business days during thesubsequent 180 calendar day period following the date of the notice (by December 5,2005), The Nasdaq Stock Market could take action seeking to delist our commonstock from the Nasdaq National Market. If we met the initial listing requirements of the Nasdaq SmallCapMarket, other than its minimum bid price requirement, we could apply totransfer our common stock to the Nasdaq SmallCap Market and, if thatapplication were approved, we would be afforded the remainder of the NasdaqSmallCap Market’s additional 180 calendar day compliance period to meet the$1.00 per share minimum bid price requirement for continued listing on theNasdaq SmallCap Market.

 

On November 1,2005, we effected a one-for-five reverse split of our common stock principallyin order to regain compliance with the minimum bid price rule by December 5,2005 and maintain the listing of our common stock on the Nasdaq NationalMarket.  However, there can be noassurance that the price of our common stock will remain above $1.00 per shareafter the reverse stock split, or that we will be able to maintain the listingof our common stock on the Nasdaq National Market, or obtain or maintain thelisting of our common stock on the Nasdaq SmallCap Market if we were unable tomaintain our listing on the Nasdaq National Market.  Delisting of our common stockfrom the Nasdaq National Market, even if it were listed and traded on theNasdaq SmallCap Market, would likely result in reduced liquidity, therebyincreasing the volatility of the trading price, of our common stock, a loss ofcurrent or future coverage by certain analysts and a diminution ofinstitutional investor interest.  Itcould also potentially cause a loss of confidence of corporate collaborators,contract manufacturers and our employees, which could adversely affect ourbusiness.

 

**Our recent one-for-five reverse stock splitcould have various negative effects on our common stock and our stockholders.**

 

Our recentone-for-five reverse stock split resulted in an immediate increase in themarket price of our common stock. However, this increase in the market price of our common stock may notbe in proportion to the reduction in the number of shares of our common stockoutstanding or result in a permanent increase in the market price (whichdepends on many factors, including our performance, prospects and other factorsthat may be unrelated to the number of shares outstanding).  If the market price of our common stockdeclines, the percentage decline as an absolute number and as a percentage ofour overall market capitalization may be greater than would occur in theabsence of the reverse stock split. Furthermore, the liquidity of our common stock may be adversely affectedby the reduced number of shares that are now outstanding following the reversestock split.  In addition, the reversesplit has likely increased the number of our stockholders who own odd lots(less than 100 shares).  Stockholders whohold odd lots typically will experience an increase in the cost of sellingtheir shares, as well as possible greater difficulty in effecting such sales.

 

**We may have substantial exposure to productliability claims and may not have adequate insurance to cover those claims.**

 

Theadministration of drugs to humans, whether in clinical trials or commercially,can result in product liability claims whether or not the drugs are actually atfault for causing an injury.  Plenaxis®, PPI-2458 or future product candidates maycause, or may appear to have caused, adverse side effects (including death) orpotentially dangerous drug interactions that we may not learn about orunderstand fully until the drug has been administered to patients for sometime.

 

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Productliability claims can be expensive to defend and may result in large judgmentsor settlements against us, which could have a negative effect on our financialperformance. The costs of product liability insurance have increaseddramatically in recent years, and the availability of coverage has decreased.  Although we carry insurance that we regard asreasonably adequate to protect us from potential claims, there can be noassurance that we will be able to maintain our current product liabilityinsurance at a reasonable cost, or at all. Our former collaboration agreements included, and some of the agreementsregarding the termination of certain of those collaborations also include, anindemnification for liabilities associated with the development andcommercialization of Plenaxis®.  If a third party, including aformer collaborator, successfully sues us for any injury, or forindemnification for losses, there is no guarantee that the amount of the claimwould not exceed the limit of our insurance coverage.  Even if a product liability claim is notsuccessful, the adverse publicity and time and expense of defending such aclaim may interfere with our business.

 

**Many of our competitors have substantiallygreater resources than we do and may be able to develop and commercializeproducts or technologies that make our potential products and technologiesobsolete or non-competitive.**

 

Abiopharmaceutical company such as ours must keep pace with rapid technologicalchange and faces intense competition. We compete with biotechnology andpharmaceutical companies for funding, access to new technology, research,medical and management personnel, and in product research and development. Manyof these companies have greater financial resources and more experience than wedo in developing drugs or drug discovery technologies, obtaining regulatory approvals,manufacturing, marketing and sales. We also face competition from academic andresearch institutions and government agencies pursuing alternatives to ourproducts and technologies. Plenaxis® has faced, and we expect PPI-2458 and futureproduct candidates we may develop will face, intense competition from otherproducts. In addition, for any products we may face increasing competition fromgeneric formulations or existing drugs whose active components are no longercovered by patents.  We also expect toface competition from other companies that are developing drug discoverytechnologies that offer advantages similar to or better than those of ourDirect SelectTM technology.

 

Ourcompetitors may:

 

•              developdrug discovery technologies that are faster, more efficient or more advancedthan our technology;

 

•              successfully identify drug candidates ordevelop products earlier than we do;

 

•              develop products that are more effective,have fewer side effects or cost less than our products;

 

•              obtain approvals from the FDA or foreignregulatory bodies more rapidly than we do; or

 

•              successfully market and sell products thatcompete with our products.

 

The success or continued success of ourcompetitors in any of these efforts may adversely affect our ability to furtherenhance and refine and partner on favorable terms our Direct SelectTMtechnology, to develop, partner on favorable terms and commercialize PPI-2458or other future product candidates, to license or sell Plenaxis® on favorable terms to allow itscommercialization, particularly outside of the United States, and to ultimatelyattain and maintain profitability.

 

**If we are unable to obtain and enforce validpatents, we could lose any competitive advantage we may have.**

 

Our successwill depend in part on our ability to obtain patents and maintain adequateprotection of our technologies and potential products. If we do not adequatelyprotect our intellectual property, competitors may be able to use ourtechnologies and erode any competitive advantage we may have. For example, ifwe are unable to obtain adequate patent protection for our Direct SelectTMtechnology, another party could offer drug discovery capabilities that directlycompete with our capabilities or could attempt to block our ability to practiceour technology.  Additionally, if we loseour patent protection for

 

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Plenaxis®, another party could produce and market thecompound in direct competition with us or a potential licensor or purchaser ofPlenaxis®, whichwould adversely affect our ability to complete a license or sale transactionwith respect to Plenaxis® on favorable terms, or at all. Some foreign countries lack rules andmethods for defending intellectual property rights and do not protectproprietary rights to the same extent as the United States. Many companies havehad difficulty protecting their proprietary rights in foreign countries.

 

Patentpositions are sometimes uncertain and usually involve complex legal and factualquestions. We can protect our proprietary rights from unauthorized use by thirdparties only to the extent that our proprietary technologies are covered byvalid and enforceable patents or are effectively maintained as trade secrets.We currently own or have exclusively licensed 30 issued United States patents.We have applied, and will continue to apply, for patents covering both ourtechnologies and products as we deem appropriate. Others may challenge ourpatent applications or our patent applications may not result in issuedpatents. Moreover, any issued patents on our own inventions, or those licensedfrom third parties, may not provide us with adequate protection, or others maychallenge the validity of, or seek to narrow or circumvent, these patents.  Third-party patents may impair or block ourability to conduct our business. Additionally, third parties may independently develop products similarto our products, duplicate our unpatented products, or design around anypatented products we develop.

 

**If we are unable to protect our trade secretsand proprietary information, we could lose any competitive advantage we mayhave.**

 

In additionto patents, we rely on a combination of trade secrets, confidentiality,nondisclosure and other contractual provisions, and security measures toprotect our confidential and proprietary information. These measures may notadequately protect our trade secrets or other proprietary information.  If these measures do not adequately protectour rights, third parties could use our technology, and we could lose anycompetitive advantage we may have. In addition, others may independentlydevelop similar proprietary information or techniques, which could impair anycompetitive advantage we may have.

 

**If our technologies, processes or productsconflict with the patents or other intellectual property rights of competitors,universities or others, we could have to engage in costly litigation and beunable to commercialize those products.**

 

Ourtechnologies, processes, product or product candidates may give rise to claimsthat they infringe patents or other intellectual property rights of thirdparties.  A third party could force us topay damages, stop our use of these technologies or processes, or stop ourmanufacturing or marketing of the affected products by bringing a legal actionagainst us for infringement. In addition, we could be required to obtain alicense to continue to use the technologies or processes or to manufacture ormarket the affected products, and we may not be able to do so on acceptableterms or at all. We believe that significant litigation will continue in ourindustry regarding patent and other intellectual property rights. If we becomeinvolved in litigation, it could consume a substantial portion of ourresources. Even if legal actions were meritless, defending a lawsuit could takesignificant time, be expensive and divert management’s attention from otherbusiness concerns.

 

**If third parties terminate our licenses, ourefforts to license or sell Plenaxis® to a third party could beadversely affected.**

 

We licensesome of our technology from third parties. Termination of our licenses couldrequire us to delay or discontinue our plan to license or sell Plenaxis®to a third party.  If Advanced Researchand Technology Institute, Inc., the assignee of Indiana UniversityFoundation, terminated our license with them due to a breach by us of the termsof that license, the likelihood of our licensing or selling Plenaxis®to a third party on favorable terms, orat all, would be materially diminished. We cannot assure investors that we would be able to license substitutetechnology in the future. Our inability to do so could impair our ability toconduct our business because we may lack the technology, or the necessaryrights to technology, required to develop and commercialize our potential products.

 

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**We are a defendant in purported class actionsecurities lawsuits regarding the adequacy of our public disclosure which couldhave a material adverse affect on our financial condition.**

 

As describedin detail in this report under Part II, Item 1. “Legal Proceedings,” in December 2004and January 2005, the Company, Chairman and (now former) Chief ExecutiveOfficer Malcolm Gefter, President and (now former) Chief Operating OfficerKevin F. McLaughlin, Chief Financial Officer and Treasurer Edward C. English,and former President and Chief Operating Officer William K. Heiden, were namedas defendants in three purported class action securities lawsuits filed in theUnited States District Court for the District of Massachusetts.  The complaints generally allege securitiesfraud during the period from November 25, 2003 through December 6,2004.  Each of the complaints purports toassert claims under Sections 10(b) and 20(a) of the Securities andExchange Act of 1934 and Rule 10b-5 promulgated thereunder, and allegesthat the Company and the individually named defendants made materially falseand misleading public statements concerning the Company’s business andfinancial results, particularly statements regarding the commercialization ofPlenaxis®.  The complaints were consolidated into oneaction in April 2005.  In August 2005,lead plaintiffs filed a consolidated amended complaint.  In September 2005, we filed a motion todismiss plaintiffs’ consolidated amended complaint.  In October 2005, lead plaintiffs filedan opposition to our motion to dismiss.

 

Managementbelieves that the allegations against the Company are without merit, and theCompany intends to vigorously defend against the plaintiffs’ claims.  As this litigation is in an early stage,management is unable to predict its outcome or its ultimate effect, if any, onthe Company’s financial condition. However, we expect that the costs and expenses related to thislitigation may be significant.  Our currentdirector and officer liability insurance policies (which, subject to the termsand conditions thereof, also provide “entity coverage” for the Company for thislitigation) provide that the Company is responsible for the first $2.5 millionof such costs and expenses.  Also, ajudgment in or settlement of these actions could exceed our insurance coverage.If we are not successful in defending these actions, our business and financialcondition could be adversely affected. In addition, whether or not we are successful, the defense of theseactions may divert the attention of our management and other resources thatwould otherwise be engaged in running our business.

 

**Pharmaceutical companies have been the targetof lawsuits and investigations and there is no assurance that if we were to beinvolved in any such lawsuits or investigation, that our defense would besuccessful.**

 

Pharmaceuticalcompanies have been the target of lawsuits and investigations including, inparticular, claims asserting violations of the Federal False Claim Act,Anti-Kickback Act, the Prescription Drug Marketing Act or other violations inconnection with Medicare and/or Medicaid reimbursement, and claims under statelaws, including state anti-kickback and fraud laws. Similar actions, investigationsand claims may also be brought or arise under comparable foreign laws.  Public companies may also be the subject ofcertain other types of claims, including those related to environmentalmatters. There is no assurance that if we were to be involved in any suchlawsuits or investigation, that we would be successful in defending ourselvesor in asserting our rights.  Governmentinvestigations of these sorts of issues are typically expensive, disruptive andburdensome, and generate negative publicity. If our previous promotional activities with respect to Plenaxis®were found to be in violation of the law, we could possibly face significantfines and penalties.  In addition, we andour senior officers could be civilly or criminally prosecuted, potentiallyresulting in our exclusion from participation in government healthcare programssuch as Medicare and Medicaid.

 

**We use hazardous chemicals and radioactiveand biological materials in our business and any claims relating to thehandling, storage or disposal of these materials could be time consuming andcostly.**

 

Our researchand development processes involve the controlled use of hazardous materials,including chemicals and radioactive and biological materials, which may posehealth risks. In addition, the health risks associated with accidental exposureto Plenaxis®include temporary impotence or infertility and harmful effects on pregnantwomen. Our operations also produce hazardous waste products. We cannotcompletely eliminate the risk of accidental contamination or discharge fromhazardous materials and any resultant injury. Federal, state and local laws andregulations govern the use,

 

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manufacture, storage, handling and disposalof hazardous materials. Compliance with health and safety and environmentallaws and regulations is necessary and expensive. Current or future health andsafety and environmental regulations may impair our research, development orproduction efforts. We may be required to pay fines, penalties or damages inthe event of noncompliance or the exposure of individuals to hazardousmaterials.

 

From time totime, third-parties have also worked with hazardous materials in connectionwith our agreements with them. We have agreed to indemnify our present andformer collaborators in some circumstances against damages and otherliabilities arising out of development activities or products produced inconnection with these collaborations.

 

**Changes in the securities laws andregulations have increased, and are likely to continue to increase, our costs.**

 

TheSarbanes-Oxley Act of 2002, which became law in July 2002, has requiredchanges in some of our corporate governance, securities disclosure andcompliance practices. In response to the requirements of that Act, the SEC andthe Nasdaq have promulgated new rules and listing standards covering avariety of subjects. Compliance with these new rules and listing standardshas increased our legal costs, and significantly increased our financial andaccounting costs, and we expect these increased costs to continue. Thesedevelopments may make it more difficult and more expensive for us to obtaindirector and officer liability insurance. Likewise, these developments may makeit more difficult for us to attract and retain qualified members of our boardof directors, particularly independent directors, or qualified executiveofficers.

 

**If we or our independent registered publicaccounting firm are unable to affirm the effectiveness of our internal controlover financial reporting in future years, the market value of our common stockcould be adversely affected.**

 

As directedby Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiringpublic companies to include a report of management on the Company’s internalcontrol over financial reporting in their annual reports on Form 10-K thatcontains an assessment by management of the effectiveness of the company’sinternal control over financial reporting. In addition, the independent registeredpublic accounting firm auditing the Company’s financial statements must attestto and report on management’s assessment and on the effectiveness of theCompany’s internal control over financial reporting.  Our independent registered public accountingfirm provided us with an unqualified report as to our assessment and theeffectiveness of our internal control over financial reporting as of December 31,2004, which report was included in our Annual Report on Form 10-K for theyear ended December 31, 2004. However, we cannot assure investors that management or our independentregistered public accounting firm will be able to provide such an assessment orunqualified report as of future year-ends as required by Section 404 ofthe Sarbanes-Oxley Act of 2002.  In thisevent, investors could lose confidence in the reliability of our financialstatements, which could result in a decrease in the market value of our commonstock.

 

**The market price of our common stock mayexperience extreme price and volume fluctuations.**

 

The marketprice of our common stock may fluctuate substantially due to a variety offactors, including, but not limited to:

 

•              ourability to enter into United States or foreign corporate collaborations for ourDirect SelectTM drug discovery technology and our product candidate, PPI-2458,and the timing and terms of such collaborations;

 

•              thesuccess rate of our discovery efforts, particularly utilizing our DirectSelectTM drug discovery technology, and our clinical trials;

 

•              ourability to identify and complete, and our announcement of, a license or saletransaction for Plenaxis® that would enable commercialization of the product in Europe and otherterritories and result in revenues to us;

 

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•              announcementsregarding the possible delisting of our common stock from the NASDAQ NationalMarket;

 

•              failureor delay by third-party manufacturers in performing their supply obligations ordisputes or litigation regarding those obligations;

 

•              publicconcerns as to the safety of Plenaxis® or our competitors’ products;

 

•              announcementsof technological innovations or new products by us or our competitors;

 

•              adverseoutcomes with respect to the pending purported shareholder class action againstus;

 

•              developmentsor disputes concerning patents or proprietary rights, including claims ofinfringement, interference or litigation against us or our licensors;

 

•              announcementsconcerning our competitors, or the biotechnology or pharmaceutical industry ingeneral;

 

•              changesin government regulation of the pharmaceutical or medical industry;

 

•              actualor anticipated fluctuations in our operating results;

 

•              changesin financial estimates or recommendations by securities analysts;

 

•              salesof large blocks of our common stock;

 

•              changesin accounting principles; and

 

•              theloss of any of our key scientific or management personnel.

 

In addition,the stock market has experienced extreme price and volume fluctuations. Themarket prices of the securities of biotechnology companies, particularlycompanies like ours with limited product revenues and without earnings, havebeen highly volatile, and may continue to be highly volatile in the future.This volatility has often been unrelated to the operating performance ofparticular companies. In the past, securities class action litigation has oftenbeen brought against companies that experience volatility in the market priceof their securities. Whether or not meritorious, litigation brought against uscould result in substantial costs and a diversion of management’s attention andresources.

 

**We expect that our quarterly results ofoperations will fluctuate, and this fluctuation could cause our stock price todecline.**

 

Ourquarterly operating results have fluctuated in the past and are likely to do soin the future. These fluctuations could cause our stock price to decline.  Some of the factors that could cause ouroperating results to fluctuate include:

 

•              thetiming of corporate collaborations relating to our Direct SelectTM drugdiscovery technology and our PPI-2458 program resulting in revenues;

 

•              thetiming of a license or sale transaction relating to Plenaxis®resulting in the commercialization of the product in Europe and otherterritories and in revenues to us; and

 

•              thetiming and level of expenses related to our other research and clinicaldevelopment programs.

 

Due to thepossibility of fluctuations in our revenues and expenses, we believe thatquarter-to-quarter comparisons of our operating results are not a goodindication of our future performance.

 

**Anti-takeover provisions in our charter andby-laws, our rights agreement and certain provisions of Delaware law may makean acquisition of us more difficult, even if an acquisition would be beneficialto our stockholders.**

 

Provisionsin our certificate of incorporation and by-laws may delay or prevent anacquisition of us or a change in our management. Also, because we areincorporated in Delaware, we are governed by

 

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the provisions of Section 203 of theDelaware General Corporation Law, which may prohibit or delay largestockholders, in particular those owning 15% or more of our outstanding votingstock, from merging or combining with us. In addition, the rights issued underour rights agreement may be a substantial deterrent to a person acquiring 10%or more of our common stock without the approval of our board of directors.These provisions in our charter and by-laws, rights agreement and underDelaware law could reduce the price that investors might be willing to pay forshares of our common stock in the future and result in the market price beinglower than it would be without these provisions.

 

**If we engage in an acquisition, we will incura variety of costs and may never realize the anticipated benefits of theacquisition.**

 

Ifappropriate opportunities become available, we may attempt to acquirebusinesses, or acquire or in-license products or technologies, that we believeare a strategic fit with our business. We currently have no commitments oragreements for any acquisitions.  If wedo undertake any transaction of this sort, the process of integrating anacquired business, or an acquired or in-licensed product or technology, mayresult in unforeseen operating difficulties and expenditures and may absorbsignificant management attention that would otherwise be available for theongoing development of our business. Moreover, we may fail to realize theanticipated benefits of any transaction of this sort. To the extent we issuestock in a transaction, the ownership interest of our stockholders will bediluted. Transactions of this kind could also cause us to incur debt, expose usto future liabilities and result in expenses related to goodwill and otherintangible assets.

 

**ITEM 3.   QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

The primary objective of our investmentactivities is to preserve principal while at the same time maximizing theincome we receive from our investments without significantly increasingrisk.  We have not entered into anyinstruments for trading purposes.  Someof the securities that we invest in may have market risk. This means that anincrease in prevailing interest rates may cause the principal amount of theinvestment to decrease. To minimize this risk in the future, we maintain ourportfolio of cash equivalents and short-term investments in a variety ofsecurities, including commercial paper, money market funds and government andnon-government debt securities.  Animmediate hypothetical 100 basis point increase in interest rates would haveresulted in an approximate $0.2 million decrease in the fair value of ourinvestments as of September 30, 2005. The same hypothetical increase in interest rates as of December 31,2004 would have resulted in an approximate $0.2 million decrease in the fairvalue of our investments.  Due to theconservative nature and relatively short duration of our investments, interestrate risk is mitigated. As of September 30, 2005, 100% of our investmentswill mature or reset in one year or less.

 

In July 2000, in connection with thepurchase of our corporate headquarters and research facility in Waltham,Massachusetts, we entered into an acquisition and construction loan agreementproviding for up to $33.0 million in financing at a floating interest rateindexed to 30-day LIBOR.  In July 2003,we exercised the first of two one-year extension options extending the maturitydate of the loan until July 30, 2004. In connection with this extension, we entered into an interest rate capagreement which limited exposure to interest rate increases above a certainthreshold through July 30, 2004.  InJune 2004, the acquisition and construction loan agreement was amended toextend the maturity date of the loan and modify certain other terms of theoriginal agreement.  The interest wasfixed at 5.95% through April 2009 and at a floating rate for the remainderof the term.  Principal and interest werepayable through a fixed monthly payment of approximately $207,000, with theprincipal portion being calculated using a 25-year amortization schedule.  Because of this amendment to the loanagreement, we do not believe that there was a material interest rate risk exposurewith respect to the loan facility through September 30, 2005.

 

On October 18, 2005, we completed thesale of our facility to Intercontinental Real Estate Investment Fund III, LLCfor $51.25 million.  We realizedproceeds, net of fees and expenses, of approximately $50.4 million from thissale, and used approximately $31.6 million of the proceeds to retire theoutstanding loan under the acquisition and construction loan agreement andterminate the mortgage on the facility.

 

35

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**ITEM 4.   CONTROLS AND PROCEDURES.**

 

*(a)*          *Disclosure Controls and Procedures*.

 

The Company’s management, with theparticipation of our chief executive officer and chief financial officer, hasevaluated the effectiveness of the Company’s disclosure controls and procedures(as defined in Rules 13a-15(e) or 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”)) as of September 30,2005.  Based on such evaluation, ourchief executive officer and chief financial officer have concluded that, as of September 30,2005, the Company’s disclosure controls and procedures were effective inensuring that information required to be disclosed by the Company in thereports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in applicable rules andforms of the Securities and Exchange Commission, and is accumulated andcommunicated to the Company’s management, including the Company’s chiefexecutive officer and chief financial officer, as appropriate to allow timelydecisions regarding required disclosure.

 

*(b)**          Changesin Internal Control Over Financial Reporting*.

 

There have not been any changes in theCompany’s internal control over financial reporting (as such term is defined inRules 13a-15(f) and 15d-15(f) under the Exchange Act) during thethree months ended September 30, 2005 that have materially affected, orare reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

36

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**PART II. OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS.**

 

In December 2004 and January 2005,the Company, Chairman and (now former) Chief Executive Officer Malcolm Gefter,President and (now former) Chief Operating Officer Kevin F. McLaughlin, ChiefFinancial Officer and Treasurer Edward C. English, and former President andChief Operating Officer William K. Heiden, were named as defendants in threepurported class action securities lawsuits filed in the United States DistrictCourt for the District of Massachusetts. Those purported class actions are captioned Katz v. PraecisPharmaceuticals Inc., Malcolm Gefter, Kevin McLaughlin, Edward English andWilliam K. Heiden, Civil Action No. 04-12581-GAO (filed December 9,2004), Schwartz v. Praecis Pharmaceuticals Inc., Malcolm Gefter, KevinMcLaughlin, Edward English and William K. Heiden, Civil Action No. 04-12704-REK(filed December 27, 2004) and Bassin v. Praecis Pharmaceuticals Inc.,Malcolm L. Gefter, Ph.D., Kevin F. McLaughlin, Edward C. English and William K.Heiden, Civil Action No. 05-10134-GAO (filed January 21,2005).  The complaints generally allegesecurities fraud during the period from November 25, 2003 through December 6,2004.  Each of the complaints purports toassert claims under Sections 10(b) and 20(a) of the Securities andExchange Act of 1934 and Rule 10b-5 promulgated thereunder, and allegesthat the Company and the individually named defendants made materially falseand misleading public statements concerning the Company’s business andfinancial results, particularly relating to statements regarding thecommercialization of Plenaxis®.

 

On February 7, 2005, a motion was filedto consolidate the Katz, Schwartz and Bassin actions andto appoint lead plaintiffs and lead counsel. On February 18, 2005, the Company and the individual defendantsfiled a brief response to that motion, reserving their rights to challenge theadequacy and typicality, among other things, of the proposed lead plaintiffs inconnection with class certification proceedings, if any.  On April 13, 2005, the Court entered anOrder granting the plaintiffs’ motion to consolidate the three actions (as wellas each case that relates to the same subject matter that may be subsequentlyfiled in or transferred to the United States District Court for the District ofMassachusetts), appoint lead plaintiffs and approve such plaintiffs’ selectionof co-lead counsel.  The consolidatedactions are captioned IN RE PRAECIS PHARMACEUTICALS, INC. SECURITIESLITIGATION, Civil Action No. 04-12581-GAO.  On August 1,2005, lead plaintiffs filed a consolidated amended complaint.  On September 12, 2005, the Company andthe individual defendants filed a Motion to Dismiss the consolidated amendedcomplaint.  On October 24, 2005,lead plaintiffs filed an Opposition to the Motion to Dismiss.  At this time, plaintiffs have notspecified the amount of damages they are seeking in the actions.

 

Management believes that the allegationsagainst the Company are without merit, and the Company intends to vigorouslydefend against the plaintiffs’ claims. As this litigation is in an early stage,management is unable to predict its outcome or its ultimate effect, if any, onthe Company’s financial condition.  However, we expect that the costs andexpenses related to this litigation may be significant.  Our current director and officer liabilityinsurance policies (which, subject to the terms and conditions thereof, also provide“entity coverage” for the Company for this litigation) provide that the Companyis responsible for the first $2.5 million of such costs and expenses.  Also, a judgment in or settlement of theseactions could exceed our insurance coverage. If we are not successful indefending these actions, our business and financial condition could beadversely affected.  In addition, whetheror not we are successful, the defense of these actions may divert the attentionof our management and other resources that would otherwise be engaged in runningour business.

 

**ITEM 6. EXHIBITS.**

 
| **Exhibit  Number** | ** ** | **Exhibit**                                               |
|---------------------|------------|-----------------------------------------------------------|
|                |       |                                                      |
| 3.1                 |       | Amended and Restated Certificate of  Incorporation (2)    |
|                |       |                                                      |
| 3.2                 |       | Certificate of Amendment (effecting reverse  stock split) |
|                |       |                                                      |
| 3.3                 |       | Third Amended and Restated By-Laws (5)                    |

 

37

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| **Exhibit  Number** | ** ** | **Exhibit**                                                                                                                                                                                |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                       |
| 4.1                 |       | Specimen certificate representing shares of  common stock (1)                                                                                                                              |
|                |       |                                                                                                                                                                                       |
| 4.2                 |       | Specimen certificate representing shares of  common stock (including Rights Agreement Legend) (3)                                                                                          |
|                |       |                                                                                                                                                                                       |
| 4.3                 |       | Specimen certificate representing shares of  common stock (post-reverse stock split)                                                                                                       |
|                |       |                                                                                                                                                                                       |
| 4.4                 |       | Rights Agreement between the Registrant and  American Stock Transfer & Trust Company, as Rights Agent (4)                                                                         |
|                |       |                                                                                                                                                                                       |
| 4.5                 |       | Form of Certificate of Designations of  Series A Junior Participating Preferred Stock (attached as Exhibit A  to the Rights Agreement filed as Exhibit 4.4 hereto) (4) |
|                |       |                                                                                                                                                                                       |
| 4.6                 |       | Form of Rights Certificate (attached  as Exhibit B to the Rights Agreement filed as Exhibit 4.4 hereto)  (4)                                                                |
|                |       |                                                                                                                                                                                       |
| 10.1                |       | Real Estate Purchase Agreement dated as of October 11,  2005 between 830 Winter Street LLC and Intercontinental Real Estate  Investment Fund III, LLC                                 |
|                |       |                                                                                                                                                                                       |
| 10.2                |       | Lease by and between Intercontinental Fund  III 830 Winter Street LLC and the Registrant dated October 18, 2005                                                                       |
|                |       |                                                                                                                                                                                       |
| 31.1                |       | Certification of Chief Executive Officer                                                                                                                                                   |
|                |       |                                                                                                                                                                                       |
| 31.2                |       | Certification of Chief Financial Officer                                                                                                                                                   |
|                |       |                                                                                                                                                                                       |
| 32.1                |       | Certification of Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002                              |
|                |       |                                                                                                                                                                                       |
| 32.2                |       | Certification of Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002                              |

 

----

(1)           Incorporatedby reference to Registration Statement on Form S-1 (Registration No. 333-96351)initially filed with the Securities and Exchange Commission on February 8,2000 and declared effective on April 26, 2000.

 

(2)           Incorporatedby reference to Quarterly Report on Form 10-Q for the quarter ended March 31,2000 filed with the Securities and Exchange Commission on June 7, 2000.

 

(3)           Incorporatedby reference to Registration Statement on Form S-1 (Registration No. 333-54342)initially filed with the Securities and Exchange Commission on January 26,2001 and declared effective on February 14, 2001.

 

(4)           Incorporatedby reference to Registration Statement on Form 8-A filed with theSecurities and Exchange Commission on January 26, 2001.

 

(5)           Incorporatedby reference to Annual Report on Form 10-K for the year ended December 31,2002 filed with the Securities and Exchange Commission on March 19, 2003.

 

38

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**SIGNATURE**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, as amended, theRegistrant has duly caused this report to be signed on its behalf by theundersigned hereunto duly authorized.

 
|                         | PRAECIS  PHARMACEUTICALS INCORPORATED |
|------------------------------|---------------------------------------|
|                         |                                  |   |
|                         |                                  |   |
| Date:  November 4, 2005 | By                                    | /s/  Edward C. English |   |
|                         |                                  | Edward  C. English |
|                         |                                  | Chief  Financial Officer, Vice President, |
|                         |                                  | Treasurer  and Assistant Secretary |
|                         |                                  | *(Duly  Authorized Officer and Principal Financial  and Accounting Officer)* |

 

39

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# **EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Exhibit**                                                                                                                                                                                |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                       |
| 3.1                 |       | Amended and Restated Certificate of  Incorporation (2)                                                                                                                                     |
|                |       |                                                                                                                                                                                       |
| 3.2                 |       | Certificate of Amendment (effecting reverse  stock split)                                                                                                                                  |
|                |       |                                                                                                                                                                                       |
| 3.3                 |       | Third Amended and Restated By-Laws (5)                                                                                                                                                     |
|                |       |                                                                                                                                                                                       |
| 4.1                 |       | Specimen certificate representing shares of  common stock (1)                                                                                                                              |
|                |       |                                                                                                                                                                                       |
| 4.2                 |       | Specimen certificate representing shares of  common stock (including Rights Agreement Legend) (3)                                                                                          |
|                |       |                                                                                                                                                                                       |
| 4.3                 |       | Specimen certificate representing shares of  common stock (post-reverse stock split)                                                                                                       |
|                |       |                                                                                                                                                                                       |
| 4.4                 |       | Rights Agreement between the Registrant and  American Stock Transfer & Trust Company, as Rights Agent (4)                                                                         |
|                |       |                                                                                                                                                                                       |
| 4.5                 |       | Form of Certificate of Designations of  Series A Junior Participating Preferred Stock (attached as Exhibit A  to the Rights Agreement filed as Exhibit 4.4 hereto) (4) |
|                |       |                                                                                                                                                                                       |
| 4.6                 |       | Form of Rights Certificate (attached  as Exhibit B to the Rights Agreement filed as Exhibit 4.4 hereto)  (4)                                                                |
|                |       |                                                                                                                                                                                       |
| 10.1                |       | Real Estate Purchase Agreement dated as of October 11,  2005 between 830 Winter Street LLC and Intercontinental Real Estate  Investment Fund III, LLC                                 |
|                |       |                                                                                                                                                                                       |
| 10.2                |       | Lease by and between Intercontinental Fund  III 830 Winter Street LLC and the Registrant dated October 18, 2005                                                                       |
|                |       |                                                                                                                                                                                       |
| 31.1                |       | Certification of Chief Executive Officer                                                                                                                                                   |
|                |       |                                                                                                                                                                                       |
| 31.2                |       | Certification of Chief Financial Officer                                                                                                                                                   |
|                |       |                                                                                                                                                                                       |
| 32.1                |       | Certification of Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002                              |
|                |       |                                                                                                                                                                                       |
| 32.2                |       | Certification of Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002                              |

 

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(1)   Incorporatedby reference to Registration Statement on Form S-1 (Registration No. 333-96351)initially filed with the Securities and Exchange Commission on February 8,2000 and declared effective on April 26, 2000.

 

(2)   Incorporatedby reference to Quarterly Report on Form 10-Q for the quarter ended March 31,2000 filed with the Securities and Exchange Commission on June 7, 2000.

 

(3)   Incorporatedby reference to Registration Statement on Form S-1 (Registration No. 333-54342)initially filed with the Securities and Exchange Commission on January 26,2001 and declared effective on February 14, 2001.

 

(4)   Incorporatedby reference to Registration Statement on Form 8-A filed with theSecurities and Exchange Commission on January 26, 2001.

 

(5)   Incorporatedby reference to Annual Report on Form 10-K for the year ended December 31,2002 filed with the Securities and Exchange Commission on March 19, 2003.

 

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